Shares in miners are at their cheapest for almost 12 years having collapsed by 76pc since early 2011, but there are important reasons to stay cautious.
Shares in mining companies are at their lowest levels for almost 12 years. Bargain hunters are right to be attracted to what looks like the opportunity of a lifetime, but industry experts are issuing a stark warning to those thinking of diving back in.
Rock bottom
The amount of value destruction has been staggering. The FTSE 350 Mining Index peaked at more than 28,000 following the 2008 financial crisis, and it has fallen more than 76pc to end last week hovering around 6,800.
In terms of individual companies, the shares in Rio Tinto were changing hands for about £43 in early 2011, and they were trading at about £17 per share at the end of last week.
The shares are also offering a mouth-watering prospective dividend yield of 7.1pc. On the face of it, this is exactly what Warren Buffet was talking about when he said: “Be fearful when others are greedy and greedy when others are fearful”.
Buying up the shares in the sector could still be a dangerous approach right now. The miners are suffering from a unique set of circumstances which make holding the equity very risky. Demand is falling as the world’s largest consumer of commodities, China, is slowing down. Huge expansion plans at the miners are seeing output of base metals rise into this worsening market. The debt that was used to fund all this expansion has also piled up on the balance sheets.
In such a scenario where earnings are falling sharply, and the cost of interest payments on the debt is rising, then a number of things have to change before the shares can be accurately valued.
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