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The credit strategy team at Bank of America Merrill Lynch has come up with an investment idea – buying U.S. dollar corporate debt issues of global mining companies – so compelling that I've already acted on it in my own portfolio.
The overriding rationale for the idea is that mining debt is cheap. Strategist Hans Mikkelsen writes:
"The Metals & Mining sector − excluding the gold names − appears to us the most promising [corporate debt] sector both short term and long term. This is due in part to very attractive valuations as the sector has repriced lower with commodities − even taking into account expected further declines in commodity prices."
The latter part of that excerpt implies that on average, debt prices in the sector offer a margin of error, taking into account the risk of commodity prices moving even lower.
Attractive valuations are only part of the story. The team also notes that one of the biggest risks for corporate debt prices – higher general interest rates – is offset by the mining business itself. If rates rise, this means the U.S. economy is strengthening, which means that commodity demand will be higher and the balance sheets of mining companies, and their credit worthiness, will be getting stronger.
Why U.S. dollar debt? One of the more interesting divergences in the current market is between Canadian materials stocks and the Canadian dollar. In essence, it appears that the loonie is defying gravity in comparison to commodity prices. The return to normalcy in this relationship would see either the Canadian dollar fall significantly, or materials stocks to jump higher.
By buying U.S. dollar mining debt issues, investors can stay out of the way of a potential fall in the Canadian dollar while benefitting from possible strength in the greenback.
I won't bore you with the detail of my personal trade (although this probably won't stop a few commenters from accusing me of frontrunning anyway). It's a small position, but barring default (god forbid), I've locked in a post-commission yield of around 4.7 per cent for a number of years with some potential upside if conditions in the mining industry improve.
Investors looking to apply this investment idea need to choose the debt issue carefully, avoiding even the slightest chance the company will go out of business. Do that, and it appears some solid returns are available.
Scott Barlow is a contributor to ROB Insight, the business commentary service available to Globe Unlimited subscribers. Click here to read more of his Insights , and follow Scott on Twitter at @SBarlow_ROB .
Scott Barlow