Mining Newsletter

In brief:

• Good company strategy was offset by weakening commodity demand and falling commodity prices in the second half of last year, resulting in the sector posting its fourth consecutive year of negative returns.
• In the past, the down stage of the cycle has been followed by a gradual recovery and we expect a similar dynamic to unfold as a number of data points suggest inflection.
• We favour base metals over bulk commodities and high quality producers, especially those whose margins are being helped by currency moves.

Two competing forces drove the mining sector in 2014: the first, a greater focus on shareholder return and the expectation of a wall of free cash flow to be created by the industry; the second, weaker than expected global growth which set the stage for the steepest commodity price drop since 2008. The aggressive sell-off in commodities during the second half saw the mining sector deliver its fourth consecutive year of negative returns. We are now in uncharted territory, with the mid-to-late 90s seeing three years of consecutive negative returns, before the next ‘up-cycle’ began in the early 2000s. As we enter 2015, a number of data points suggest that we are reaching an inflection point. Return on capital for the sector is at a near four decade year low, companies are cutting capex and not reinvesting so as to protect base dividends, valuations are below 30-year averages and the sector trades at a significant dividend yield premium to the market. In the past, periods of low returns such as in the 80s and 90s have been followed by a gradual recovery and we expect a similar dynamic to unfold as a consequence of the industry’s natural reaction to the current commodity price environment.