Base metals equities correction presents 'strong buying opportunity'

CIBC analysts recently forecast that base metals prices will remain high despite the current credit crunch, while the correction of equity prices “represents a strong buying opportunity.”

RENO, NV - 

In a recently published industry update, CIBC World Markets suggested that base metals prices should stay high despite current investor fears of slower economic growth.

Meanwhile, CIBC declared that "the recent correction in base metals equity prices represents a strong buying opportunity. With an average pullback of around 30%, most equities are trading at a discount to our long-term NAV estimates."

CIBC analysts Cliff Hale-Sanders and Terry K.H. Tsui said, "The primary question facing investors in the base metals sector is whether the current credit crunch in the U.S. capital markets will result in a lowering of the overall global economy, pushing the metals markets into surplus and re-basing commodity prices."

As problems in the housing and sub-prime mortgage markets have spread, investors are much more fearful of risk, and worry that these issues could result in a modest reduction in global growth rates, which could return commodities to a surplus, bringing the recent bull run to an end, they suggested.

"If metals prices remain robust, as we believe, valuations for base metals equities look very attractive at current levels and we would look to add positions in this environment," Hale-Sanders and Tsui said. "We view this correction as another bump in the road (maybe bigger than one would like) and a buying opportunity."

The analysts noted that the "spectacular bull run in metals prices" has not only been driven by strong base metals fundamentals, "but also by rampant speculation caused by excessive liquidity and leverage within the capital markets as investors tried to take advantage of tight market conditions. With this environment now possibly set to change, there has been a significant unwinding of positions."

Despite the current market turmoil, the analysts said they believed metals prices will remain "well above historical averages until at least 2009 as metals supply growth remains restricted during this period, barring a collapse in demand. Inventories are also expected to remain near historical lows, which should support high metals prices given the potential for ongoing supply disruption."

Nevertheless, CIBC isn't as bullish about "the potential absolute level of metals prices." In the analysts' opinion, "it is hard to envisage a fundamental need for metals prices to move materially higher on an average annual basis to entice new supply."

"If one assumes, as we do, that global demand is positioned to remain positive, albeit at slightly lower growth rates than in previous years, then the global mining industry is likely to continue to struggle to develop new sources of metal supply to catch up to demand despite record-high prices," according to Hale-Sanders and Tsui. "As such, this price cycle appears to have more legs than previous cycles."

CIBC asserts that the mining industry "is well behind in terms of adding new supply and, therefore, we are unlikely to see the traditional boom-and-bust price cycle in the mining sector. ...This, of course, assumes demand remains strong. If demand levels wane, new supply may not be required."

Current metals prices are providing mining companies "significant and abnormally high profit margins from which to grow their businesses and prices remain more than high enough to act as an incentive for new entrants," CIBC noted.

"While it is next to impossible to say if prices have already peaked or are just pausing on their long-term uptrend," the analysts said, "we are confident that prices are set to remain well above historic averages and should result in a sustained period of profitability for the mining sector."

"This period of sustained robust cash flows, combined with low multiples being ascribed to the sector, leads us to believe the stocks are positioned to be re-rated in the market in the next 12 to 24 months."

"In summary, we view the outlook for metals demand as remaining health for the next several years, barring a global recession, which would curtail demand and, in doing so, impact supply-side constraints," the analysts concluded.

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