Outlook remains cloudy with occasional sunny spells
* 2015 has been another bad year for the sector. The last 5 yrs have now been the worst
period of performance since 1966: Looking forward it is hard to see what might pull the
sector out of its tailspin. A demand shock seems unlikely given the state of China’s
economy, although there are some signs of near term improvement (M2, property starts,
TSF growth). Pinch points in supply/demand are getting pushed back implying marginal
costs will govern pricing for longer. Costs themselves are under negative pressure.
Meanwhile, returns on equity are sub cost of equity following unprecedented
capex/depreciation levels, and net debt as a proportion of EV is at an all time high. Finally
one has to sift through valuations to find metrics that support an investment case. So we
downgrade our sector view to Neutral (we would have reverted to our Negative call of
2013-14 if it weren’t for the recent pick up in some Chinese data, plus sector positioning).
* Stock specifics. Only Boliden and a few gold stocks have provided any positive
performance YTD. Rio Tinto screens the best still on valuation/balance sheet strength
so we upgrade to OW. We stick with OW on Glencore (commodity mix, catalyst
expectation, overly negative perception and FCF yield), but remove it as our ‘Top Pick’.
We downgrade BHPB to EW with very little valuation support and stick with AAL and
Vale as UW. We are downgrading the more leveraged Vedanta and Kazakhmys to UW.