Clever investors can buy at bottom of cycle, see earnings improve then sell before global growth peaks

PUBLISHED : Sunday, 01 April, 2001, 12:00am
UPDATED : Sunday, 01 April, 2001, 12:00am
 

TECHNOLOGY INVESTING could be a mug's game for some time. So what is the next big thing? Step forward that oldest of old economy sectors - mining.


If investors dig into the sector's fundamentals they are in for a pleasant surprise, claims Evy Hambro, who manages Merrill Lynch Investment Managers' Global Mining Fund.


'Mining is a very good story. It is quite topical at the moment because it is defensive and has good earnings visibility,' he said.


Mining stocks have traditionally been seen as a play on global growth. A clever investor might scoop them up at the bottom of the cycle, see earnings improve along with commodity prices and then sell them before global growth peaked out.


Corporate executives in the sector have had the bad habit of getting carried away at the top of the cycle by adding new production capacity, which becomes uneconomic when commodity prices fall in the down cycle.


But those watching the sector closely say things have been changing for the better in mining since 1999.


'People are saying 'why do I want to build new mines, when the metal prices aren't high enough to justify it. I can buy new capacity in the market, so let us not invest in new mines and [instead] go and buy each other's companies',' said Mr Hambro.


'They are getting higher returns as a result of it. If you start to get higher returns you should end up getting higher ratings. The sector is still on a big discount to the general market.'


The new attitude in the boardrooms, where profits are being put before market share and empire building, has touched off a wave of consolidation.


Last year was a record for mergers and acquisitions in the mining industry with US$24.1 billion in deals being done. Just three months into this year that figure has been eclipsed, with the Oppenheimer family taking diamond giant De Beers private for US$16 billion and the US$28 billion mega-merger of Australia's diversified BHP with South African rival Billiton.


The new attitude is typified by BHP's chief executive Paul Anderson, a hard-nosed American who was brought in to give the stumbling goliath a thorough shake up.


'BHP had a lot of emotional attachment to a number of projects. Things like platinum in Zimbabwe, things like the hot briquette iron plant in Australia.


'Some of them were bleeding cash, some of them were being badly managed, some had never been built. He just said 'new management, new view, boom, boom, boom, get rid of these things, they are never going to deliver',' Mr Hambro said.


Employees were given a stake in the turnaround through share options. Mr Anderson's key pledge when he took the job on was to double the stock price from A$12 (about HK$41.86).


The wave of consolidation and focus on returns was creating a new dynamic in supply and demand characteristics of the industry, Mr Hambro said.


For instance, aluminium has seen 4.5 to 5 per cent of supply going offline as a result of the closing of smelters. United States prices for power, which account for a third of production costs, have become too high.


The same is happening in copper with US giant Phelps Dodge putting workers on notice of the closure of three mines that could take a significant 300,000 tonnes of capacity offline.


'With supply slowing you have got deficits intact at the bottom of the cycle now if demand turns, it is very positive for commodity prices. The companies are getting a little bit excited when you speak to them,' Mr Hambro said.


Thanks to the electronics-intensive new economy, consumption growth for metals is above the GDP trend.


'With higher standards of living you end up with stainless steel buildings instead of brick buildings, you end up with more telephone sockets which is more copper wire, there's more electronics in your car. Your whole life is much more metals intensive than it has been in the past.'


Consolidation is giving producers new clout in price negotiations with clients. In iron ore, the largest three producers now control 62 per cent of capacity, up from 45 per cent. Annual benchmark talks with Japanese buyers produced a rise in lump ore prices of 3 and 4 per cent for fine ores, even though the Japanese were saying 'the situation is terrible, demand is falling off a cliff', Mr Hambro said.


The sexiest mining story is in platinum group metals (PGMs), which include platinum's cheaper cousin palladium.


Palladium soared from US$100 an ounce to US$1,000 before recently settling back to US$800.


PGMs are mainly mined in South Africa and Russia. Russia once dumped its PGMs to satisfy its desperate need for hard currency, but either its stock piles are dwindling or captains of the industry have liked the effect on prices of withholding some supply.


Demand for PGMs has been growing rapidly largely because they are the active components in vehicle exhaust catalytic converters.


'As environmental legislation becomes stricter, particularly in California, you are going to need more and more PGMs,' Mr Hambro said.


Environmentally friendly fuel cells, which also need PGMs, provide a fresh leg for demand. The first consumer models will go on sale in the US this year for use by campers to charge batteries.


Plans are afoot to increase production, but with shafts having to go two kilometres underground, new supply cannot be turned on like a tap.


PGM stocks make up 21 per cent of Mr Hambro's fund and have been the top performers.


South Africa's Impala, with profits up 187 per cent for the six months to December, still trades on only six times earnings. The dividend yield is expected to be 11 per cent.


Rival Amplats, with profits up 165 per cent for the year to December, is on eight times earnings and a yield of 6 per cent.


'The one that has been the real star has been Aquarius Platinum. These guys are the new nimble-footed youngsters on the block.


'They are doing very well,' Mr Hambro said.


The bright overall story for mining has been reflected in the fund's performance figures.


It gained 18.5 per cent in the year to February, according to Merrill Lynch Investment Managers.


That beat the 12 per cent gain by the HSBC Global Mining Index, a 3.5 per cent rise by the Dow Jones Industrial Average, and a 55 per cent loss by the Nasdaq Composite Index.


The fund is run with a bottom-up stock-picking approach and a concentrated list of companies.


The top 10 companies make up 54 per cent of the fund.


Evy Hambro


1994: Graduated from Newcastle University.


1994: Joined Merrill Lynch Invest ment Managers in London.


1996: Assistant fund manager on World Mining Trust.


1997: Promoted to fund manager.


1998: Moved to Australian office.


2000: Moved back to London.


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