Mining shares could be set to rally in 2019 and 2020, after “a year of stagnation” over the past 12 months, according to BlackRock’s Evy Hambro.
Miner companies across the globe have undergone a quite remarkable transformation since the commodity bear market of 2014 and 2015 and are in much better shape today, he insists. Meanwhile, the wider commodity market remains “completely normal”.
“What’s not normal is the equity prices,” laments Hambro, co-manager of BlackRock World Mining (BRWM). “They are just so far away from the fundamentals it’s extraordinary.”
After five years in the doldrums, 2016 and 2017 marked a bounce back for the trust, with gains of 100% and 25% respectively. But 2018, the 25th year since inception, has been tricky. The trust has lost over 13% in the year to 29 November, which puzzles Hambro.
“We had conservative expectations that 2018 would be yet another good year,” he admits, “so it’s obviously disappointing to be sitting here today with a negative return.” However, Hambro sees this as “a point of huge opportunity because valuations are so depressed”.
Hambro’s co-manager, Olivia Markham, formerly worked in the merger and acquisition department at miner BHP Billiton (BLT), during a time of huge consolidation in the industry. Back then, she says, it was all about growth.
“It was all about market share, being the biggest company possible. There was very little discussion around what value we were creating for shareholders,” she explains.
That continued to be true for a long time afterwards, until commodity prices slumped thanks to rising production and falling demand. Past excesses meant mining companies struggled and share prices followed the oil price fall.
In December 2015, the big miners had a net debt/earnings before tax of around 4 times. Three years on, the picture’s looking much better. The net debt/earnings before tax stands at about 0.5 times and the companies are buying back shares and paying out healthy dividends with that extra cash.
Companies are now much more disciplined in how they allocate capital. They’re more cognisant of building at the same time as others, so they’re not overpaying for engineers and other labour, Hambro says.
But sentiment remains extremely depressed. Of course, previous management failings contribute hugely to that. “People just don’t believe that this change is sustainable,” adds Markham.
There are other pressures, though. The US-China trade war hasn’t helped, with both countries key cornerstones of the market. The strength of the US dollar this year has been another key headwind. Most commodities are dollar denominated, so when the greenback is on the up, they become more expensive and demand wanes.
Is Another Commodities Bear Market Imminent?
So, are we about to experience another commodity bear market, particularly in the light of the wider market correction seen in the fourth quarter of 2018? Markham thinks this is unlikely: “The mining sector went through its correction only two years ago.”
Hambro agrees, adding: “We’re approaching three years away from that low point; a typical commodity cycle is four or five years. And in every commodity up-cycle you have a year of stagnation, which we’re probably in now.”
With firms now in a better place than they have been for a long time, a resolution to the US-China situation would only provide upside for share prices. We saw a potential thawing of relations at the G20 meeting this weekend.
Should interest rates not rise as much as is generally expected, as Fed Governor Jerome Powell suggested recently, dollar strength could reverse, too.
Then, there’s new commodities that could be set to take off, particularly with the looming mass adoption of electric vehicles on the horizon – and much sooner than many believe, according to Hambro.
“My hope,” Hambro asserts, “is that you will have a higher rate of return, made up with better quality and a lower level of risk. The output of that should be a higher multiple.
“What we are seeing today is that shares are trading at a lower multiple than they have done historically. Therefore, the room for even a partial re-rating would deliver a substantial change in share prices.”
