Big investment banks join those eyeing opportunity in the chaos

Volatility was the theme of last week’s edition of Prospector’s Diary, and boy did we all learn a lot about what that means this week
20th March 2020
Tim Treadgold

Volatility was the theme of last week’s edition of Prospector’s Diary, and boy did we all learn a lot about what that means this week, leading to the question of what’s next. In a word, drought, and the lessons investors can learn from farmers when they hit a dry patch.

The first things farmers don’t do is panic because they know that in Australia drought is as natural as flood.

Anyone who doubts the drought and flood comparison is referred to Dorothea Mackellar’s classic 1908 poem, My Country, which includes the lines about loving a sunburnt country with its “drought and flooding rain”.

It’s during a drought, and we really are in the financial world’s equivalent of a drought, that farmers get ready for the season to turn. They repair roads and fences, dig dams, and they cull the flock, keeping the best rams and ewes and eating the rest.

Brutal as it sounds that’s what today’s investors need to do because we are locked in a process that involves more hardship before (and this is the good news) an inevitable recovery with the great unknown being the date of the revival.

But even as you read this, the seeds of recovery are being sown in the form of massive government spending programs which will (eventually) spark increased demand for the basic raw materials that Australia exports and renewed interest in gold because too much liquid cash is going to debase all fiat (paper) money, leaving gold as one of the few trusted currencies.

A second piece of good news is that China, which is where the coronavirus crisis started, appears to be emerging from its lockdown with a significant development yesterday being news that no new local virus-infections were reported for the first time in two months.

As the big picture of public-health protection measures is painted and alarms sound, such as Qantas cancelling all international services, investors should be doing the farming world’s equivalent of culling the flock.

That means selling (if it’s not too late) any sub-standard stocks in your portfolio, or those not expected to survive the drought, clearing the way to restock when recovery kicks in.

Several pointers have emerged during this week’s wild trading, with the rest of the world likely to follow events in the place where it started: China.

UBS, a leading investment bank, pre-empted the news from China about no new local infections with a promising analysis of that country’s property market, a major consumer of raw materials under the headline: “China property to the rescue?”

The question mark left a touch of doubt but the overall assessment was that a recovery in cement consumption and power demand pointed to the building industry heading in the right direction.

Macquarie Bank followed UBS with a fresh and remarkably positive view of iron ore miners which are exposed to Chinese steel demand and continue to benefit from Brazil’s slow recovery after last year’s outages.

Significantly, every Australian iron ore miner is on the Macquarie buy list thanks to an unexpected, and very under-reported, increase in Chinese steel prices.

Fortescue Metals, the leading pure-play iron ore miner, is a useful case study, trading at $10.69 when Macquarie published its latest analysis on Monday. The stock is now up to $11.15, heading for the bank’s price tip of $12.40.

BHP, trashed because of its exposure to the sharp fall in the oil price, is forecast by Macquarie to reclaim a $41 share price, a country mile above last sales of $26.82, while Rio Tinto is said to be heading back to a share price of $100, well ahead of last sales at $81.69.

The views of one investment bank will not be enough to convince investors that it’s safe to consider a spot of bargain-basement shopping, but there are positive signs that indicate a bottom forming in the market as portfolio culling continues.

The dollar, not always a factor in investor considerations, is returning as a major force in driving the earnings of Australia’s export industries and at its latest value of US55c, the impact on key commodities is profound.

Gold, which has been tossed out with the bathwater by some investors, has traded up to an all-time high in Australian dollars, reaching $A2662 an ounce thanks to the collapse in the local currency.

Leading Australian goldminers are benefitting from the higher local price, but not as much as might be expected. Northern Star, for example, has moved up from $10.10 to $11.08 over the past week, but is expected to reach $13.50, according to J.P. Morgan.

Macquarie’s view of the gold sector is that value is emerging thanks to the rising local gold price and the fact that the entire sector is down 28% since the start of the year.

After noting the “disinflationary” shock of the collapse in the oil price, which helped rub $US200 an ounce off the gold price, Macquarie reckons the worm is turning.

Interest rates near 0% and the re-introduction of non-conventional monetary policy mean that gold is in a perfect condition to flourish.

“In our view, the earnings outlook for Australian gold miners remains strong,” Macquarie said. “Balance sheets are in good order with downside protection from hedging.

“There is even the potential for a cost-out story as lower energy prices filter through.

“The recent sell-off offers investors an opportunity to reset and upgrade their gold exposure. We reiterate our outperform recommendations on Northern Star and Saracen which offer all the benefits of exposure to $A gold along with the best growth in the sector.”

Morgan Stanley’s view of the mining world is also encouraging, with buy recommendations on a number of over-sold stocks, including sector leaders BHP, South 32 and Newcrest, but also including smaller stocks such as Western Areas and Sandfire Resources.

Citi has the most optimistic outlook of the big banks and while not exactly predicting a quick flip from drought to flood it is very much in the oversold camp.

“There is some reason to be hopeful about the second half recovery, which is our increasingly high-conviction base case,” Citi said.

“We see copper, nickel and the platinum group of metals as standout medium-to-long-term performers.”

The challenge for investors during the drought is to do what farmers do, repair the fences, cull the flock and get ready for the season to turn.

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