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Cool commodities? Mining stocks back in vogue
Bashed, beaten and unloved, mining stocks have fallen out of favor with investors in the last two years as commodity prices showed signs of peaking. But just when things could have turned from bad to worse it appears that the basic resources sector is the new contrarian play for 2014.
Nothing sums up the change in opinion better than JPMorgan's assessment of the situation in a research note on Monday. Detailing a rebound in activity, the U.S. investment bank has stated it is now "overweight" on the mining sector, after being "underweight" for the last two years.
"We believe the risk-reward for miners is improving," a European equity strategy team led by Mislav Matejka said in a note on Monday. "We have been structurally cautious on miners for nearly three years, but believe one should be reversing that stance now."
Read More 2014 a good year for commodity bulls, so far
The basic resources sector (STOXX:.SXPP) added 2 percent on Monday with this bullish outlook adding to positive data coming out of China. U.K.-listed Rio Tinto (London Stock Exchange: RIO-GB) climbed 3.2 percent by midday with JPMorgan adding it to its list of top picks with BHP Billiton (London Stock Exchange: BLT-GB) rising 2.3 percent for the same reason.
Figures last week showed China's official factory activity number picked up slightly in April, creeping up to 50.4 last month from 50.3 in March - rising further above the 50-point mark that separates expanding activity from a contraction. This gave rise to further suggestions that the world's second-largest economy is beginning to stabilize. Matejka believes that the data were strong and showed a robust figure for commodity imports. He added that growth-supportive measures by the Chinese government, with inflation remaining fairly subdued, should also boost the sector in the coming years.
China's ruling Communist Party has been piling on the rhetoric in recent months, indicating that a change to a more consumer-led economy would provide the backbone of the country's future success. Many analysts have seen this as a sign that the commodity supercycle could be ending as China opts to buy more dishwashers than raw materials. However, Matejka's research suggests that there is more room to run for the miners with exposure to the region.
And it's not just the China story that is fueling his bullish views. Cost cutting and a reduction in capital expenditure are also seen as benefits to these mining firms, while a weak dollar will push the price of commodities traded in dollars up.
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The basic resources sector was the worst performing industry group on the pan-European Euro Stoxx 600 Index (STOXX:^STOXX - News) last year, falling over 13 percent and was the only sector to post a loss for the year. This year's performance shows a change in fortunes, with the sector ticking higher by nearly 5 percent despite the wider equity bourses failing to show the strong rallies of 2013.
Equity analysts at Citi, meanwhile, point out that the sector is still "delicately balanced" at the moment and remain "super-vigilant" with equity prices effectively going sideways in the last nine months.
"Our current view is that diversified miners will outperform single-product producers in the year ahead," Jon H Bergtheil, an analyst at Citi, said in a note on Monday.
"The key observation must be that the diversified miners (with their easier access to capital) should have the edge on a sub-sector comparison basis, but that individual single-commodity producers are quite capable of outperforming their big brothers by simply being managed well."
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