Mining equity valuations have shown a significant recovery in May with the ASX 300 Australian Mining index rising by 18% so far this month, to within a whisker of its start-year level. The index is also now within 10% of its 3-year high. Whilst valuations in the gold sector have outperformed the rest of the mining industry, recent increases in mining equities have been widespread. For example, the share price of the fourth largest iron ore producer, Fortescue Mining Group, has risen to a record high.
Valuations in the mining sector are proving to be remarkably resilient in the face of a fairly catastrophic economic backdrop and are outperforming the broader equity market. That is in notable contrast to previous economic cycles, where mining valuations tended to be more geared to changes in global economic activity.
The recent rally has been driven by more positive economic sentiment over the Chinese economy and resilience in metals prices, especially in markets such as manganese, chrome and tantalum, where supply disruptions have offset a loss of demand. Industrial production in China was up 3.9% y-o-y in April compared to a 13.5% contraction in February. Other factors supporting the share price of mining companies include lower fuel input prices, exchange rate movements and cuts in interest rates. It is also the case that, going into the downturn, metals prices and industry multiples were already at relatively modest levels after performing badly in 2019. Finally, the industry was much less leveraged going into the downturn compared to other cycles and, in contrast to many firms in the oil and gas sector, mining companies have been able, mostly, to maintain dividends.
Equity markets are often a leading indicator of the broad economy but Roskill is cautious about the economic outlook over the next couple of quarters. In contrast to China, US industrial production was down 15% y-o-y in April. Italian output was down over 29% y-o-y in March, highlighting the scale of further downside risk. The number of COVID-19 cases is yet to clearly peak at the global level and rising rates of unemployment have led to lower expectations for any quick return to “normal”. Whilst industrial output has been rising again in China, this can only be sustained if final demand also recovers and retail sales in the country were still down 9.1% y-o-y in April. Export demand is also likely to remain weak for a while. That said, the chance for a “V shaped” recovery in the world economy remains plausible and Roskill continues to include this case, along with more bearish scenarios, in its demand modelling.
Roskill will be publishing a White Paper in the coming weeks, available free to subscribers of Roskill’s commodity research, on the current economic cycle and its longer run implications for the mining sector.