Mining in 2016: The year of the perverse
One year ago, I looked at the sector with, “A funny thing happened in 2015.” We went on to describe the effect of the reduction in the total US monetary base on the gold price. But, if 2015 was ‘funny’, then 2016 was downright perverse. While we were right that the FOMC came nowhere near its stated interest rate targets, almost no one forecast that Britain would vote to leave the EU or that Donald Trump would be the next US President. The US election, in particular, proved to be a watershed moment in 2016. While it had been precious metals that had been in the driving seat in the early part of the year, it was very much the industrial commodities that performed later on. Even then, however, it wasn’t the metals and minerals that most analysts thought. This time a year ago, it was orthodox thinking that, almost whatever happened, iron ore and coal, in particular, and oil (albeit to a lesser extent) were due for a hiding. In the event, these were three of the top four performing commodities in 2016.
To be fair to the analysts, they were broadly right on the fourth (zinc); however, again, they were badly wrong on the subject of copper. Whereas analysts had expected the red metal to wilt under a wall of supply, in the event, a post-Trump rally saw it overtake both gold and silver in the performance tables, to record a price increase of 17.4 percent over the year cf 15.9 percent for silver and 9.0 percent for gold. As such, it was a good year for commodities overall. While gold (+11.6 percent) was just pipped to the post by the Dow Jones Industrial Average (+14.1 percent) in the thirteen months since the Fed’s December 2015 interest rate rise, it still comfortably outperformed the FTSE 100 index (-2.2 percent in US dollar terms). In general, most commodities recorded price rises in the range 10-20 percent. In fact, the only real decline was recorded by uranium, which fell over 40 percent. But, 2016 was also the year in which equities rediscovered their traditional gearing to metals’ prices. Thus, in the period in which gold rose 11.6 percent, the NYSE Arca Gold BUGS (HUI) index rose 85.2 percent and the FTSE Gold Mines index rose 75.1 percent.
The average performance of a sample of 20 major miners was 128.6 percent in US dollar terms, with Coeur Mining recording the best increase of 324.9 percent. In general, the top of the table was populated by recovery stories (eg Anglo American +257.7 percent and Glencore +202.5 percent) and silver producers (eg Hochschild +301.4 percent and Hecla +193.3 percent). All counters outperformed gold and silver prices, with the single exception of Eldorado. Of note however, was the performance of iron ore (+93.7 percent), which outperformed not only the likes of Kinross (+88.2 percent) and Yamana (+78.1 percent), but also, more importantly, BHP Billiton (+56.2 percent) and Rio Tinto (+37.5 percent).
On historical measures, the outperformance of the precious metals’ miners in 2016 leaves them generally close to fair value. Future share price increases are therefore likely to be predicated on upward movements in gold and silver prices – although investors may still expect a geared response to such increases. Edison believes that this remains likely as time exposes some of the fault lines in the new President’s economic policies. Among the diversified miners however, analysts remain steadfastly bearish on iron ore in particular. Assuming that this is already discounted in equity prices therefore, one obvious immediate strategy is for investors to go long of Rio Tinto and BHP and short of iron ore.
By Charles Gibson, Director of Mining at Edison Investment Research
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