February 14, 2009 / 5:20 AM / in 9 years

Base metal stocks cheap, but no bargain

TORONTO (Reuters) - Rock-bottom valuations and a huge investment by China would seem to bode well for the future of Canadian base metals stocks, but market pros are still wary of wading into the hard-hit sector.

The investment -- state miner Chinalco said this week it is investing $19.5 billion in Australian mining giant Rio Tinto -- was taken as a sign that top metals consumer China is expecting a swift recovery in materials demand.

But the news wasn’t enough to shift opinion on the base metals sector, where stock losses among established names such as Teck Cominco and Lundin Mining have exceeded 90 percent from last year’s highs.

“I‘m not even looking at that area at the moment,” said Bill Belovay, a resource fund manager at Jones Heward Investment Counsel, who has instead focused his attentions on the resurgent gold-mining sector.

“There’s so many uncertainties. You don’t know who owes who. Long-term commodity prices like coal and iron ore, one doesn’t have a clue where they’re going to settle.”

As recently as last year, the sector was awash in cash, with near-record base metals prices driving rich profits, while miners in towns such as nickel-rich Sudbury, Ontario, earned as much as C$150,000 a year, courtesy of bonuses tied to metals prices.

But the industry has had a rough ride since then, with prices of nickel, zinc, and copper losing more than half their value due to slumping global demand.

This has forced mine closures, mass layoffs, and made deals such as Teck’s debt-funded $13 billion takeover of Fording Canadian Coal Trust look like big mistakes.

Meanwhile, tight credit has boosted the cost of borrowing, or even cut it off for smaller players.

The result has been a 61 percent year-over-year drop for the Toronto Stock Exchange’s S&P/TSX mining sector, which tracks 13 Canadian base metals stocks.

The S&P/TSX venture composite, which tracks a large basket of Canadian junior issues heavily weighted to the mining sector, has fared even worse, dropping 64 percent.

Despite the sharp declines, few are ready to call the market’s bottom, as many unprofitable mines continue to operate, while companies with debt due over the next year could struggle to make payments and face insolvency.

“I think we’re still in the camp that this market still might try the support of the November lows again,” said John Kinsey, a portfolio manager at Caldwell Securities.

With governments forking out hundreds of billions to stimulate their economies, some are looking ahead to a rebound in metals prices that could light a fire under the mining sector.

“The problem is, is it six months from now, is it a year from now, or is it four years from now?” Kinsey said.

The fourth-quarter earnings period, which will get into full swing next week with Teck’s earnings, will give an update on the health of the sector and give the market a better sense of how miners will fare in an extended cheap metals environment.

But the market will need to see clear evidence of rebounding demand and looser credit conditions before investors decide these hard-hit stocks are bargains in waiting, said John Hughes, a mining analyst at Desjardins Securities.

“A lot of the bad news I think is already there in terms of the production side and the supply side, but the fact is several of these commodities mining companies are operating at best at a break-even cash level,” he said.

However, once there are clear signs of light at the end of the tunnel, the sector’s fortunes may turn very quickly.

“Two to four years down the road, these things could be rolling in the money again,” said Kinsey. “It depends, obviously, on the world economy.”

($1=$1.23 Canadian)

Reporting by Cameron French; editing by Peter Galloway

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