EquitiesSep 30 2014

Mining stocks slump hits resources and income managers

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A sharp downturn in global mining stocks will have hurt natural resources funds as well as a slew of UK equity income managers, as the sector has been hit by oversupply and fears of a slowdown in China.

Between July 29 and September 25 the FTSE World Mining index fell by 12.7 per cent, leaving it down by 2.75 per cent so far this year.

A drop in China’s industrial production has hit the market. The country’s growth has fallen to its lowest level since the financial crisis, while its property market has continued to weaken amid falling sales volumes and unsold inventories.

The sharp fall will have hit resources managers in particular, but also several high-profile UK equity income managers who have built up stakes in the likes of Rio Tinto and BHP Billiton in the past year.

Rio is now one of the top-10 holdings in 26 of the funds in the IMA UK Equity Income sector.

But managers have suggested the sell-off was unlikely to continue, as they predicted demand for metals would outstrip supply and prices would begin to rise again.

The price of iron ore has collapsed this year, from more than $130 (£82.3) per tonne to closer to $80. This has affected diversified miners across the world – in particular, those heavily exposed to iron ore, such as Rio Tinto.

The Australian company last week took the step of reassuring investors that its progressive dividend policy was completely safe with the iron ore price at $80 per tonne.

But James Sutton, a member of Neil Gregson’s JPM Natural Resources fund management team, said: “If the price goes down another $10, then I do think that dividend payments will be under threat.”

However, Mr Sutton said he did not think the price would fall that far because there were a lot of iron ore producers for whom the total cost of extracting a tonne of iron ore was $80, so they would be making no profit at the current price and would have to close operations if the price fell further.

This would then lead to the supply of iron ore diminishing, which, barring another downturn in global demand, would result in a recovery in the iron ore price.

Joanne Warner, head of global resources at First State Investments, said that, in general, the “mining sector can be classified as being close to the bottom of the cycle”.

Ms Warner predicted the problem of oversupply in the market would not remain the case for long.

She said: “We believe this downturn could be shorter than previous downturns because demand for most commodities remains quite robust; it has primarily been the increase in new supply that has resulted in price weakness.

“As investment in new supply is curtailed and global growth slowly continues, we expect this mismatch to reduce.”

In spite of Mr Sutton’s fears for mining dividends, Ms Warner said “some diversified miners could increase their dividend payments by more than 30 per cent over the next three years”.

Ms Warner said she had been reducing her fund’s overweight energy position in favour of miners because of the attractive valuations in the sector.

Mr Sutton said the JPM Natural Resources fund was only focused on miners that had the lowest costs per ounce of iron ore extracted, one of which he said was Rio Tinto.

But he said he would not be adding to his position because such a price recovery “always takes longer than you expect”.

EQUITY INCOME FUNDS HOPING PRICE FALLS WILL NOT HURT MINING DIVIDENDS

Aviva Investors UK Equity Income

Chris Murphy

While his fund has very little in the overall basic materials sector – just 7.5 per cent – that whole allocation is divided between Rio Tinto and BHP Billiton which, at 4 per cent and 3.5 per cent respectively, are the top two holdings.

Mr Murphy said earlier this year that he had increased his conviction about the prospects for the two firms following meetings with the new chief executives, who had laid out cost-cutting and sustainable dividend plans.

Rathbone Income

Carl Stick

Rio Tinto occupies the second-biggest weighting in Carl Stick’s fund, at 4.51 per cent.

Mr Stick first bought into Rio in 2013, having long avoided investing in the mining sector. The stock quickly entered the fund’s top 10 and has carried on rising through 2014.

Like Mr Murphy, he was attracted to the more disciplined, cost-cutting approach from the Australian miner, pitching it as a stock-specific purchase.

JOHCM UK Equity Income

Clive Beagles and James Lowen

Like Mr Stick, managers Clive Beagles and James Lowen have held a dim view of mining stocks for several years, as they have tended to avoid stocks heavily exposed to emerging market growth.

However, they first started to buy into Rio Tinto and Glencore in the second half of 2013.

The two stocks are now firmly ensconced in the JOHCM UK Equity Income fund’s top 10. Rio Tinto takes up 4 per cent of the fund, with Glencore at 3.8 per cent.