Has the resources cycle turned?
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Climbing share prices suggest investors have a renewed interest in the mining sector, but it would be unwise to expect a return to boom conditions.
Rising coal and iron ore prices have boosted confidence in the mining industry, with climbing share prices suggesting investors also have a renewed interest in the sector. Has the resource cycle finally turned positive?
From a low of US$37 per tonne in December 2015, the benchmark price for iron ore has risen to above US$63, boosting profits at major iron ore miners such as Rio Tinto (ASX: RIO) and Fortescue Metals (ASX: FMG) and potentially swelling government revenues.
Meanwhile, the spot price of coking coal has more than doubled, recently hitting a four-year high over US$206 a tonne, while thermal coal prices have also surged by 30 per cent, amid Chinese supply cuts and continued strong demand.
The price surge has helped coal miners such as Whitehaven Coal (ASX: WHC), which has seen its share price double over the past year, and new miners such as Stanmore Coal (ASX: SMR), up nearly 300 per cent.
The renewed optimism has flowed through to the junior end of the sector, too. In its latest quarterly survey, accounting group BDO reported an increase in exploration spending in the June quarter for the first time in nine quarters, with the proportion of so-called "zombies" not doing any exploration at all dropping to 46 per cent.
Among those taking advantage of the rebound is explorer Carpentaria Exploration (ASX: CAP), which recently raised nearly $1.6 million from investors to upgrade the resource at its Hawsons Iron Project near Broken Hill.
"Investors are voting with their wallets to support projects with the potential to generate shareholder value," said Carpentaria's managing director, Quentin Hill.
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According to Morningstar resources analyst Mathew Hodge, the Perth-based miner has set itself apart from its peers by focusing on return on capital, "withholding supply from the market when conditions were weak and paying out the majority of free cash flow as dividends".
Hodge sees the miner benefiting from a recovery in mineral sands prices, which may already be underway following recent gains in zircon prices and titanium dioxide shipments.
Morningstar analyst Mark Taylor also recommends Woodside Petroleum (ASX: WPL) as "the best ASX-listed energy exposure for risk-averse investors".
Taylor noted the Perth-based company is the "least leveraged of the three larger hydrocarbon producers" and should be free cash flow positive from 2016 due to reduced capital expenditures, benefiting from the commissioning of its Wheatstone liquefied natural gas project from the second half of the year.
"End in tears"
However, while the recent price surge has confounded analyst forecasts, few expect a return to boom conditions.
In an April report, Morningstar analysts said the rally in bulk commodity miners "will end in tears," due to expected falling Chinese steel demand and rising Chinese steel scrap availability.
Morningstar's long-run forecasts are US$30 per tonne for iron ore and US$75 per tonne for metallurgical coal, both well below current prices.
"We've seen a cyclical pickup driven by supply-side changes in China, and by it pushing more debt and expenditure through state-owned enterprises. However, their underlying health isn't great and there's still a lot of debt in China that is going to be very difficult to clear," Hodge said.
"The big problems are still there, and it will be interesting to see what happens when the stimulus peters out. After seeing the runs some of these resource stocks have had, taking some profits isn't a bad idea."
Hodge instead points to gold producers such as Newcrest Mining (ASX: NCM), which should benefit as gold becomes consumption rather than investment-driven.
Along with Iluka Resources, he also suggests iron ore miner Mount Gibson Iron (ASX: MGX) as it is trading at a discount to its net cash per share, while Morningstar's positive view on oil prices makes it prefer BHP Billiton (ASX: BHP) over rival Rio Tinto.
"I'll be surprised if 2017 is anything near as strong as 2016," Hodge said. "If you think about the main driver of the cycle, it's been China. So, what will be the next big thing to come up behind China?"
"I'd be more interested in finding stocks that will benefit from demographics or disruptive technology--those are more interesting in a world where the market is pushing up prices on the assumption that China keeps on growing."
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Anthony Fensom is a Morningstar contributor.
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