It's getting hard to ignore the pileup of bad news in the global mining sector. For investors, you have to ask yourself: If miners are feeling pessimistic, should you follow suit?
On Thursday, London-based Kazakhmys PLC – the largest copper producer in Kazakhstan – blamed rising labour costs and tumbling metals prices for its dismal results in the first half of the year. Earnings sank 67 per cent and sales fell 17 per cent.
On Wednesday, Australia's BHP Billiton Ltd. made similar admissions. The world's largest mining company backpeddled on an earlier commitment to spend $80-billion (U.S.) over the next five years on projects designed to capitalize on Asian demand for commodities.
After reporting that its earning fell 35 per cent over the past six months, the company delayed about $68-billion in project-spending this fiscal year and said that it expects volatility in commodity prices to persist.
Australia's resources minister added to the gloom, remarking on Thursday: "The boom in commodity prices is over. No one can deny it."
No wonder Canada's commodity-heavy S&P/TSX has been lagging the gains of many other major global indexes this year. The materials subindex has fallen 30 per cent from its post-recovery high in 2011. Even worse, the narrower diversified metals and mining index has plunged 47 per cent from its 2011 high and is now at three-year lows.
In other words, while the S&P 500 is exploring four-year highs, Canada's mining companies are mired in deep, bear-market lows. And you can blame it on the shift in China's once-insatiable appetite for commodities, which has been severely challenged by signs that the country's economy is slowing amid surging inventories of unsold homes and cars and piles of coal.
The question is whether things are going to get any worse before they get better.
The stock market has done a fine job of anticipating this downturn, with mining stocks falling well ahead of any significant signs of deterioration at the corporate level.
Specifically, BHP Billiton shares in New York have fallen 32 per cent over the past four months. However, the fact that the shares rose slightly on Wednesday, despite its grim financial news, suggests that doom and gloom is now built into share prices – just as the earlier rise in mining stocks started long before the global economy began to recover from the financial crisis.
Longer-term, it is not hard to construct a bullish argument for commodities in general and mining companies in particular. The global population is rising and many emerging economies are growing more affluent, putting increasing pressure on limited resources.
Tom Albanese, chief executive of Rio Tinto Group, remarked on Thursday that he sees another six months of slow Chinese demand for iron ore, but added that "the long-term picture for me hasn't changed...."
Meanwhile, mining stocks are cheap. Bloomberg News calculated that as a group, base metals miners have an average price-to-book ratio that is at the low end of their historical average. Another valuation measure, the value of companies next to their cash flows is below the six-year average.
That suggests the downside is limited – and the upside can be big.