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For Mining Stocks, Rock Bottom Is Near

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Mining companies have suffered from a selloff recently, but are set to return to favor with a number of analysts recommending buying after recent losses.

The sector has fallen out of favor as worries about growth in China have dampened prices for metals such as copper and iron ore. This wasn’t helped by mining giant Rio Tinto reporting worse-than-expected falls in iron ore and copper production for the first quarter of 2012, which it blamed on weather conditions.

Valuations (measured by share price to earnings) are approaching levels last seen in the first quarter of 2009, when the industry was plagued by questions about how it would fund further mining and exploration as credit lines threatened to dry up and some companies looked at risk of breaching their banking covenants.

There is also the growing threat of resource nationalism, shown in Argentina moving to seize control of YPF, part-owned by Spanish energy company Repsol. The cost of oil is also hiking the cost of production across the board.

With the Stoxx Europe 600 Basic Resources close to 20 percent lower than its recent highs, analysts at Deutsche Bank believe it is time to buy on weakness in the sector. They argue that the index usually pulls back by about 15 percent to 25 percent during its bull market declines, which suggests that it is now close to the bottom.

“Natural resources have lagged other sectors such as autos and chemicals which already had good recoveries in earnings momentum. Miners earnings are showing early signs of troughing,” they wrote in a research note.

Worries about growth in China, now the world’s biggest economy and one of its fastest-growing markets for resources such as metals and coal, are overdone, according to Deutsche Bank. The analysts recommend buying Rio, or September options on the Mining and Basic Resources Index, to give time for the sector to rally.

Andrew Latto, senior analyst at Fat Prophets, points out that iron ore prices and copper prices holding up well. Fat Prophets recommends buying Rio as well as BHP Billiton and Anglo American, and has a hold recommendation on Xstrata, which is in the process of being taken over by commodities trader Glencore in one of the biggest London-based mergers of recent years.

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“The key concern for the market is the Chinese numbers. It’s slowing down, there’s no question of that, but it looks to be a measured slowdown and long term we’re seeing very strong demand growth for key commodities,” he told “Squawk Box Europe.”

“Broadly, the miners are a better strategy now (than commodities),” he said. “The major miners are investing for growth and that’s going to drive profits, whereas you could see a situation where the commodities themselves remain at elevated levels without substantial further gains.”

His top pick is BHP, as he argues that its energy assets give it a hedge against the continuing strong oil price, while other miners will have to absorb the added cost of production.

The cautious dividend policy pursued by some of the larger miners has led to suggestions that they could return more money to shareholders, although Latto advocates a more careful approach.

“It’s a cyclical sector and miners are going to be conservative. You’re going to see the gains in the long term and I think they’re correct in being conservative on dividends as investors don’t like dividend cuts,” he said.

Additional News: Inflation Is Hurting Chinese Miners

Additional Views: Don’t Exit Mining Stocks on Weak Aussie Trade Data: Pro

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Disclosures:

Andrew Latto does not own any of the shares mentioned in this story. Deutsche Bank owns shares in Rio Tinto and has been paid fees by it in the past year.

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