There's little doubt that mining stocks have become dirt-cheap. But that doesn't mean they're a bargain.
Last week, investment research firm BCA Research noted that price-to-earnings (P/E) valuations on commodity stocks have been falling for two years, and base-metal producers have been hit harder than most. Globally, non-gold mining stocks are nearly 30-per-cent below last year's highs, while their P/Es, at about 11 times, are near historical lows.
This is all occurring, wrote BCA's head of commodity and energy strategy David Abramson, in an environment where risks have been easing and economic growth in China, the big driver of commodity demand, looks to slow only modestly, to still-robust levels.
Valuations on mining stocks appear to be pricing in a much higher risk of calamity in the euro zone and China than makes sense, he argued. "Non-gold mining stocks are our favourites, with 30-per-cent or more upside."
But a few factors suggest that those low valuations might be more justifiable than Mr. Abramson thinks.
Shadowing the slipping PMI
A look at JPMorgan's global manufacturing purchasing managers' index (PMI) shows that the MSCI World Metals and Mining index and P/E levels have tracked the PMI trend fairly closely over the past two years. The decline in stock prices and valuations, far from being out of step with the economic reality, reflect the deterioration of global manufacturing activity.
Economist Marco Lettieri of National Bank Financial noted that for Canadian stocks in particular, the decline in global economic prospects has sparked concern that profit margins – which for the materials sector "have surged to unprecedented levels" – are unsustainable.
Stalling price momentum
BCA's Mr. Abramson noted that resource stocks typically track the momentum of commodity prices, rather than the absolute price. Even if commodity prices are highly profitable, stocks will tend to slip if price gains slow, or reverse. So the outlook for metal prices is hardly good news for stock values.
Analysts' consensus forecasts for copper show strong quarter-over-quarter price gains turning into small declines later this year. Similarly, gold prices are expected to see their strong pace slow to a crawl in the coming months.
One key contributing factor is the outlook for the U.S. dollar – the currency in which commodities trade globally, and against which commodity prices typically move inversely.
"If the euro weakens [against the U.S. dollar]– our baseline assumption – then the current commodity price [forecast]that underpins current valuations of resource stocks must be revised down," said Stéfane Marion, National Bank's chief economist and chief strategist.