Investment: Should you invest in... the mining markets?

TRADITIONALLY, MINING shares were among the stalwarts of the private investor's portfolio, but they have lost much of their lustre. "Mining has been a pretty miserable area to try to get excited about over the past few years," says Geoff Miller, head of research at Brewin Dolphin Securities.

"It is almost exclusively overseas and most companies price their shares and set their dividend polices in dollars. So for sterling investors, there is always a risk that if the currency goes the wrong way, their income will be affected."

The main factor determining the value of mining stocks is the price of the commodity they produce. "Mining has been overlooked by investors for some time, but the tide may be turning," Miller adds. "This is one reason why the price of Rio Tinto went up from pounds 6.50 to pounds 10.50 in a couple of months earlier this year when there were signs that commodity prices were bottoming out."

Brian O'Neill of Gartmore Fund Managers, says: "With the continued strong US economic growth this year and the oil price perking up, you have seen a bit of a switch into cyclical industries, such as mining. Some metal prices are looking firmer, although gold has gone down a lot and the platinum group metals have been very volatile. The base metals have been more positive."

Gold has long been a benchmark for investors. Unfortunately for the health of much of the mining sector, it has been underperforming for nearly 20 years. Tony Plummer of Invetsec Guinness Flight says: "The problem with gold is that it has been in a bear market since January 1980, when it touched US$835 an ounce. It closed last Thursday at $277. Basically, the price of gold, which is traditionally seen as a hedge against inflation, has fallen as inflation has come down."

Even the idea of a turnaround in base metals prices is not universally accepted. Vicky Wong of stockbrokers Killik & Co says: "The investor enthusiasm in mining stocks appears to be discounting in advance any rise in metals prices. Various commodity prices may have bottomed, and the supply and demand factors do not look immediately favourable, which implies that prices might stay low for the time being."

The key elements for investors would seem to be size and diversification. Geoff Miller says: "Three large stocks dominate the sector, Rio Tinto, Billiton and Anglo American. The last is in the process of coming to the market and will be in the FTSE 100 Index from June."

Given the current prevalence of index tracking funds, the arrival of such a new addition is bound to be given considerable momentum. "This will be the first time since the demise of Consolidated Goldfields that investors will have a real alternative to Rio Tinto," Miller adds.

"Admittedly Billiton floated last year, but it is capitalised at under pounds 4bn, and Rio Tinto and Anglo American are more than pounds 10bn. The Anglo American share price is bound to be squeezed up at the beginning because the index trackers don't hold it and need to buy it."

Vicky Wong says: "Rio Tinto has the broadest sales mix, but it is highly sensitive to the prices of gold, copper and aluminium, all of which have fallen significantly in the past year. Its latest results indicate the turmoil in Asia mean that demand was likely to remain weak and production had risen in most operations, which had steepened some price falls.

"Billiton also suffers from depressed aluminium and nickel prices, although its long-term coal production contracts with power generators help reduce the cyclical nature of its earnings."

Geoff Miller says: "These days, you need a good global spread to take advantage of the opportunities as they come along. For example, Reunion Mining recently did a deal with Anglo American, which three or four years ago they would have been able to do on their own. Smaller mining companies can't get access to sufficient funds and the big companies are taking advantage of that by putting up a lot of the cash, but then taking a significant slug of the profits in return."

Brian O'Neill points out: "You have to remember that these stocks are part of what is now a relatively small global sector. It may still be big in South Africa and Canada, but mining companies are not even significant in Australia any more, so it doesn't need a huge weight of money flowing around the sector to cause significant moves."

Geoff Miller says: "The big three are financially very strong, perhaps too strong because at this stage of the cycle they should be geared up but they are not. I would expect them to expand very rapidly over the next few years as new opportunities open up. Smaller mining companies are speculative investments and a lot haven't come up with the goods over the last few years."

Investors looking for a less volatile stock closer to home could glance at RJB Mining, which has most of the UK's remaining coal producing capacity. Vicky Wong says: "RJB Mining has a long-term supply contract with National Power and has sufficient commitments in place to secure its immediate survival. But its longer-term prospects rest on cost-cutting and reducing the risk profile of its portfolio by diversifying outside the UK coal industry, which is increasingly uncompetitive compared with imported coal and gas."

The recent announcement that the UK is to sell off half of its gold reserves won't help the gold price either. Tony Plummer says: "Governments are reflating their economies and the gold price would normally reflect this. But it is depressed by official sales. Clearly gold doesn't offer any return other than its price and presumably there will be a switch into bonds, but why this is being done at the end of a 19-year bear market I find hard to fathom."

Vicky Wong is definite. "Summer is the seasonal low ebb for metals prices. They are likely to rise only if there is a sharp increase in demand or a big cut in capacity. Neither seems likely in the short term so it is too early to buy mining stocks and we recommend selling into strength."