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Investors’ patience is tested once again as commodity prices go into reverse
Thursday 11 May 2017 Author: Daniel Coatsworth

Last year’s 100%+ hike in the value of the FTSE 350 mining index seems a long distant memory. A recent pullback in commodity prices has resulted in a sea of red for anyone watching the share prices of miners on their screen. Is this cause for panic or just a natural pullback?

‘Based on our meetings and calls with investors in the UK and Europe over the past two weeks, we conclude that sentiment regarding mining has shifted from euphoria earlier in the year to cautious optimism now,’ said investment bank Jefferies on
3 May. Commodity prices have declined further since that comment was made.

The FTSE 350 mining index went through four straight years of decline between 2012 and 2015 before making an impressive comeback in 2016. The index is down 6.1% so far in 2017, according to data from SharePad.

What's the bad news?

Metal and energy prices have taken a hit over the past few weeks. In a nutshell, key reasons are too much supply versus demand, plus new China data has caused many people to speculate about weakness in the world’s second largest economy.

Copper stockpiles have shot up, iron ore has rapidly fallen in price and even oil’s recovery since early 2016 has gone into reverse.

Credit tightening in China is particularly relevant to the negative performance of commodities and shares in natural resource companies.

Chinese authorities are reducing liquidity in the banking system which has pushed up short term lending rates. This harks back to 2013 when authorities deliberately squeezed liquidity as a warning to some domestic banks against taking on too much balance sheet risk via excessive lending.

This is relevant to investors in mining stocks, in particular, as experts now fear that tighter lending in China could hit the property market and reduce demand for commodities used in construction such as copper for pipes and iron ore for making steel.

In March, investment bank Investec gave the view that the Chinese real estate market would remain stronger than many people anticipate as construction ‘starts’ over the past two years continue to lag housing sales.

What should I do next?

Jefferies believes now is a good time to buy shares in miners amid price weakness as it believes underlying fundamentals in the industry ‘remain strong’. Its top picks among UK-listed stocks are Rio Tinto (RIO) and Glencore (GLEN). Coal miner South32 (S32) also gets the thumbs up from the investment bank.

Bill McQuaker, multi asset portfolio manager at fund provider Fidelity, says ‘if you’re going to be positive on a commodity market, make it oil’. He says there are interesting bits of information once you dig below headline data of rising US oil production and a vast increase in US oil rigs.

‘There are signs that the market is beginning to come into balance, with US and OECD total petroleum inventories declining.

‘Member states seem to have been complying with OPEC’s recent production cuts, with signs that these could be extended further throughout 2017. In terms of global market share, OPEC still matters more than the US, let alone shale oil.’

In my opinion, you should never dump your holdings in resource stocks purely off a few bad weeks on the market.

If you believe the market fundamentals and are bullish on the global economy, keep a hold of the resource stocks for the long term.

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