Stocks across commodity classes have experienced terrific price rises in recent weeks thanks to the broad recovery in resources prices.
Dedicated copper miner Antofagasta (LSE: ANTO) has seen its share value sprint up 23% in the past month, while gold producer Randgold Resources (LSE: RRS) has seen its price rise by a quarter during the period.
And those providing support to the mining and energy industries have also enjoyed strong rebounds. Pumpbuilder Weir Group (LSE: WEIR), for example, has seen its share value advance 22% since the corresponding point in February.
However, I believe these heady rises leave the stocks in peril of a significant share price correction.
Demand still drags
Quite why commodity prices have staged such a turnaround remains rather questionable, in my opinion.
Sure, further rounds of quantitative easing by the People’s Bank of China — allied with chatter of similar measures by the European Central Bank — have boosted hopes that a significant uptick in resources demand could be in the offing.
But such action has consistently failed to light a fire beneath underlying commodities demand, as illustrated by fresh Chinese industrial data. The official manufacturing PMI index remained in contractionary territory in February, falling to a five-year nadir of 49.
Against this backcloth it is hard to expect a turnaround for copper-play Antofagasta’s bottom line in my opinion — China is the world’s top ‘red metal’ importer by some distance.
This scenario also bodes ill for the oil sector, particularly as production volumes across OPEC nations, Russia and the US continue to climb. Indeed, many oil majors have introduced fresh near-term troubles and introducing additional operational cutbacks in a desperate bid to conserve cash.
The situation has forced Weir Group to warn that “2016 will be another challenging year … driven primarily by lower activity levels in upstream oil and gas markets.” The company saw orders at constant currencies slump almost a quarter last year, to £1.88bn.
Gold gallops
Of course the gold market is not subject to the same supply/demand pressures as most other major commodity classes. But that does not mean the likes of Randgold Resources are quite out of the woods.
A rush to ‘safe-haven’ assets has seen gold march 21% higher during the course of 2016, the metal hitting its loftiest price since January last year in the process, at around $1,280 per ounce. Gold’s ascent has been helped by a significantly weaker US dollar in recent weeks, also.
But I believe the likelihood of a resurgent greenback in the months ahead could put paid to gold’s rally, a scenario that would also play havoc for other dollar-denominated commodities. This would, of course, put additional pressure on Weir Group and Antofagasta, as well as Randgold.
Prices fail to reflect risks
The City expects Antofagasta to enjoy a 62% earnings bump in 2016, while Randgold is anticipated to see a 13% uptick. Weir Group is predicted to endure a 26% bottom-line drop in the period, however.
But regardless of whether these numbers suffer substantial downgrades — a very real possibility, in my opinion — I believe that all three firms remain grossly overvalued at the present time. Antofagasta and Randgold deal on huge P/E ratios of 80.3 and 42.7 correspondingly, while Weir Group carries an earnings multiple of 16.7 times.
Considering the gargantuan long-term risks facing all three stocks, I would consider a reading closer to the bargain benchmark of 10 times to be a fairer value.
Given the poor state of the commodities sector, I reckon a sharp correction to bring all three share prices in closer correlation with this reading is a very real possibility.
