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Mining Stocks Are About to Get Buried

The end of a 'supercycle' is bad for base and precious metals


There’s talk of a rally in gold prices right now, and the threat of long-term inflation hidden in the economic data. As a result, some investors may think that miners would be looking up as both base and precious metals could be given a boost.

Fat chance.

The Market Vectors Gold Miners ETF (NYSE:GDX) is off almost 9% vs. a 7% rally for the Dow Jones Industrial Average year-to-date. Top decliners in this fund include Barrick Gold (NYSE:ABX), Goldcorp (NYSE:GG) and Newmont Mining (NYSE:NEM).

The small and midcap miners are equally battered, with the Market Vectors Junior Gold Miners ETF (NYSE:GDXJ) off almost 14% since Jan. 1, led by declines in top holdings Silvercorp Metals (NYSE:SVM) and Rubicon Minerals (NYSE:RBY).

It’s not just precious metals either. The SPDR International Materials ETF (NYSE:IRV) includes base metal companies and is also in the red year-to-date. Major holdings there include diversified miners BHP Billiton (NYSE:BHP) and Rio Tinto (NYSE:RIO). Both are down on the year.

What gives? Well, as the Financial Times recent wrote, it’s the end of a “supercycle” in commodity stocks like miners. The gist is that years of surging Chinese demand are tapering off, while the supply side is improving as previous constraints caused by past under-investment are offset.

“Underlying earnings before interest, tax, depreciation and amortisation — a proxy for cash flow — fell between 20 and 40 per cent from the second half of last year to the first half of this year” for the sector, according to the FT post. It then adds, “Some miners’ first-half cash flows did not cover their capital expenditure and dividends.”

Not good.

The rising debt due to mining investment and shrinking earnings as commodity prices soften will likely persist. Thus miners have reduced their spending on projects this year to both save costs and put a floor under prices.

Diversified miners like BHP will likely weather this storm the best because of their . .. well … diversification. BHP Billiton has its fingers in iron ore, coal, copper and aluminum on the base metals front, also operates an energy segment and even produces potash for fertilizer.

Another defensive miner could be Vale (NYSE:VALE), which produces iron ore, manganese, nickel, copper and aluminum along with fertilizers.

But any way you slice it, mining is in for a rough short-term as the “supercycle” ends. Be aware of this before you go bargain hunting or dividend chasing.

Jeff Reeves is the editor of InvestorPlace.com and the author of “The Frugal Investor’s Guide to Finding Great Stocks.” Write him at editor@investorplace.com or follow him on Twitter via @JeffReevesIP. As of this writing, he did not own a position in any of the stocks named here.

Article printed from InvestorPlace Media, http://investorplace.com/2012/08/mining-stocks-are-about-to-get-buried/.

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