The global economic outlook might be dim, but you wouldn’t know it by looking at stocks in the resources sector.
Since early summer, stocks in the mining, coal and steel industries have largely stabilized and, in some cases, delivered outstanding gains. Investors who are focusing on the one- or two-year returns for this group therefore might be missing an important signal: While many of these stocks remain miles below their 52-week highs, they also have stopped going down.
Steel stocks are a prime example. Since June 1, the Market Vectors Steel Index Fund (NYSE:SLX) has gained 10.2%, led by ArcelorMittal (NYSE:MT, +19.2%) and US Steel (NYSE:X, +13.3%). The S&P 500 Index has tacked on 11% in this same interval, so the steel sector has provided returns that are at least competitive with the broader market. In contrast, the two-year return for SLX is still -32.9%, an astounding 47 percentage points behind the 15.9% gain for the S&P 500.
The story is similar in coal, though the returns are lower thanks to the higher degree of regulatory risk. While the Market Vectors-Coal ETF (NYSE:KOL) has underperformed in the six-month time frame, it has eked out a gain against the S&P in the past three months, returning 3.2% vs. -1.4% for the index. Among the individual stock winners in this interval have been Peabody Energy (NYSE:BTU, +13.7%) and Alpha Natural Resources (NYSE:ANR, +20.1%).
Outside of coal and steel, other key mining-related shares have begun to show signs of emerging from their downward spiral. BHP Billiton (NYSE:BHP) has surged 21.6% since June 1, while Southern Copper (NYSE:SCCO) — which saw its market cap cut in half in the first nine months of 2011 — has rocketed 42.5%. Alcoa (NYSE:AA) continues to lag, but it’s nonetheless in positive territory with a gain of 3.2% in the past six-plus months — a far cry from its 48% decline in the prior 12-month period.
China, Valuations Driving the Improvement
While the general mining sector isn’t out of the woods yet, two key factors have led to the stabilization in performance.
First is the improved outlook for China, where investor fears of a potential “hard landing” have given way to the realization that economic growth, while unlikely to match its pace of the previous decade, will at least remain in positive territory. On this front, it’s notable that iShares Trust FTSE China 25 Index Fund (NYSE:FXI) has surged 20.5% since June 1. Given that steel, coal and other industrial metals shares tend to track FXI over time, this might indicate an opportunity for positive mean reversion in the year ahead.
The second factor working in favor of this group has been valuation. While resource-stock P/E’s have jumped in the past few weeks, the sector has been trading at extremely low valuations all year. As of Oct. 31, for instance, the trailing P/E on the SLX was 9.1, while the KOL portfolio was changing hands at just 10.8. All it took was a whiff of good news — in this case, improving data in China — to spark a rally from these levels.
These groups remain a very high-risk play, even more so now than they were a month or two ago since their shares are beginning to price in a China recovery that might not necessarily materialize. In the event of a broader market selloff or unexpected bad news out of China, coal, steel and other troubled materials stocks could trade back down to their lows for the year.
Investors might therefore be better off waiting for a pullback, since it rarely pays to chase rallies in stocks that have been getting pounded for as long as this group has.
Still, the one-year charts in the resources group are looking better with each passing day. BHP, Rio Tinto (NYSE:RIO) and Teck Resources (NYSE:TCK) have all moved above their 200-day moving averages, while Alcoa, KOL, SLX and countless others are closing in on theirs.
The SPDR S&P Metals & Mining ETF (NYSE:XME) — which aggregates the entire group into a single fund but leaves out the ADRs — closed Monday just short of its 200-day. Keep a close eye on this one in the weeks ahead: If XME and other names in this group can climb off of their current bases and sustain a move above their 200-day MAs, it will be the clearest sign yet that these longstanding value traps finally represent an opportunity.
As of this writing, Daniel Putnam did not hold a position in any of the aforementioned securities.