Why the boom in mining shares isn't just another bubble

By John Stepek

published 10 October 2007

in Features

***Why the boom in mining shares isn't just another bubble

***One little-known metal you shouldn't ignore

***RECOMMENDED ARTICLES: Four reasons gold will only go higher... Why the bond market spells trouble for the US...

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The boom in mining shares - not just another bubble

There are bubbles popping up all over the global economy. Contemporary art, Google shares and houses from Sheffield to Sydney are all over-valued and destined for a fall in our humble opinion, at least.

But what of the sector we're most keen on commodities? Plenty of commentators reckon that precious metals, for example, are in bubble territory too could they be right?

We don't think so, and in fact, broker Credit Suisse First Boston has just brought out a lengthy and rather interesting report on why it believes mining stocks are still well worth buying in 2006.

And the group also recommends an oft-overlooked metal which we brought to readers' attention back in November...

Broker Credit Suisse First Boston reckons the bull market in metals, and in mining stocks will carry on for a good long time yet.

"Years of underinvestment, a lack of industry response to the new demandfrom China and attractive valuation suggests significant upside to current share prices," the group reckons.

One of the main arguments is that mining company managers still lack the faith to invest in building new mines, because of fears that the market is nearing its top. They are also put off by the increasing expense of building new mines, which has been exacerbated by a shortage of skilled labour and equipment.

But CSFB points out that long-term commodity price assumptions used in the industry are still too low given the continuing expansion of China and other emerging economies.

And with demand still growing faster than supply, metals prices will just keep heading higher until mining companies finally decide that they can't afford not to invest in new capacity.

Even then, it takes a long time for new mines to come on line. Suffice to say, CSFB reckons the mining and metals sector is a long way away from bubble' territory yet.

Take a look at p/e ratios in the sector. Even at its current share price, close to a record high, Anglo American only trades at around 13 times 2006 earnings, while Antofagasta sits on around 12.

Compare that to typical valuations of technology stocks at the time of the tech bubble in fact, compare that to the valuation of Google today and frankly, you have to wonder what's wrong with some investment analysts.

They suggest that paying in the region of 100 times future earnings for Google, a company that derives 99% of its money from an industry with dozens of competitors, and next to no barriers to entry, is a good deal.

But in mining you have a sector where the major companies can't produce enough product to satisfy their customers, where barriers to entry are high and getting higher, and yet the top companies in the sector can barely muster a double-digit p/e rating.

A bubble? We don't think so.

Aluminium - a little-known metal you shouldn't ignore

One of CSFB's most intriguing tips for 2006 is aluminium. It reckons the market could be short of 187,000 tonnes this year. The key problem is that aluminium requires a great deal of electricity to make.

But as CSFB points out, "the world is running out of cheap sources of electricity." China was forced to restrict aluminium output in the recent past due to electricity shortages. There's every chance the same thing could happen this year, and the same problem could hit European producers.

India-based miner Vedanta has already announced plans to more than double its aluminium production capacity, with the expansion due to commence in March 2006.

MoneyWeek alerted investors to aluminium's potential back in November. Subscribers can read the piece by clicking here: Don't overlook aluminium

If you're not yet a subscriber, you can get access to all the content on the MoneyWeek website and sign up for a three-week free trial of the magazine, just by clicking here: Sign up for a 3-week FREE trial of MoneyWeek

And turning back to the UK for our latest update on the high street...

Kesa Electricals disappointed investors after it said pre-tax profit would be at the lower end of forecasts, despite a pick-up in demand for electronic gizmos over Christmas. Shareholders had been hoping that Kesa would copy DSG International's relatively upbeat trading update and had bid up prices in advance. Shares fell 2% to 258.5p.

And Matalan has lost its third chief executive in the space of six years. John King plans to leave at the end of 2006. The company has been a perennial underperformer in the retail sector, and Mr King's move suggests things aren't set to get better any time soon.

As Richard Ratner at Seymour Pierce put it: "It looks as if he is going of his own volition - which is a clear indication of where he thinks the business is going."

We don't blame Mr King for his lack of confidence. UK consumers are set to feel even more pressure on their wage packets than they did last year. And more importantly, this year they can no longer rely on their houses as cash machines.

In this week's issue of MoneyWeek, out today, economist James Ferguson explains why, despite the apparent pick-up in activity, the optimists are wrong on the UK housing market. And that means more trouble up ahead for the high street.

Money Morning readers keen to hear more from James will be glad to learn that his exciting new investment advisory service - "Model Investor" is about to launch. You can read more here: James Ferguson's new investment service.

Turning to wider markets...

The FTSE 100 gained 29 points to 5,693. Miners were once again among the top risers on strong metal prices. Kazakh copper mining group Kazkhmys rose 6% to 861.5p, while BHP Billiton climbed 4% to £10.25. For a full market report, see: London market close.

Over in continental Europe, the Paris Cac 40 closed up 42 points at 4,814, while the German Dax gained 35 to close at 5,430.

Across the Atlantic, US markets headed higher. Better-than-expected results from drugs giant Pfizer and a decent update from chipmaker Advanced Micro Devices helped offset investors' worries after disappointing figures from Yahoo and Intel earlier in the week. The Dow Jones gained 25 points to 10,880, while the tech-heavy Nasdaq rose 22 to 2,301. The S&P 500 climbed 7 points to 1,285.

In Asian trading hours, oil continued higher, after spiking in New York on the release of what appears to be a new message from terrorist leader Osama Bin Laden. Crude was trading at around $67.20 a barrel in New York, while Brent crude was up at around $65.10.

Meanwhile, spot gold prices headed higher to just under $558 an ounce. Silver was trading at around $9.10 an ounce.

In Asian stock markets, the Nikkei 225 was flat at 15,696. Concerns linger over the investigation into internet giant Livedoor and the reliability of Tokyo Stock Exchange's computer systems.

And in the UK later this morning, official figures on December retail sales will give a further indication of how the high street fared over Christmas.

And our two recommended articles for today...

Four reasons gold will only go higher

- Gold has had a good run so far this year, says gold commentator Paul van Eeden. But the good times may have only just begun. The US dollar is under attack on all sides - from threats of Chinese revaluation to the prospect of an imminent halt to interest rate rises. To find out why gold has a lot further to go, click here: Four reasons gold will only go higher

Why the bond market is predicting trouble for the US

- Investors seem to be throwing caution to the winds, with stock markets hitting fresh four-year highs. But the bond market is flagging up trouble ahead, says Jeremy Batstone at Charles Stanley. To find out why that means stock markets are set to become a lot choppier than in 2005, click here: Why the bond market is predicting trouble for the US

John Stepek is a senior reporter at Bloomberg News and a former editor of MoneyWeek magazine. He graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.