Resource stocks fall in commodities price gap

Commodity prices have dropped … but many miners have fallen much further.

Summary: The general fall in commodity prices over the past 12 months, including copper, gold, iron ore and others, has been a catalyst for share price falls among many mining stocks.
Key take-out: Some stock price falls have been severe, reflecting specific problems, however an upturn in commodity prices could trigger an outsized share price reaction.
Key beneficiaries: General investors: Category: Commodities.

Most commodity prices have fallen over the past 12 months, which is one reason why mining company share prices are also lower. But, if you’re looking for a direct connection, it’s not there because shares have fallen faster and further than their underlying commodity.

This disconnection is best shown through the 4% fall in the price of copper since June last year (from $US3.35 a pound to $US322/lb) and the 52% fall in the price of OZ Minerals over the same time ($8.49 to $4.08).

There are a number explanations for this dramatic difference which, in the case of OZ can be attributed to concern about rising costs, compounded by the falling copper price, and uncertainty over the life expectancy of the company’s flagship Prominent Hill mine in South Australia. Adding to these is the potential for OZ to try and expand through acquisition, a step which might require additional capital from shareholders.

OZ is not alone in the “copper gap” that has opened up between the commodity and companies, and it is widest when applied to explorers because they are also being buffeted by investor concern about the possible need to raise capital in a difficult investment climate.

Blackthorn Resources, which has a promising copper project in Zambia, has dropped by 76% over the past 12 months, while Rex Minerals, which has an equally promising copper project in South Australia, has fallen by 64%.

Before considering a few more examples of this remarkable disparity between commodity and company, it’s worth thinking about the flipside of the situation, or to visualise the leverage effect of a modest recovery in commodity prices on company share prices.

What have gone down fastest and furthest, share prices, could rebound just as quickly, especially as investors start to factor in the beneficial effects of the 10% fall in the value of the Australian dollar over the past few months.

Given that most commodities are traded in US dollars, a simplistic assumption is that the price received by an Australian-based miner is now 10% higher than a few months ago.

In the case of copper, that 4% fall in US dollars over the past 12 months becomes a modest price rise on conversion, which makes the OZ Minerals price collapse (and the potential for a rebound) quite interesting.

Resources rotation

It is the recovery potential of the resources sector that has caused some investment analysts to switch their portfolio structure recommendation away from the once outrageously popular banking sector back to the heavily sold-off resources sector.

That rotation of funds out of financials and into resources can be seen best at the top end of the mining and oil world where most leading stocks are holding up reasonably well. BHP Billiton, for example, is actually about 12 cents higher today that 12 months ago, a flat performance that reflects its diversified portfolio and the inclusion of oil assets, which have benefited from a 13% rise in the oil price since June last year.

Other big miners lacking an oil division have not fared as well. Rio Tinto, which has also been hit by a management shake-out, is down by 5% on 12 months ago, and Iluka is down by 16%.

Gold is another sector worth applying this commodity/company test to, with Newcrest the obvious starting point after its spectacular crash before (and after) its profit and dividend warning.

Over the past 12 months Newcrest shares have dropped by 51%, a fall which far outweighs the 17% fall in the gold price, which converts into a 13% fall on conversion to Australian dollars given that the dollar was at parity at this time last year and is now down around US94.5c.

Other goldminers have been hit harder than Newcrest for a variety of reasons, including rising costs, ill-timed acquisitions, and other poor management decisions. Kingsgate is down by 70%, St Barbara is down 68%, Endeavour is down 53% and Evolution is down 62%.

Goldminers resisting the full blast of the sell-off include Regis, which has lost just 10% over the past 12 months, and Northern Star, which is down by 6%.

In all categories the commodity price decline has been far less significant than the share price falls of companies exposed to a particular mineral.

In the case of iron ore, the price is currently about 15% less than at this time last year, but iron ore miners are down by far more. Fortescue is down by 30%, Mt Gibson by 47%, and Atlas by 63% – falls which could be reflecting an expectation of a steeper fall in the iron ore price to come (as happened in August last year), or that even at the current price of around $US110 a tonne some of the smaller miners have been reduced to marginal profitability.

Perhaps the most interesting comparison is in the two least “loved” minerals, zinc and lead. Zinc, which is seen as possible recovery situation over the next two years, is down by 2.3% over the past 12 months to US83c a pound (and up on conversion to Australian dollars). Lead is up in either currency, by 9% in US dollars and by 15% in Australian dollars.

Those zinc and lead rises sit curiously along the share price of the biggest locally-listed zinc producer, Perilya, which has fallen by 55% from 30c to 13.5c over the past 12 months. The drop reflects an ongoing squeeze on profitability caused by the low prices, but appears exaggerated given the rising underlying commodity prices.

No-one is suggesting that the decoupling of commodity prices and share prices is a buy signal. Most of the companies mentioned are facing compressed profit margins and, like Newcrest, could have a nasty surprise in store for investors in the form of June 30 asset-value write-downs.

But, what the comparison of commodity and company might be indicating is that resource company shares have absorbed all of the mineral price falls (and more) and that first indication of a sustainable upturn in commodity prices could deliver an outsized share price reaction.

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