Metals mania raises hopes – and concerns

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Metals mania is back.

Since the start of January, the Toronto Stock Exchange's mining sector has surged to double-digit gains, led by the likes of Ivanhoe Mines Ltd., HudBay Minerals Inc., First Quantum Minerals Ltd. and Teck Resources Ltd., each of which has rocketed ahead by 27 per cent or more in less than four weeks.

The big gains reflect a growing consensus that global growth is picking up, fuelled by solid growth in China, an improving outlook in Europe and enthusiasm about U.S. President Donald Trump's spending plans.

However, the leaping share values also raise questions about whether investors may be getting ahead of themselves.

After gaining 10.6 per cent so far in January, the TSX materials sector doesn't look particularly cheap in terms of underlying earnings – especially since global growth, while on the upswing, remains muted.

"There is now too much optimism about demand priced into metals markets," Capital Economics argued in a recent report. "Trump is unlikely to push through his spending plans in full. And in any case, the U.S. is a relatively small consumer of metals and strong growth there will not offset the likely moderation in China's demand."

For now, though, the sector's ascent has provided a powerful push for the S&P/TSX composite index and helped the Toronto benchmark climb into record territory.

Canada is just one beneficiary of the global mining resurgence. The Bloomberg world mining index, which tracks leading miners around the world, is up 14.1 per cent since the start of the year.

Some of the biggest winners on foreign exchanges have been the world's biggest miners. In the first few weeks of January, shares of Glencore PLC have jumped 17.9 per cent in value. Rio Tinto PLC stock has advanced 13.2 per cent, and BHP Billiton Ltd. shares have climbed 11.6 per cent.

Among recent converts on the sector is Goldman Sachs Group Inc., which upgraded its outlook on commodities to "overweight" – the equivalent of a buy recommendation – this past November. "We're seeing a cyclical uptick in global economic activity and that's driving demand, not only for oil but for all commodities," Jeffrey Currie, head of commodities research, told Bloomberg News this week.

Citigroup Inc. is also positive on the outlook. In December, it said most commodities should perform well in 2017 on the back of stronger global demand.

But other commentators cast doubt on whether fundamentals are really as bullish as recent prices would indicate.

Consider copper prices, which have surged more than 16 per cent since Mr. Trump was elected. The United States uses about 1.6 million tonnes of copper a year, about 7 per cent of world consumption, according to Robert Edwards of consultants CRU. Even a major jump in demand as a result of Trumponomics would be unlikely to bump up global demand by more than a percentage point or two. It's difficult to see why that should translate into big, immediate gains in the price of copper.

"Copper market fundamentals continue to be secondary to the overwhelmingly positive sentiment toward the ferrous and non-ferrous commodities space," Mr. Edwards writes.

Gold also faces questions. The precious metal usually doesn't fare well at times, such as now, when interest rates appear to be headed up. Bullion, which pays no yield, tends to lose its lustre as rising rates make bonds and other investments more attractive.

But investors appear determined to look on the bright side. Among the biggest gainers on the Toronto exchange this month is Ivanhoe Mines, which is developing a major copper project in Democratic Republic of the Congo, a jurisdiction not noted for its political stability. Ivanhoe is up 61.4 per cent since the start of the year.

First Quantum Minerals, another Africa-centred copper producer, has also done exceptionally well. It has gained 28.8 per cent so far in January.

More gains may be in the offing, but investors should keep in mind that the S&P/TSX materials sector is now trading for more than 23 times estimated earnings. The sector will need a fair bit of good news to make the current valuations look like a bargain.