Entering 2018, mining stocks have the potential for a third year of positive returns. The last time the sector pulled this off was during the go-go years of 2003-2007.
Mining can do it, because the global economy is looking at a year where synchronized growth should be the main theme. The caveat to all this is the significant geopolitical risk around the world. Therefore, investors should favor cyclical sectors, with mining being one of them. After all, growth-oriented institutional investors dominate the ownership of the sector.
The unemployment rate in advanced economies, as a whole, is below six percent–the lowest in ten years. Even the eurozone, which has historically been slow to generate job growth, has falling unemployment.
Furthermore, global economic growth continues to be respectable and broad based, with only a few laggards. And global fixed investments steadily recover with emerging economies leading the way. Consequently, commodity prices should remain well supported, and mining companies continuing to generate strong cash flows.
The big diversified miners are accumulating cash at a fast pace, even after allowing for capital expenditures and dividends. If management teams don’t repeat the mistakes of the past–namely spending huge amounts of cash in acquisitions without solid fundamentals–then investors should be rewarded with a bigger cut of the pie.
Miners will continue to decrease their debt positions and share more of the cash with investors. It’s the only way to succeed in an environment where running the business right has become more important than the growth in commodity prices.
As a result, capital discipline remains the name of the game in capital expenditures, too.
Back in the heydays, the big diversified miners were spending 140 percent of their operating cashflows on capital expenditures, essentially borrowing to cover these costs. But, and as has been noted here before, mining companies have cut back capital expenditures by 70 percent since the peak in 2012. Consequently, new capacity is restricted and will remain so for this year–at least on the aggregate.
Obviously, capital expenditures should eventually increase, even this year. But the bet here is that those increases will be better rationalized than before given the changes the global economy and sector has gone through the past five years.
China will, once again, be the pivotal factor regarding commodities this year. The reason is twofold. First, as regular readers may remember, China has been cutting mining production for some time. The Chinese authorities are now reducing production even faster, especially in the least regulated and most environmentally harmful parts.