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Mining Stock trades at a discount to the Market

· mining,stocks,brokerage,investing

Generally speaking, mining stocks trade at a discount to the market, even the most established ones that rank highly on major international stock exchanges like NYSE, ASX and HKSE, are trading at a fraction of their fair market value.

Companies such as Glencore, BHP Bhiliton, China Shenhua Energy and Value produce a range of minerals critically essential to civilisation today, operating projects situated in a range of geographies. They ought to be doing better on the Stock Markets shouldn't they?

BlackRock’s Evy Hambro outlined in a recent Bloomberg TV interview, the factors that set to drive investment in the mining sector. "Years of under-performance, due to a combination of synchronous global growth and under-investment in new supply is now driving commodity prices." said Evy, "Many commodities, including oil are at multi-year highs. The discount that the sector is trading at relative to the historic multiples is a reflection of the underweight that most investors have to this sector.”  Evy Hambro manages the firm’s $6.4 billion World Mining Fund.

Mining stocks in fact, did show a remarkable recovery last year after commodity prices staged a comeback following three or four years of reversion. But on almost any metric compared against the broader market, they continue to trade at a discount, be it "price-to-book" or "price-to-cash-flow".

Different Risks, Different Rewards

Perhaps one of the factor that work against mining company performance on the stock prices are news during exploration and pre-development.

If a mining major like BHP Bhiliton or Rio Tinto, who has hundreds of deposits staked and/or being mined, news about contents of any single deposit aren't likely to shake the stock value too much. A news indicating a change in the market value of a mining deposit will have a larger effect on a junior mining company than a mining major, because that deposit makes up a larger percentage of the junior miner's portfolio compared to the portfolio of mining major. Unless the deposit is a significant world-class deposit owned by the mining major like the Jadar Project in Serbia owned by Rio or Pilbara Iron Ore owned by BHP. Vice-versa, junior miners will see a much larger effect on their stock price on news relating to a new deposit or a failed deposit. A junior mining stock lives or dies on the results of its exploration programs.

A junior mining stock typically sees the most action leading up to, and immediately after, an announcement about activities or results on its exploration program. If the news is positive, such as favourable assay results from their current program, then the value of the company may shoot up. The opposite, of course, is also true. Often, a junior miner won't explore a feasible deposit to the end. Instead, they sell the deposit (or the company) to a larger miner and move on to search for another one. In this sense, junior mining stocks form an exploration pipeline that feeds the major miners in the end. In this view, the big risks and rewards mostly reside at the junior mining level.

Choosing how to invest

As an aspiring mining investor, you're probably wondering whether you should invest in junior mining stocks or major mining stocks. The answer depends on what you are looking for. Juniors have the potential to offer a lot of appreciation in the right market. This makes them an ideal destination for risk capital, but hardly the best place to put your CPF or Superannuation checks. If you are looking for a lower-risk stock with the potential for dividends and some decent appreciation, then major mining stocks may be for you.

3 possible fates

Generally, for the juniors, there are really three possible fates.

  1. Most common is failure, which leaves a hole in everyone's pocket, including that of the banks and investors.
  2. The second fate occurs when a junior has enough success to justify a major paying a decent premium to gobble it up, leading to decent returns all around.
  3. In the third and most rare fate, a junior finds a large deposit of a mineral that the market wants a lot of, and continues to explore and develop and become a producer themselves. It is a magical combination of the right (usually world-class) deposit at the right time. When this happens, juniors can return more to investors in a short time than a major will return in years.

China will drive foreign direct investment into Mining Companies

The value of global mining and metals deals hit a four-year high in 2017, according to accountancy firm EY, boosted by a jump in money raised on stock exchanges to a six-year high. Mining and metals deals totalled $51 billion last year, up 15% from 2016. Activity was dominated by coal and steel transactions. However, the volume of deals fell 6% as M&A focus in the sector started shifting from divestment to strategic acquisitions, EY said in a quarterly report on the sector, published on Monday.

“Last year we saw fewer deals but at better values. In 2018, we expect to see more deals supported by investment-led strategies to diversify by commodity or region. Some of this activity will be to shape portfolios for future growth and sustain shareholder returns.” said Lee Downham, EY Global Mining and Metals Transactions.

"Some of this activity will be to shape portfolios for future growth and sustain shareholder returns," said Mr Downham, "but the return of transformational consolidation across the industry is unlikely as capital discipline is maintained".

Already Canadian miners are definitively back in the mergers and acquisitions (M&A) game, with the value of such transactions hitting $25 billion during the first three months of the year, or 86% more than in the same period of 2017, though volume of deals was slightly down. Canadian miners have also successfully raised capital on the private markets this year.

Critical materials for the making of batteries that power electric cars, particularly lithium and cobalt, led the pile, with the transformational merger between two giant potash producers, PotashCorp and Agrium, being the top example, a study published Thursday by Ernst & Young reveals.

With Trump administration's America First policy affecting curbing imports (using tariffs and other protectionists measures) on 35 minerals including Lithium, Cobalt and Uranium, North American Companies have no choice but to raise to produce these critical minerals. And this means China electric vehicle battery producers will continue to look to North America and its companies for critical minerals like Lithium and Cobalt.

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