China has been the key driver of growth in mining over the last decade. With China still growing at a healthy 7.7%, why are mining shares coming under so much pressure?
The Australian sharemarket (ASX 200) is up by 11% in 2013 so far. In contrast the materials sector is down 13% for the year so far. What is driving the losses in the share prices of mining shares?
Share prices reflect future expectations
Have you ever seen a company announce a record profit only to see the share price fall? Or bought a good quality, solid business to only watch the share price track sideways for years? A key principle of share prices is that future expectations are already priced in. Hence, for the share price to rise there needs to be a change in those expectations.
Let’s look to China with the healthy 7.7% growth rate. While 7.7% is a good growth rate, the expectation was for growth to hit 8%. 8% growth is the number that had already been built into share prices and commodity prices. When the number came in below expectations, prices had to adjust for the new information. Since expectations around future growth were revised down, it makes sense that prices tied to China’s growth also moved lower.
While China is still growing at a solid 7.7%, that means that growth is slower than what was priced in. We are seeing a period now where expectations around growth in China and hence the world are being revised. It’s a period of adjustment to the new information.
So despite many mining companies having a solid balance sheet, strong cash flow and profits, expectations around future growth are changing and that is what is impacting prices lower.
Are there any opportunities in the sector?
Individual companies can also be boosted by catalysts within the business rather than the big macro factors. This can include events such as new discoveries, resource upgrades and takeover interest to name a few. While these factors are important to the underlying business and future profitability, the reality of a bear market in commodities means that even good news is discounted. It can be hard to move against the tide.
One thing to watch out for is a change in dividend policy. Woodside Petroleum (WPL) recently changed its dividend policy. Instead of paying out around 50% of profits as dividend, it’s decided to pay 80% of profits. It means that investors get a larger part of the profits as income. This move together with the payment of a special dividend has seen Woodside’s share price rise higher. A potential positive catalyst for mining stocks is the lifting of dividends. Watch companies like BHP & RIO to see if they follow suit. This could provide a lift for the share price.
A larger turning point for the sector will be when growth expectations for China and the world are revised upwards instead of down. China’s growth peaked at 13% in 2007 and is currently at 7.7%. Once expectations start being revised upwards, this should have a positive impact on mining shares.