With many investors around the world still worried about the action in gold, silver, and the mining stocks, one firm just told clients to over-weight mining stocks in their portfolios and laid out the reasons for a boom in commodities in 2017.
Below is a portion of a lengthy report issued today by UBS on the mining stocks as well as the metals.
Portion Of UBS Report: Strategy for 2017 – Upgrading the sector to over-weight
As we transition into 2017, we upgrade our recommendation for the Metals & Mining sector from market weight to over-weight. We are cognisant that commodity & equity prices have rallied hard this year; however, we think i) earnings momentum will lead to strong free cashflow, healthy balance sheets and improved returns through the upcoming reporting season, ii) China’s construction pipeline underpins solid demand through 2017Q1, iii) Global fiscal policy may be more accommodative through 2017; and, iv) selected supply cuts & producer discipline will remain…
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What will we be watching in 2017?
Our base case for China is property starts to be maintained with 0-2% growth forecast for 2017, as well as infrastructure investment to remain strong. Subsequently, we will remain focused on sales, inventory and new starts. Global fiscal policy could provide a boost to commodities, so we will be watching PMI’s and the CRB Raw Materials Index. For the equities, we believe free cash flow and improved returns will remain the focus for investors. Within the base metals sector, we believe reduced investment in new projects over the last 3-years could see markets tighten further, in this environment companies looking for growth may struggle with the ‘buy vs build’ conundrum.
Preferred commodities and equities
We continue to prefer base metals (Cu, Ni & Zn), which are more exposed to fit-outs in China & accelerating US growth; and, are undergoing a rebalancing. Our price forecasts are above consensus, due to an improving view on China demand & an above consensus oil call (reflation). Preferred equities include Glencore, Norilsk and Southern Copper. Our least preferred commodities are coal and manganese due to our belief that current prices are unsustainable and likely to retreat in 2017 – the potential speed of the retracement will ultimately determine the impact on miner’s earnings next year.
Q: Is it too late to buy the miners ?
A: Despite the strength of the sector in 2016, we believe investors should be overweight the miners going into 2017. In our view, the upcoming financial reporting season is likely to provide some pleasant surprises in terms of free cash flow, balance sheet strength and shareholder returns. Beyond Q1, some questions do remain; however, new property construction and infrastructure investment in China are likely to underwrite better commodity demand well into 2017e. Elsewhere, policy has emerged as both a supply and demand side risk (Coals, Mn, Ni), with Fed normalization, US/China/Euro government transitions and the shape/extent of stimulus to be scrutinized closely.
Q: Which commodities offer the best risk/return into 2017 & why?
A: In our view, copper, zinc & nickel are the commodities that investors should maximize exposure to. These metals tend to be later cycle & are benefiting now from fit-out demand from China’s still buoyant property market. They are also more exposed to US economic growth and a current rebalancing. We see bulk prices as unsustainable at current levels; however, we believe the speed & magnitude of price retracement will be slower & lower than consensus providing cashflow windfalls to producers.
Upgrading to overweight: As we transition into 2017, we are upgrading our previous market weight recommendation to overweight.
Base metals rebalancing, investor rotation ongoing: From a commodity perspective, we see supply in the base metals beginning to tighten at the same time as China’s property & infrastructure construction is showing some resilience. Should a global fiscal response be forthcoming, further tightness could occur. For this, we will be watching global policy trends (including US Fed interest rate normalization) and PMI data. For the equities, our EPS and DPS upgrades For the equities, the upcoming reporting season highlight significant free cash flow generation and the likelihood of improved shareholder returns.
1) China’s 2016Q1 stimulus saw property and infrastructure investment at levels above those expected, which saw a lift in the CRB at the start of the year. Recently, the CRB has broken out again, suggesting an uptick in activity (also in-line with rising PMI’s)
2) Rising oil prices (energy costs) and a weaker US dollar thanks to the US Fed moderating rate normalisation path expectations are putting in place reflation pressures; cost curves are no longer deflating
Executive Summary
In terms of how UBS views the global economy as we transition into 2017, the macro picture is a story of modest improvement with global growth to increase for the first time in 7-yrs to 3.5% from 3.1% in 2016. Key drivers of our view include:
- Above consensus growth in the US
- Recovery in oil sector related investment
- Several EM (Emerging Markets) emerging from recession (Brazil, Russia, and Argentina
- US $ likely to have peaked against G-10 currencies
With China still remaining the key market for most commodities, we continue to focus on the high frequency data around property and infrastructure. Ultimately, we believe new property construction (0 – 2% growth forecast for 2017) and continuing strength in infrastructure investment in China are likely to underwrite better commodity demand well into 2017e. This demand could potentially be further boosted by global fiscal policy leaning to additional infrastructure investment.
Subsequently, we upgrade our recommendation on the Metals & Mining sector to over-weight from our previous market weight position. In addition to the underlying picture for demand, momentum for the sector is likely to remain positive with a continuation of the earnings upgrade cycle, in our view. ***ALSO JUST RELEASED: UBS Says “Gold Down, But Not Out” – Plus A Look At The Silver Market CLICK HERE.
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