Mining Stocks: Can the Trump Bump Last? - Barron's

BHP Billiton Ltd BHP.AU 0.7131537242472267% BHP Billiton Ltd. ADR U.S.: NYSE ^USD38.13 0.27 0.7131537242472267% /Date(1478815320802-0600)/ Volume (Delayed 15m) : 8149205 AFTER HOURS ^USD38.06 -0.07 -0.1835824809861002% Volume (Delayed 15m) : 77509 P/E Ratio N/A Market Cap 55454005006.7397 Dividend Yield 1.4686598478888016% Rev. per Employee 473754 More quote details and news » (BHP.AU) (AUD24.96, Nov.10, 2016)

Independence Group (IGO.AU) (AUD4.82, Nov.10, 2016)

Rio Tinto Limited (RIO.AU) (AUD59.38, Nov.10, 2016)

Western Areas WSA.AU -0.6369426751592356% Western Areas Ltd. Australia: Sydney ^AUD3.12 -0.02 -0.6369426751592356% /Date(1478902263000-0600)/ Volume (Delayed 20m) : 3841820 P/E Ratio N/A Market Cap 762251599.518932 Dividend Yield 2.5641025641025643% Rev. per Employee N/A More quote details and news » Limited (WSA.AU) (AUD3.06, Nov.10, 2016)

Following the unexpected results of the US election and (even more surprising?) response from the markets, we outline some high-level thoughts on the resources sector specifically as it pertains to our Australian coverage universe.

1. RBC’s US Economist suggests a Trump presidency could re-invigorate the US economy. Lower taxes, regulation and an increase in fiscal stimulus could provide a boon to the US and is no doubt part of the driver for renewed enthusiasm for base metals observed in recent trading. Although we’re amateur economists, this sounds plausible for the near-medium term, although two things nag at us: the impact on inflation of additional stimulus on top of the easing we have already seen over the last 4-5 (6, 7, 8..) years and; the impact on the global economy of a rampaging/resurgent America (which would likely see an appreciating USD, as well as interest rates on USD debt). Is this a zero-sum game? Can the US experience an economic renaissance at the expense of the rest of the world OR while we are still seeing negative rates in Europe and Japan? How does this play out medium-long term - particularly if pre-election commentary about protectionism/trade tariffs are actioned?

2. Emerging downside risk to gold price? While Australian gold companies are well positioned under spot fx and gold price, trading has been volatile. A stronger US economy in the near term is likely to see a continuation of pressure on the gold price, and is somewhat contrary to the prevailing views leading onto the election (as gathered anecdotally). The shining light here for Australian producers, is that simplistically we would expect to see a stronger USD/weaker gold price followed closely by a declining AUD, which would help preserve the margins of local producers. Based on trading moves over the last week we wouldn’t expect Australian gold producers to avoid share price falls, this currency relationship would better position Australian (and other local currency exposed producers in Canada etc) producers, and would be an appropriate relative trade for gold focused investors.

3. We’ll be watching fund flows into/out of the ETF’s (Van Eck GDX/GDXJ, SPDR etc) to see whether the trend over the last 9 months starts to reverse and the slow/long money also starts to buy into the ‘Vitamin T’ shot to the economy. In our view, this remains the best indicator of sentiment around interest rates, inflation and by-proxy the gold price.

4. However, the longer term upside to gold price may be elevated if the ‘Trump-experiment’ ends in tears (and it might be a while before we know that). If less-regulation and tax cuts can’t adequately stimulate the economy to fund “making America great again”, the country’s balance sheet could become even more burdened. Numerically to reflect such an outcome in our estimates, we would lower the near term gold price forecast (which is currently US$1500/oz in CY17/18), but also increase our LT gold price forecast (US$1300/oz from 2021). this would manifest in our models with softer near-term cash flow, but given the relatively and generally shorter mine life (compared to North American producers) would not necessarily lift longer term NAV metrics for local producers.

5. While the recent moves in copper are understandable given the market commentary post-election, it is worth reiterating several items. Firstly, we (and most) in the market are (were) already assuming a base-case rise in copper price (RBC US$2.50/lb CY18, US$3.15/lb LT from 2021), so the moves of the last week are effectively bringing forward the kind of earnings many will likely have already forecast for CY17/18 anyway. In addition, we believe consumption of copper in the world’s largest consumer (China) is still significantly more important than incremental moves in the US. Whilst our estimates already have some recovery in demand baked-in (+3.7%in both 2017 and 18), growth in the US at the expense of China and potentially the rest of the world is likely not sufficient to sustain higher copper prices to a level where we would need to increase our long term assumption (and therefore lift the valuation of companies under our coverage).

6. Moves in the bulks started before the election, and we’re not sure to what extent stimulus in the US is likely to assist in demand for either iron ore or seaborne coal - especially if (as inputs to steel making) America is intent on providing its own inputs. We think (although without proof) iron ore is undergoing a transition whereby futures/paper-positioning is now the price benchmark, meaning daily prices can become more removed from fundamentals. This has long been the case in oil, and to a lesser extent in copper, but importantly is not yet the case (as far as we understand) in coal due in part to the more diverse range of products. Despite the move in iron ore stocks, we reiterate our house forecasts which commence 2017 at US$65/t and average US%59 throughout the course of the year. As we understand this is well ahead of consensus, it means that spot prices are largely factored in to the June year-end miners under our coverage.

7. Lastly, we highlight the pricing effect on commodities. A strengthening base currency naturally results in lower prices when all else is considered equal. In the event that the US consumes more metals (but no-one else does), could this actually result in price declines (in USD terms)?

Our thoughts:

So what matters now is the duration of this renewed exuberance (let’s not forget, the market was selling off at the prospect of a Trump presidency as recently as a week ago when the FBI announced a second investigation which implied a greater prospect of a Clinton loss at the election!). It appears as though the gold stocks are destined to be the laggards, as any of the remaining miners enjoy what seems to be a broad rotation into the sector which is largely commodity and company agnostic. The more liquid names should benefit (hence we see BHP/RIO with the same kind of daily performance as relative minnows WSA and SFR), while the market fails to pause and appropriately assess exactly what it is paying for (that comes later... if at all). It feels like momentum is key now, and to that end excessive bottom-up analysis of commodity price, management, asset quality and growth are all redundant (for example, OZL’s 30% and IGO’s 30% gold exposure hasn’t bothered investors in recent days).

Company Name	Exchange	Ticker	Rating	Risk Qualifier	Price Target (AUD)	Price (AUD)
BHP Billiton Limited	Australian SE	BHP AU	Sector Perform	Not Assigned	22	24.96
Independence Group NL	Australian SE	IGO.AX	Sector Perform	Not Assigned	3.2	4.82
Rio Tinto Limited	Australian SE	RIO AU	Outperform	Not Assigned	60	59.38
Western Areas Ltd	Australian SE	WSA.AX	Underperform	Not Assigned	1.8	3.06

The companies mentioned in Hot Research are subjects of research reports issued recently by investment firms. Their opinions in no way represent those of Barrons.com or Dow Jones & Company, Inc. Share prices at the time the report was issued and the date of the report are in parentheses.

To be considered for this feature, please send material to asiaresearch@barrons.com

Comments: E-mail online.editors@barrons.com