Risk appetite on the comeback in mining stocks

Resources is one of the few sectors where value buys can be found and Glencore’s US$2.6bn bid for Rio Tinto’s assets will put the spotlight on the sector. But there are other reasons to be bullish.

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Mining stocks are back in focus as Glencore crashes the Yancoal Australia Ltd (ASX: YAL) party. The Swiss mining giant has kicked off a bidding auction for Rio Tinto Limited’s (ASX: RIO) coal assets.

This is an interesting development for all investors who have been asking themselves if mining stocks need higher commodity prices to look attractive. This has been a particularly poignant question given that the price of most hard commodities, such as iron ore, have been sliding over the past two to three months due to oversupply worries at a time when the global economy is struggling to gain growth traction.

These worries have not stopped Glencore from offering up US$2.55 billion for Rio Tinto’s Hunter Valley coal assets, which is US$100 million more than what Yancoal was willing to cough up.

This news is likely to give Rio Tinto’s share price good support when the stock starts trading again on Tuesday, although all investors should be paying close attention too as this development will lend support to the argument that mining stocks are good value even though some analysts are expecting iron ore prices to fall towards the US$40 a tonne level in the not too distant future.

That could well lead to further declines in the mining sector over the near-term as mining shares are heavily correlated to commodity prices. What’s more, I am also expecting a further market correction that may well drag resource stocks lower with the S&P/ASX 200 Index (XJO).

But investors should be using any weakness as a buying opportunity as there are a number of reasons to be bullish on the medium-term to longer-term investment horizon.

For one, the larger mining companies are arguably one of the most cashed-up sectors on the market thanks to aggressive cost cuts, a significant ramp-up in production from the last capex cycle, and extreme conservatism as they had to bunker down a few years ago when commodity prices looked like they were falling off a cliff.

This means their fairly attractive dividend yields are sustainable and investors are likely to benefit from capital returns from the likes of BHP Billiton Limited (ASX: BHP) as cashed up miners struggle to find meaningful ways to deploy their cash. This is one sector where some value can still be found.

Further, falling commodity prices are largely reflected in share prices. Consensus estimates are forecasting a drop in profits until FY18 at least.

Lastly, the “smart money” has been coming back into the sector, particularly the junior end of the market. Brokers and wealth managers in Perth only wanted to look at tech and biotech companies 12 to 18 months ago and had no appetite for resources.

However, the tables have turned in more recent months with these same parties telling me they have lost interest in tech stocks and are now actively seeking meetings with mining juniors.

Don’t get me wrong, this isn’t a bull market for resources by any stretch of the imagination as there is still a pervasive air of caution, but it’s clear that risk appetite is returning after several years of famine.

Outside of the mining giants, I think BHP’s unwanted child South32 Ltd (ASX: S32) looks very attractive too. I “inherited” some from holding BHP shares and I am hoping to top up my holdings if the stock pulls back under $2.50.

Those looking for more speculative plays, should keep an eye on Sliver City Minerals Ltd (ASX: SCI) and Metals X Limited (ASX: MLX).

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Motley Fool contributor Brendon Lau owns shares of BHP Billiton Limited, Rio Tinto Ltd., and South32 Ltd. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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