Mining Stocks Primed for a Comeback as Prices Recover

Shares of mining giants may have slumped this year on falling demand from China and as investors shun assets but they may be due for a bounce.

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Stocks such as BHP Billiton and Rio Tinto are now looking attractive after declining almost 11 percent and 9.7 percent respectively in Sydney, and 5 percent and 6.7 percent in London this year, analysts tell CNBC. Prices will be supported by a combination of faster growth for China, the world’s biggest consumer of commodities, and robust output from miners in the second quarter, which they say will lift metal prices by the end of the year, if not the third quarter.

“I think most of the negative outlook for commodity prices is factored in to the stocks,” Hayden Bairstow, Head of Australian Resources Research at CLSA told CNBC. “Production should be strong across the sector, which should provide a near-term boost. We see value in BHP and believe Rio is probably closer to fair value at current levels.”

On Wednesday, BHP Billiton said that iron ore output at the world’s biggest miner rose 15 percent from a year ago and that total output for financial year 2013 may rise 5 percent. The report came a day after Rio Tinto said its output of iron ore, which makes up 80 percent of its earnings, was flat in the June quarter from a year ago, while sales fell slightly short of output.

Australia’s third biggest iron ore miner producer Fortescue Metals Group also reported production figures on Tuesday, which showed a 54 percent jump in output for the June quarter to 19.2 million metric tons from a year earlier, and analysts told CNBC that they are encouraged by these output figures.

“Fortescue's production result was very solid both in terms of tonnage mined and average costs of production,” Ric Spooner, Chief Market Analyst at CMC Markets Asia Pacific in Sydney, said. “Similar results from BHP and Rio could easily see buying at current levels.”

He said investors should start looking at these big miners because current valuations have already priced in “significantly lower long-term prices” for most of the major commodities.

Lower Metal Prices Ahead, But Reaching Bottom

Analysts also believe that China’s slowdown may have reached its nadir in the second quarter. Although Barclays Equity Research had slashed its forecast for metal prices last week to reflect weaker demand, it expects a pickup towards the end of the year because of recent pro-growth rhetoric and policies from the Chinese government.

“We think iron ore prices in the very short term is going through a soft patch but as the effects of the interest rate cuts in China come through, especially at the end of the third quarter, early fourth quarter, we could see prices rise,” Ephrem Ravi, Head of Metals & Mining Sector at Barclays, told CNBC Asia’s“Squawk Box”on Wednesday.

He also believes that the June lows of most commodity prices were probably “too low”, considering there’s no deterioration in the economic situation in Europe. Iron ore with 62-percent iron content, for example, is now trading at $130.10 a metric ton on Monday, based on data from the Steel Index. It was trading at $180 a metric ton last year.

While Barclays had slashed estimates for zinc by 11 percent, nickel by 10 percent, aluminum by 7 percent and copper by 5 percent, it said it will be the last set of downgrades for a while.

The British bank also slashed price targets and earnings estimates for both BHP and Rio Tinto, along with Anglo-American, but it retained ‘overweight’ rating for the two miners.

“We are buyers into the weakness of both BHP and Rio Tinto,” Ravi said. “Of the two, we have a slight preference for BHP because although the target price is lower in terms of the upside, it is also a lower risk in this kind of environment. Rio with its huge iron-ore exposure is clearly more risky.”

Ravi said he would wait “a month or two for a better entry point”. The bank has a 12-month target of 2300 pence ($35.95) for BHP’s stock in London and 3900 pence ($61) for Rio, representing upside of about 28 percent and 31 percent.

- By CNBC's Jean Chua.