Will Mining Stocks Beat the Market?

BHP Billiton's announcement that China's resource demand was slowing had a negative impact on mining stocks.

The past year has been a rough ordeal for nearly every sector of the market, but the metals and mining industry seemed to be battered on all fronts, despite previous run-ups in commodity prices across the board.  As if a stalled economic recovery on a global scale and a debt crisis in Europe were not enough, the industry was beset by earthquakes, flooding, and political maneuverings that prevented it from outperforming the S&P 500 index over the previous two-year period.

When Australia’s BHP Billiton Ltd. (Stock Profile – ASX:BHP & NYSE:BHP), the world’s number one miner, recently cautioned that China’s steel growth rates “will flatten, and they have flattened”, a shudder went through the industry.  When the word came down that the legislature in Australia finally passed a controversial mining tax after two years of near “bare-fisted” brawls over the issue, the shudder became a panic.  Mining stocks fell immediately, after several positive months of appreciation.

Setbacks are to be expected from time to time, but are mining stocks poised for additional growth in 2012?  BHP did temper its comments by stating that prices will hold up over the medium term and that only in 2025 will it “soften markedly.”  China dominates the demand side of the equation for nearly every commodity produced.  Their share of global iron ore shipments is almost 50%, while other metal shares are as follows: copper (38%), coal (47%), nickel (36%), lead (44%), and zinc (41%).

The immediate market “correction” may have been an overreaction, but to assess future prospects, let’s first take a look at past performance:

Past performance of mining ETFs and the S&P 500.

The S&P 500 index bettered both ETF “proxies” for the mining industry, while Gold and Silver benefited from risk-averse investor buying for most of 2011 until an extended consolidation period commenced. Silver has replaced Gold as the top-return achiever, nearly compounding in value at a 50% per year clip.  A resumption of appreciation trends will depend on a number of factors, but any semblance of real sustained economic activity on a global scale will generate a quick dose of demand.

The mining industry usually suffers from an over supply of materials, but if the comment from BHP is to be believed, then general pricing levels will hold for the next few years, allowing mining executives to focus on development projects with expectations that demand support will not materially decline.  The mining industry, however, has a number of challenges that stand in its way.  Addressing the following issues will be necessary to jumpstart growth and earnings in the foreseeable future:

  • With commodity prices at all time highs, mining executives have moved to accelerate production projects.  The issue, however, is that costs have also escalated, whether from labor, new taxes, or extraction techniques.  Cost management will be a critical priority;
  • Demand demographics in emerging markets, especially China and India, are far from transparent.  When BHP confirmed slackening China import demand, the market was quick to react.  Commodity pricing may be more chaotic than stable going forward;
  • Capital expenditures are rising quickly, but there is a talent and skills “gap” that could restrain the growth engine from ever getting out of the gate.  New approaches are needed to make assignments in remote locations more attractive to workers;
  • Despite excess cash on mining firm balance sheets, finding adequate financing in today’s more risk-averse environment will prove to be difficult.  Better relationships in foreign markets will be the key.

Challenges abound, but the reality is that commodities will be in short supply.  At some point, the fundamentals are anticipated to propel the industry forward ahead of the pack.

By Tom Cleveland.

Tom Cleveland writes for ForexTraders.com and has an engineering degree and extensive business background. The information herein has been provided to MiningFeeds.com by the author and, as such, is subject to our disclaimer: CLICK HERE.

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