Sector strategy: What would make us BUY the miners?m

- Cautious on metals and mining stocks but value emerging "A few weeks ago we downgraded many of the more leveraged metals and mining names. We also did a broad brush downgrade on European steel. To be clear, it does look as though value is starting to emerge in some metals and mining shares. Larger cap names are trading on around 0.7-0.9x DCF. In this note we outline what we would like to see before becoming more positive in the sector. Key datapoints: 1) Newflow from China less negative 2) Lead indicators hit inflection point 3) Commodity prices find support “level” 4) Positive newsflow from Europe on credit and banking system. Our preference is for the precious metals names – we are buyers of Centamin, Hochschild & Petropavlovsk."
- Our key concerns are macro in nature "Our key concerns are macro in nature: 1) Slowing in China driven mainly by policies designed to cool the property market 2) Anaemic recovery in the US (see our recent cuts to US GDP estimates) and 3) Fallout from the European debt crisis leading to fiscal tightening and causing slower growth in Europe."
- China is key, Chinese property policy is key "China’s government has become quite vocal of late on its concerns on speculation in the property market. Feedback from Chinese property team of late has been cautious with a view that there is still further risk both in terms of downside to prices and more punitive policy. A property tax hasn’t been ruled out and could be a “nuclear bomb” for the sector. China consumes circa. 50% of the world’s steel with some 60% of that steel used in construction & infrastructure."
- Lead indicators turned down, looking for inflection point "Global lead indicators have peaked and are falling. We look for a 2nd derivative inflection i.e. indicators hinting that they might be close to bottoming in key global indicators such as Chinese PMI, US ISM & the OECD lead indicator."
- Commodity prices: Copper $5500-6600, iron ore $110 "We see further near term downside to commodity bellwethers and look for a “floor”. For iron ore, we think $110/t (CIF) would see material production cuts from local, Chinese producers which would provide price support. For copper, we have recently seen Chinese buyers step in when copper goes below $6000/t."
- Europe (& US): Some positive newsflow would be helpful "Last but certainly not least, some positive newsflow from Europe regarding credit and the banking system. The stress test to be announced in July could be a key catalyst as could some definitive newsflow, one way or another, on Spain."
Merrill Lynch European Metals Mining 20100706