Nerves of steel are needed if iron rally is over: taking stock

The Stoxx Europe 600 is still stuck in a tight range as the earnings season is getting into full swing. The first results have been generally ok so far, albeit with a low bar. Looking at sector performances, the mining sector is still the top this year and miners have been partying on soaring iron ore prices. But there’s a shift in the newsflow this week, which could crash the party.

Rio Tinto was first to cut its production targets, in a widely expected move. BHP Group followed through with a similar warning. This isn’t a big deal given soaring iron ore prices were still guaranteeing a decent margin improvement that would largely compensate lower volumes and cost inflation. Vale’s unexpected swift restart of production may be a game changer.

Among the members of the Stoxx 600 basic resources index (SXPP), Rio and BHP are the most impacted by iron ore price moves, with 43 and 35 percent of 2018 revenues respectively, while Anglo American has a 13 percent exposure. Outside the sub-index, Ferrexpo is the main pure-play.

Iron ore shipment issues might not be over just yet, the risk could lie in prices getting ahead of themselves in anticipation of massive shortages that may not materialize in the end. It will impact the SXPP as Rio, BHP and Anglo have a 49 percent weight in the index. Analysts have yet to adjust their forecasts, while all three stocks already trade near or above consensus price targets.

It’s not just iron ore, though. Copper is still one of the main drivers of miners’ performance. Prices stalled since the end of February, but seemed to have broken out yesterday. Voices are also warning that the market will go into deficit this year. In fact, opportunities might arise from other metals’ moves, especially as China’s growth held unexpectedly well in the first quarter, and further stimulus measures are still on the table.

HSBC analysts wrote in a note this week that EPS sensitivity is relatively high to base metals for South32 and Glencore, seeing significant potential EPS upside from spot in aluminium, copper, nickel and thermal coal prices. Both stocks have substantial leverage to changes in these commodities’ spot prices, they said.

(By Michael Msika)

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