Metal prices could be set to bounce back – here’s how to profit

Metal prices have been battered, and with them mining stocks. But they could both be about to bounce back. Dr Matthew Partridge explains why.

150130-metal

Life has been tough for miners lately.

Metal prices just keep falling. Copper and lead are both down by around 20% since July. Aluminium is down 10% since September. And the price of iron ore has more than halved since its peak.

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As a result, mining and commodity-related shares have dived too. Glencore is down 25% in the last four months. And mining giant Rio Tinto is down 20% from its 2014 peak.

But there could be light at the end of the tunnel. And that could make now a good time to hunt for mining sector bargains.

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Why money printing could boost commodity prices

One is the slowing economy in China. The second is the end of quantitative easing (QE) in the US. And the third is simple oversupply high prices drove miners to back ever more marginal projects and dig ever more metal out of the ground.

China's prospects don't look likely to change soon. But the other two negatives might not be quite as powerful as they used to be.

The US might have ended QE, but Europe has just embarked on it. The European Central Bank (ECB) is printing money to buy bonds each month. QE doesn't encourage banks to lend it just buys them time while they repair their balance sheets. Instead, the printed money largely finds its way into financial markets.

And while European shares will likely be among the first to benefit from Mario Draghi's largesse, at least some of this money printing is likely to spill out into the commodity markets too.

What's more, there also signs that lower prices are starting to affect supply. During the boom of the past few years, even marginal projects found it easy to get funding. But this has gone into reverse.

Companies have been reducing their spending on exploring and setting up new mines. Some are even mothballing entire mines. For example, Glencore has cut production by 50,000 tons from a copper mine in Argentina. Rio Tinto has also reduced output at one in the US by 100,000 tons. The biggest single cut comes from BHP Billiton's copper mine in Chile, which is the largest in the world.

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And it's not just copper of course. One of the largest lead mines in the world has been forced to shut down too. In fact, so many mines are closing or slashing production that some analysts who had been predicting a large oversupply now think that this won't happen after all.

Two miners to play a potential rebound

So how should you play this?

The simplest way to bet on rebounding base metals prices is to invest into one of the large mining companies whose shares have been hit by the recent plunge in prices. These mining stocks may have further to fall, but they are also large enough to ride out the boom-and-bust cycle without collapsing.

While many of the major miners look attractive, one I'd highlight is Anglo American Mining (LSE: AAL). Anglo mines a range of base metals, from copper to nickel, so it isn't dominated by the fortunes of just one commodity.

The company currently trades at a 28% discount to the value of its net assets. While this is likely to narrow as a result of falling metals prices, it still represents quite a significant margin of safety. It also pays a dividend yield of 5%, which the firm should be able to support by delaying future investment.

The company is also making strong progress in cutting costs, with total costs down by 7% across the group in the past six months or so. Most of its operations are in either South Africa or Latin America. As a result, it should benefit from a stronger dollar because its income from sales of commodities is in dollars, while its costs are in weaker local currencies.

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If you're feeling like more of a punt, then a purer play on metals is Freeport-McMoRan Inc (NYSE:FCX), which gets around half its revenue from copper, with the rest coming from gold and oil. The dividend yield is 7% the sort of level that suggests the market is sceptical about its ability to maintain it but earnings should be helped by a decision last year to hedge around 80% of this year's oil production before the crash.

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