Morgan Stanley has upgraded European miners to “overweight” and now rates the mining sector overall as “attractive”.
While one broker does not a summer make, markets liked the cheerful outlook nonetheless, lifting Rio Tinto (LON:RIO) by 7.5% in BHPBilliton by just under 5% in response.
The real question of course is: is Morgan Stanley right?
The argument put forward is that newsflow from China is likely to improve during the current quarter and that this, combined with a “four decade trough in company fundamentals” has created a buying opportunity.
“Emerging markets and China in particular remain key to commodities demand,” wrote Morgan Stanley analysts.
“In the next few months we expect the perception around this demand to improve. In particular the acceleration of financial and administrative stimulus policies in China in recent weeks should start to feed through in both actual activity levels and equity market expectations.”
The drop-off in Chinese appetite for copper this year has had a marked effect on the copper price, which has fallen from over US$3.00 per pound this time last year to a current price of US$2.35.
That copper price weakness in turn set off the chain of events that saw billions of dollars wiped off the value of Glencore (LON:GLEN) in recent weeks.
But Glencore too was up on the back of Morgan Stanley’s endorsement.
That’s because Morgan knows Glencore is as exposed to as broad a range of commodities as the other companies it has endorsed, namely Rio, BHP Billiton and Anglo (LON:AAL).
And suddenly, as time is pushing on, it’s becoming a little bit more bullish on commodities.
The broker’s base case scenario for commodities is that prices will rise by 14% in 2016 and by a further 19% in 2017.
“Using those forecasts we estimate 19% upside to our overweight-rated stocks.”
Some of that upside has already been gobbled up by a market desperate for any hint of positive sentiment.
But there could be more to come.
Morgan Stanley also argues that the comparison of a complicated set of metrics including price to book and return on equity shows that the sector is trading at historic lows not seen since the global recession of 1982.
That’s quite a claim, and it’s not one that’s mirrored by actual share price performance.
It’s true that at BHPBilliton’s shares are flat on where they were ten years ago. And the same is true of Rio. But go back 20 or 25 years and shares in both companies are still sitting on market gains, both up several times on the prices they were trading at in the late 1990s.
Morgan Stanley argues that the tightness of the return on capital and price to book ratios ought to ensure that the major companies keep “supply discipline maintained”.
That may be true, and it may in turn be good for commodities.
“Together with weaker project returns this drives large scale cutbacks of new projects even at the industry’s cost leaders. Furthermore, some of the cost savings made across the industry will prove unsustainable in our view.”
Cutbacks in copper output are already in evidence, as Glencore trumpets the closing of African projects.
Other sectors have to date seemed less responsive. Indeed in iron ore, the major companies have indulged in a series of doubling down bets predicated on the idea that what they lose in margin they can make up for by boosting the top line.
That’s cleared a lot of junior and less economic projects out of the development chain. But it hasn’t particularly curtailed production, meaning that oversupply is still a danger.
So there is a temptation to argue that instead of calling the bottom Morgan Stanley has done no more than precipitate a little bit of a dead cat bounce.
BHPBilliton rose a further 3% on the Thursday following the Morgan Stanley note, but even that strength only takes the price back to where it was in the middle of September, and lifts the company off its five year low.
Is there more to come? Undoubtedly. The efficiencies that the tightened metrics Morgan Stanley has referred to will eventually begin to show through on the supply side, driving up commodities prices and in turn boosting sentiment towards the miners.
At their current levels though, shares in both Rio and BHPBilliton are now back at 2005 levels.
And that gives rise to mixed emotions. In 2005 there was a boom in full swing to support those valuations, even though the oil price was US$20 a barrel higher than it is now.
This time round there is no boom – not even a hint of one. And the momentum is in the other direction.
So perhaps what we have here is a signpost from Morgan Stanley. Things may yet get worse before they get better. But watch for the boomerang effect as fiscal discipline applied by the miners feeds back through into the commodities markets and in turn drives up prices.
The conditions for the next upswing are gradually being put into place.