Why mining stocks are due for a 20% drop - MarketWatch

A rip-roaring recovery for European mining giants have seen the sector zip past other industries this year, but the striking performance is set to come to an abrupt end, according to Deutsche Bank.

Coming out of a horrible 2015 — plagued by huge debt loads and crumbling commodity prices — the miners across Europe have shot higher since mid-January, so far mustering an impressive 90% outperformance relative to the broader stock market.

“Since the middle of March, copper has fallen by 9% and the U.S. dollar has risen by 2%, both negative signals for mining — yet, the sector has nonetheless outperformed by a further 30%,” the analysts led by Sebastian Raedler, noted in a report out on Friday.

But that’s all coming to an end now. Based on the outlook for copper HGZ6, -0.33%  and the DXY, +0.40%  dollar, the bank’s model for the European mining sector is now pointing to a 20% selloff.

Read: Dollar jumps to 8-month high as euro retreats

“The model’s projected downside is larger than at any other point over the past three years,” they said, reiterating their underweight stance on the sector.

Looking at year-to-date performances in Europe, mining companies are at the top of the list. Anglo American PLC AAL, +2.82%  has soared a whopping 268%, followed by Glencore PLC GLEN, +0.21% GLCNF, -0.82% 0805, +0.44%  up 163%, ArcelorMittal SA MT, +4.56%  148% higher and Fresnillo PLC FRES, -0.24%  up 133%.

Out of that bunch of the four top performers, only ArcelorMittal is not British, highlighting an important point about the sector’s ability to continue to rally this year.

Around 75% of all European miners are listed in the U.K., where the pound GBPUSD, -0.1387% GBPEUR, +0.3746%  has plunged against other major currencies following the Brexit vote in June. That means the London-listed miners are getting a FX-related boost to their earnings when they translate their overseas profits back into sterling.

However, that correlation is not stable and won’t continue to be a boon for the industry, Deutsche Bank said.

“It is likely to dominate only in periods of sharp pound moves and low metal price volatility. In a scenario of falling metal prices and a gradual pound depreciation, mining is likely to underperform,” the strategists said. “However, any further political shock in the U.K. would likely boost mining’s relative performance.”

The basic material miners are so far showing no signs of fatigue, with heavyweights such as Glencore, Rio Tinto PLC RIO, +1.91% RIO, +2.07% RIO, -0.02%  and BHP Billiton BLT, +0.37% BHP, +0.83% BHP, -0.37%  all showing sizable gains in recent months, including October so far.

But it’s a different story for its precious-metals peers. Silver SIZ6, -0.45%  and gold GCZ6, -0.14%  miners are among biggest decliners across all industries, falling in step with their underlying metals. The VanEck Vectors Gold Miners ETF GDX, -1.29%  is off 6.8% in October so far, while Randgold Resources Ltd. RRS, +1.27% GOLD, -0.30%  has dropped 8.2% and Fresnillo is down 9.2%.

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