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Rebound in mining stocks during February and March has already pushed prices far above fundamental values.

REUTERS

The great rout in raw materials prices is over, according to Citigroup analysts, but anyone who hopes to ride the spectacular rebound in mining stocks should think again.

Most commodities have now "stared at a price bottom and are groping for a return to normal," Ed Morse and other Citi analysts write in a report released Monday.

However, investors should be wary because the huge rally in mining stocks during February and March has already pushed prices far above fundamental values. "We think that the stocks have run too hard, too fast and valuations look stretched," an accompanying note from the metals and mining team says.

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The Citi analysts downgraded three of the world's largest diversified miners on Monday. They cut Rio Tinto PLC from "neutral" to "sell." They also reduced Glencore PLC and South32 Ltd. from "buy" to "neutral."

In addition, the team moved its stance on precious metals from bullish to bearish with a raft of downgrades to many London-listed gold miners, including Acacia Mining PLC and Randgold Resources Ltd.

Most mining companies now offer little in the way of dividends and their earnings display no upward trend, Citi notes. This leaves investors with the difficult problem of how to define value in a sector that has consistently disappointed shareholders over the past four years.

On the plus side, "the key change for us is that the mining companies have stopped destroying value," the analysts write. However, it's not clear that miners actually have a strategy to enhance their value, beyond paying down debt and hoping for better times ahead.

"There is now a substantial risk of giving back up to 50 per cent of the gains made so far during 2016," the analysts warn.

The Citi team was particularly skeptical of the bounce in gold miners.

"Many gold shares have risen by between 40 per cent and 60 per cent year-to-date … [taking] many shares beyond even our new, higher target prices," they say.

For all their caution, the Citi analysts join the growing chorus of observers who see an end to the four-year-long rout in commodity prices. Credit Suisse recently published a report in which it predicted better times ahead for aluminum, metallurgical coal, zinc, lead and gold.

For both Credit Suisse and Citi, the key factor is fading fears of a severe Chinese downturn. In its report on Monday, Citi noted that the Chinese economy is showing signs of improvement.

While a broad recovery in commodity prices still remains in the distance, the bank sees reasons to be optimistic about the prices of industrial metals, especially zinc, as China boosts infrastructure and real estate activity.

It is also upbeat about the outlook for energy prices, calling for both oil and natural gas prices to trend higher. "This optimism is based simply on the view that current prices are too low to sustain supply at levels required to compensate for declines from mature assets and to accommodate ongoing demand growth, however anemic," the report says.

It cautions, however, that bulk commodities such as iron ore and thermal coal are likely to remain under pressure.

Iron ore is in serious oversupply, the bank notes. Thermal coal – that is, coal used for power and heat generation – suffers from declining demand as a result of environmental concerns as well as competition from natural gas.

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