After a brutal reckoning, the base metals sector is starting to generate some cautious optimism amid early indications of an uptrend.
While any optimism for mining stocks has generally been punished over the past three years, the demoted sector now features some discount valuations. And now that many fears over China have eased, and the U.S. economy is perking up, base metals prices have begun to advance, drawing some renewed investor attention.
“This is an industry that was absolutely savaged. It’s not unlike what happened with American banks,” said Terry Shaunessy, president and portfolio manager at Shaunessy Investment Counsel.
“The downside risk was almost zero, because expectations, there weren’t any. All you’re really waiting for is the cycle to get going.”
Mr. Shaunessy said he believes base metals have bounced off the bottom and are now poised to benefit from an uptick in global economic growth.
The bear market for base metals ended about a year ago, Dundee Capital Markets said in a recent note. In June, 2013, the S&P/TSX Capped Diversified Metals and Mining index dipped to a new four-year low, having fallen by almost 60 per cent since February, 2011.
That correction enfeebled the sector as mining companies ousted their executives, shelved projects, cut costs and waited for the pall to lift.
It was an abrupt end to an era of excess fuelled by China’s ravenous appetite for resources. As the consumer of 40 per cent of the world’s base metals, Chinese economic growth sustained Canadian mining companies through the recession.
Slowing economic growth in China challenged the sustainability of that model. Fears of a potential Chinese financial shock ranked among the market’s top fixations earlier this year. Those concerns have since eased with the recent stabilization of China’s GDP and improvement in manufacturing data.
With the focus shifting back to buying opportunities in an aging bull market with few undervalued sectors, mining stocks have regained some lustre. Since March, the metals and mining index is up by 22 per cent.
Base metals stocks are now some of the cheapest on the TSX, priced more attractively than the big Canadian banks, said Irwin Michael, portfolio manager at ABC Funds.
“It’s not to say the banks won’t do well; however, we have no banks in our portfolio,” he said.
But he does have large stakes in some smaller base metals miners, including Capstone Mining Corp., which acquired an Arizona copper mining operation from BHP Billiton Ltd. last year.
Capstone has a cash cost of about $2 a pound of copper, compared to a current price of about $3.23 on the commodity itself, leaving a substantial buffer to protect against a copper price correction, Mr. Michael said.
The company also has a clean balance sheet, is in production, and operates in politically safe jurisdictions, he said.
His other top pick in the space is Trevali Mining Corp., a zinc mining company that is another low-cost operator with little debt.
Both stocks also appear on Dundee’s list of recommended base metals miners, a sector that is trading at a discount to the broader market, analyst David Charles said. “This highly cyclical sector is about to play multiple-catch-up with the broader market.”
With an industry call like that, Mr. Shaunessy said he sees an exchange-traded fund as an ideal vehicle to bet on a rebound.
Late last year, he took a position in the iShares S&P/TSX Global Base Metals Index ETF, which has holdings in mining giants like BHP Billiton and Rio Tinto PLC.
“The big guys have to get going [increasing earnings and stock prices] before it filters down to the smaller guys,” Mr. Shaunessy said. “With expectations so low and inventory levels pretty lean, it’s going to happen.”