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Resource stock plunge looks a lot like history

Even by the standards of the recent financial crisis, Thursday's selloff in stock markets was sizeable.

The growing nervousness over the debt crisis in Europe, the risk of a "double-dip" recession in America and a view among investors that policy makers, including the Japanese government and European Central Bank, had failed to shore up confidence accelerated this week's selloff.

The worst hit stocks were those of the world's big natural resources groups, including miners, oil companies and traders. Despite the prices of many commodities remaining near recent highs, their shares prices tumbled, sending valuations to the lowest levels of the year.

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The divergence between resources stocks and the prices of actual raw materials evokes memories of mid-2008, when equity investors were quicker in anticipating the global financial crisis.

Are equity investors right again? If so, a sharp economic slowdown, or worse, could be at hand. Other sectors, such as financial services, suffered steep falls too on concern over their exposure to the sovereign debt crisis in Europe and the risk of more bad loans.

The list of tumbling resources stocks on Thursday included Xstrata, the London-listed miner, which fell 8.5 per cent, Royal Dutch Shell, Europe's largest oil group, which fell 5.2 per cent, and Vale of Brazil, the largest iron ore producer, which dropped 6.3 per cent.

Freeport-McMoRan, a top copper miner, fell 5.9 per cent and Archer Daniels Midland, one of the largest food commodities traders, was 4.5 per cent lower.

After two weeks of heavy losses, the FTSE All World Mining and the FTSE all World Oil and Gas indices are up just 7.6 and 14.6 per cent, respectively, over the past year.

In the same period, the benchmark Reuters-Jefferies CRB index, a basket of commodities including oil, copper and wheat, is up 22.1 per cent.

Glencore, the world's largest commodities trader, which came to the market in a $60-billion (U.S.) flotation in May, is among those hardest hit. The company has lost 17.9 per cent so far this week. On Thursday, it closed at 391p, more than 26 per cent below its flotation price and 8 per cent down on the day.

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Equity investors appear far more concerned about the potential of a double-dip than commodities investors, according to industry executives.

Investors say that high oil and food prices are forcing emerging countries' central banks to tighten monetary policy, slowing economic growth in China, India and other big commodities consumers. That has compounded the negative sentiment surrounding the euro zone crisis and US fiscal burden.

"We began the year expecting slow but persisting growth in mature economies with China compensating by continuing with its robust growth," says Jon Bergtheil, mining analyst at Citigroup. "Those assumptions are being called into question."

But Colin P. Fenton, head of commodities research at JPMorgan in New York, warns against being too gloomy. "The global economy is weathering a soft patch, but is likely not heading into a double-dip recession".

Commodities prices are starting to fall, although from historically high levels. Brent crude, for example, fell on Thursday to a five-week low, yet it remains about 40 per cent higher than in January 2010.

Economic fears aside, another important factor behind the sharp falls in commodity-related share prices has been rising production costs, which have eroded companies' profitability even as the selling prices of the raw materials they produce have increased. Tom Albanese, chief executive at Rio Tinto, said on Thursday that the sector was suffering from inflation hot spots: "Coupled with the increasing strength of the Australian and Canadian dollars, this has put pressure on our cost base."

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The impact of that rising cost inflation is clear in iron ore. The price of the steelmaking commodity hit a 2½-month high of $179.5 a tonne on Thursday, up nearly 30 per cent year-on-year. Yet shares in the world's largest ore miners – Vale of Brazil, Rio Tinto and BHP Billiton – have tumbled 10-12 per cent this week.

Other factors are weighing on share prices. Oil and mining groups have produced less than expected due to bad weather – for example, flooding in Australia – and labour disputes including strikes in South Africa's mining sector, as well as political turmoil such as the civil war in oil-rich Libya. The resulting supply shortfalls have lifted commodities prices, but are eroding profitability as companies miss production targets.

Total of France, Eni of Italy and Repsol YPF of Spain produced oil in Libya before the civil war started. Their net profits fell year on year in the second quarter despite higher year on year Brent crude prices. The boom in resources stocks already feels like history.

Copyright The Financial Times Ltd. All rights reserved.

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