Metals Stay Strong in a Shaky Market

Even as major stock indexes have wobbled in recent weeks, mining stocks keep powering ahead

Market volatility over the past few months has been sufficient to fray the nerves of even the savviest investors. Yet amid the uncertainty provoked by the U.S. subprime mortgage crisis and its knock-on effects, the metals and mining sector has continued to surge on investor optimism. Since Aug. 1, resources giants such as London-traded BHP Billiton (BHP), Rio Tinto (RTP), and Anglo American (AAUK) have posted double digit stock growth—far outpacing the 3.8% uptick in the FTSE 100 index over the same period.

Indeed, BHP Billiton shares hit an all-time high of $39.23 on Sept. 28 after the company announced a $20 billion expansion of its iron ore division. Rio Tinto shares are up nearly 23% since Aug. 1 as investors predict cost savings and ramped-up production from the company's $38.1 billion takeover (BusinessWeek, 7/12/07) of Canadian mining company Alcan. "The mining stocks have done considerably better than other sectors during the credit crunch," says Charles Cooper, mining analyst at NCB Group in London. "Major players continue to generate significant cash flow and have little debt exposure."

Healthy bank balances have in part shielded an industry that historically has faced cyclical booms and busts. According to a study by accounting firm PriceWaterhouseCoopers (PWC), net cash flow from operating activities of the world's top 40 mining companies reached $76.7 billion in 2006, a 40% increase from the previous year.

Commodities at 30-Year Highs

Total market capitalization also rose 22%, to $962 billion, last year, up from $791 billion in 2005. This trend is set to continue for 2007, with PWC's mining, oil, and gas team leader Tim Goldsmith predicting double-digit growth into next year. "Profits for the mining majors are still in line with expectations," he says. "Current market estimates [for companies] are being done on commodity prices that are still undervalued, so their values will certainly rise."

Underpinning such bullish growth is commodity prices that are running at 30-year highs. On Sept. 27 gold bullion hit $747.10 an ounce—the highest since 1980, when prices rose to $850. But the gains aren't limited to precious metals. Copper for three-month delivery peaked at $8,065 a metric ton on Sept. 25—only $735 off the all-time high of $8,800 set in May, 2006—while lead topped $3,475 a ton on the same day, only $25 off its record of $3,500 in July 2007.

Strong demand from China and India have pushed prices through the roof, as mining companies struggle to keep up with growth in their surging economies. Goldman Sachs (GS) forecasts GDP growth this year for China and India of 12.3% and 8.7%, respectively.

Human Resources Strained

The increasing importance of developing economies for miners has offset the recent credit crunch and weakness in equity markets, which has been relatively isolated to North America and Western Europe. "The mining industry is more focused on the jumps and troughs in the Chinese market than on what happens in the U.S., where there has been no real growth in the commodity market for years," says PWC's Goldsmith.

To be sure, there are still some concerns for a sector that is undergoing prolonged double-digit growth. The industry's operating costs rose 23% in 2006, while expenditure for new site exploration rose 30% last year. Rising demand for metals also has put a strain on secondary industries, such as smelting. And supplies of workers, especially skilled engineers, are being strained as companies expand production to keep up with the developing economies.

"Getting the necessary people and equipment could become an issue," says Simon Toyne, mining analyst at London investment bank Numis Securities (NUM.L). "This is lengthening the time it takes to get a project off the ground."

Out of the Way of Volatility

But even given these rising costs, few analysts believe the sector will return soon to the usual boom-bust cycle. Predictions show China and India posting strong economic growth until the end of the decade, and the resilience of the so-called BRIC countries—Brazil, Russia, India, and China—to the recent credit squeeze bodes well for mining companies banking on developing economies to boost their bottom lines.

A slowing global economy eventually could take its toll, but industry analysts believe the sector will outperform others well into 2008. That should come as welcome news to shareholders. After being whipsawed by the ups and downs of commodity prices for so many years, mining is now sitting pretty as other industries face the full force of volatility in the global equity markets.