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Don’t panic about Australian miners’ sudden slump: Credit Suisse

A mine worker inspects conveyer belts transporting iron ore at the Fortescue Solomon iron ore mine located in Western Australia.

DAVID GRAY/REUTERS

It didn't take long for a freak-out to ensue. As soon as Australian markets opened on Monday morning, the country's big diversified miners took a beating because of heightened fears about China's cooling economy.

Since the opening bell that morning, shares of Rio Tinto Ltd. slumped 7 per cent, while Fortescue Metals Group Ltd.'s dropped 11 per cent.

Investors can't be blamed for panicking – especially given what's transpired in the gold space over the past two years. But analysts at Credit Suisse swear there's no reason to.

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First there are market values to consider. The affected miners just saw their stocks hit one-year highs in February. For now, this is just a pullback.

Better yet, the fundamentals can't be ignored.

"Eventually the market must look beyond momentum and into value; large-cap miners are highly cash flow generative but trade at substantial discounts to valuation metrics, pricing in commodity prices well below forwards and analyst forecasts," the analysts wrote.

They get the irony in this argument. "It may seem odd to preach fundamental value when stocks are responding to momentum (and we expect iron ore prices to fall further). But it remains a conundrum that miners must be punished for high prices," the analysts added, noting that iron ore still trades at $115 (U.S.) a tonne, and forward contracts are still priced at more than $100 a tonne.

To cover their bases, the analysts countered many of the naysayers' arguments. Even though a slew of iron ore and copper is expected to hit the market next year, they say political risk and market surprises can't be discounted. Rio Tinto recently gave 2014 iron ore production guidance that came in 15 million tonnes below their expectations, and Freeport-McMoRan Copper & Gold Inc. just cut copper exports by about two-thirds from Indonesia.

Then there is the dichotomy between stocks and the commodities markets. "Commodity forwards do not seem to be pricing in the same tail risks as equities," they wrote, noting that iron ore forwards for 2017 were still trading at $101 a tonne at the time of publication.

The analysts also contrasted public perceptions of metals producers with those of energy names to lay out some double standards. Miners – especially iron ore miners – suffer from weakening Chinese economic expectations, yet energy producers don't even though oil prices are arguably more susceptible to shocks. Developed markets are reducing their oil consumption, whereas developing markets, which are in trouble, are the ones devouring oil at faster clips.

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And in the case of Australian energy, some of the biggest companies such as Santos Ltd. and Oil Search Ltd. are riding high on the prospects for liquefied natural gas exports. But returns can be hindered by rising capital expenditures. BHP's and Rio Tinto's projects, meanwhile, "are all relatively simple" and soaring expenses are "limited in an industry where global capital expenditures is declining and costs are coming down – the cycle turned for miners two years ago."

"Decline rates for most mine assets are far below the [approximately] 10 to 20 per cent seen for oil projects (less for conventional gas but LNG is expensive to replace) with most iron ore and coal mines lasting 20-plus years with modest additional spend," the analysts noted.

What nobody knows is whether investors will care about any of those facts. As the analysts themselves admitted, mining shares are now trading on momentum. It's hard to make any logical arguments stick in this environment.

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About the Author
Reporter and Streetwise columnist

Tim Kiladze is a business reporter with The Globe and Mail. Before crossing over to journalism, he worked in equity capital markets at National Bank Financial and in fixed-income sales and trading at RBC Dominion Securities. Tim graduated from Columbia University's Graduate School of Journalism and also earned a Bachelor in Commerce in finance from McGill University. More

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