The worst may be yet to come in the commodity market in 2016, but savvy investors should hang on for the ride, analysts say.
Commodity prices have been ravaged in 2015 as the Chinese economic downturn hit demand for staples such as copper, iron ore and zinc.
The crisis has sparked radical cost-cutting moves by the industry, such as Anglo American’s (LON:AAL) decision this week to axe dividends this year and next.
Many analysts see more woe in the year ahead as the industry adjusts to the new reality of low prices and sluggish demand.
But some say investors would be foolish to ditch the sector altogether, pointing to a rich seam of returns if they place their money wisely.
Hargreaves Lansdown investment manager Adam Laird said the slump is unlikely to last for ever and may offer merger and acquisition opportunities for fitter firms. “I’m not
completely pessimistic in this area,” he said.
Investor gloom
It is not difficult to understand investors’ gloom given the turmoil that has engulfed the sector in the last few months.
Copper prices have fallen to six-year lows of about US$5,600 a tonne as global economic fragility and uncertainty have hit the construction and energy industries in China and elsewhere.
SP Angel sees the price dropping slightly to about US$5,500 in 2016 before gradually rising to US$6,000 in 2017 and US$6,500 in 2018.
But the broker’s analyst Sergey Raevskiy said US$6,500 was “not such a bad price” relative to the US$2,000 it was trading at 15 years ago.
Raevskiy added that Chinese demand had not completely disappeared and economic growth would resume.
“We don’t think prices will collapse from current levels,” he said.
Hargreaves's Laird said the impact of lower prices was still feeding through to emerging economies in Asia and South America, which were feeling the strain.
But he added: "There's a lot of action being taken and if we can stimulate more growth, we may see demand rise again."
Capital Economics was also upbeat about China, saying it believed improved economic activity in 2016 would boost commodity imports.
Capital Economics senior commodity economist John Kovacs said: “This increase in imports in turn supports our forecasts for a recovery in prices next year.”
At the precious end of the metal market, SP Angel reckons gold prices will rise from the current level of about US$1,076 an ounce to US$1,300 in 2018.
US interest rate rises are always a risk as gold stakes do not pay interest, whereas currency holdings do. Hargreaves’s Laird said: “If the Fed raises rates, cash might start to look more appealing.”
But Raevskiy said gold would still keep its value as a safe haven in times of trouble. “It will still be used as an investment tool to diversify risk,” he said.
Eggs in one basket
The commodity slump has caused mining companies, particularly smaller players, to shelve projects, seek partners or even sell themselves to rivals.
International Ferro Metals (LON:IFL) put South African subsidiary IFMSA into administration last month due to the collapse in steel prices and administrators are now looking to sell it to Samancor Chrome before a February 15 deadline.
Another South African group, Lonmin (LON:LMIN), last month confirmed a US$407mln rights issue to help it cope with weak platinum group metal prices.
But others have rode the downturn relatively well, such as lithium explorer Bacanora Minerals (LON:BCN), which hopes to cash in on the growing market for lithium batteries for computers, mobile phones and cars.
Raevskiy said the impact of the downturn was likely to vary depending on where miners operate, what commodities they deal in and the strength of their finances.
“Some companies have low debt and low costs while others are in a mess,” he said.
Hargreaves Lansdown’s Laird said the price downturn could usher in a wave of consolidation in the industry as buyers take advantage of low asset prices to snap up bargains.
Given the fact that the market and the industry are likely to recover at some point, albeit not in the immediate future, analysts say investors should keep the faith.
But as ever, there’s a caveat – spread investments around and don’t put all your eggs in one basket.
Laird said: “Our message is, be cautious. There are reasons to hold stakes in the mining sector, but don’t focus solely on it.”