Bull Market? Not for Mining Stocks

by Daniel Putnam | March 6, 2013 1:23 pm

Bull Market? Not for Mining Stocks

While the rest of the world has on their party hats in honor of the Dow Jones‘ record high, investors in mining stocks have been stuck on the outside looking in.

The simple equation is this: If a company’s business involves pulling solid materials out of the ground, its stock has been going in the opposite direction of the broader indices so far this year — and in a big way. Even as the S&P 500 Index has rocketed to a year-to-date gain of 8.3%, the SPDR S&P Metals & Mining ETF (NYSE:XME[1]) has shed 12.8%.

xme Bull Market? Not for Mining Stocks[2]

The key driver of this underperformance has, of course, been the news flow out of China. Even though the country retained its target for 7.5% growth in 2013, weaker recent economic data and growing concerns about the property bubble — highlighted by last weekend’s 60 Minutes report — are causing investors to ratchet down their expectations for commodity demand. China also announced new steps to cool its property market on late Friday — news that was followed by weaker-than-expected reports regarding the country’s factory growth and services sector.

Lacking incremental demand from China, commodities are under pressure from the weak growth in the rest of the world. Not coincidentally, Deutsche Bank predicted earlier this week that iron ore prices would slide another 24% by year-end.

The result has been a decline in the prices of industrial metals, as illustrated by the 7.4% loss in PowerShares DB Base Metals Fund (NYSE:DBB[3]) since Feb. 1. And keep in mind, this has occurred during a time of massive monetary easing by the world’s central banks.

Precious metals have done little better, and in this case the culprit is not just slowing demand but also the rising U.S. dollar. Year-to-date, the SPDR Gold Shares (NYSE:GLD[4]) and iShares Silver Trust (NYSE:SLV[5]) have lost 6% and 5.5%, respectively.

These developments have had a major impact on the company level. Last week, the Brazilian iron ore miner Vale (NYSE:VALE[6]) announced a quarterly loss of $2.6 billion — well below expectations — and slashed its dividend. This isn’t an isolated event: Rio Tinto (NYSE:RIO[7]), Cliffs Natural Resources (NYSE:CLF[8]) and BHP Billiton (NYSE:BHP[9]) have all announced disappointing results in recent weeks.

In the coal space, Peabody Energy (NYSE:BTU[10]) — which is heavily dependent on exports to China — is off 16.7% since the start of February. A look at the company’s earnings estimates shows why: In the past 90 days, the consensus estimate for the June quarter has fallen from 43 cents to 3 cents, while full-year 2013 estimates have dropped from $1.96 to 41 cents. The broader sector, as measured by Market Vectors Coal ETF (NYSE:KOL[11]), has dropped 8.7%.

Gold and silver miners, meanwhile, have been walloped from the combination of falling output prices and rising input costs. The Market Vectors Gold Miners ETF (NYSE:GDX[12]) is down 22.6% year-to-date, while Global X Silver Miners ETF (NYSE:SIL[13]) has cratered 22.2%. Notable losers include the South African gold miners AngloGold Ashanti (NYSE:AU[14]) and Randgold Resources (NYSE:GOLD[15]), down 25.3% and 17.8%, and in the silver space, First Majestic Silver (NYSE:AG[16]) and Hecla Mining (NYSE:HL[17]), off 24.8% and 31.2%.

With such awful return numbers, are there values anywhere to be found in these groups? Perhaps.

The past year has brought a cycle of worry and renewed hope when it comes to China’s economy, and previous rallies in the dollar have proven short-lived. As a result, there will continue to be plenty of trading opportunities in this space. For now, the best approach is to use weakness in these sectors to take advantage of bounces, employing tight stops and selling once 5% to 10% gains are in the books.

This said, it should be noted that mining stocks’ poor performance has occurred amid pronounced strength in the rest of the market. If the rally begins to run out of steam in the second quarter, as has been the case in each of the past three years, it’s extremely unlikely that the resources group will be able to gain any traction.

Also, as long as China continues to put up weak economic numbers — a trend that could continue after last week’s measures to curb the property market — mining stocks are likely to remain under pressure. With 1% to 2% growth in other major global economies, commodities need China’s demand to stay high to keep inventories in check. Without it, the trend of falling earnings estimates will continue — and in this scenario, the low valuations of the stocks in this group aren’t going to matter.

The takeaway: Be ready to capitalize on trading opportunities, but don’t let the valuations fool you: Until China exhibits a sustainable recovery and/or the miners begin to break out from their longstanding bases, this remains a dangerous place to invest.

As of this writing, Daniel Putnam did not hold a position in any of the aforementioned securities.

Endnotes:
  1. XME: http://studio-5.financialcontent.com/investplace/quote?Symbol=XME
  2. [Image]: http://investorplace.com/wp-content/uploads/2013/03/xme.gif
  3. DBB: http://studio-5.financialcontent.com/investplace/quote?Symbol=DBB
  4. GLD: http://studio-5.financialcontent.com/investplace/quote?Symbol=GLD
  5. SLV: http://studio-5.financialcontent.com/investplace/quote?Symbol=SLV
  6. VALE: http://studio-5.financialcontent.com/investplace/quote?Symbol=VALE
  7. RIO: http://studio-5.financialcontent.com/investplace/quote?Symbol=RIO
  8. CLF: http://studio-5.financialcontent.com/investplace/quote?Symbol=CLF
  9. BHP: http://studio-5.financialcontent.com/investplace/quote?Symbol=BHP
  10. BTU: http://studio-5.financialcontent.com/investplace/quote?Symbol=BTU
  11. KOL: http://studio-5.financialcontent.com/investplace/quote?Symbol=KOL
  12. GDX: http://studio-5.financialcontent.com/investplace/quote?Symbol=GDX
  13. SIL: http://studio-5.financialcontent.com/investplace/quote?Symbol=SIL
  14. AU: http://studio-5.financialcontent.com/investplace/quote?Symbol=AU
  15. GOLD: http://studio-5.financialcontent.com/investplace/quote?Symbol=GOLD
  16. AG: http://studio-5.financialcontent.com/investplace/quote?Symbol=AG
  17. HL: http://studio-5.financialcontent.com/investplace/quote?Symbol=HL

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