Mining analysts missing the mark: report

ROMA LUCIW

Globe and Mail Update

February 6, 2008 at 4:46 PM EST

Financial analysts are missing the mark in their predictions for a sharp drop in metal prices, consistently issuing pessimistic price forecasts that undervalue mining companies, says a report from consulting firm Ernst & Young.

“Contrary to the continued assertions of mining analysts, current metal prices are actually a return to sustainable price levels following an extended period of artificially depressed prices,” said the reports co-authors, Lee Downham and Tim Williams.

Metal prices have rallied in the last three years - particularly industrial metals like copper, nickel, steel and aluminum. “It is clear from our reading of the equity research notes that the metals analysts did not foresee these price rises, nor that the price rises would endure as long as they have,” the report said.

Since the start of 2005, short-term metal prices forecasts by analysts have missed targets by between 20 and 200 per cent, the report said. The forecasts, invariably on the pessimistic side, have resulted in the undervaluation of mining and metals equities.

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The price of gold, for example, has surged to record highs above $900 (U.S.) an ounce this year, and with the powerful U.S. economy teetering on the edge of an economic recession, some analysts are questioning whether its run is coming to an end. Silver, copper, zinc, and aluminum have also climbed sharply in recent years, treading into new price territory.

Although “analysts are wary of straying too far from their comfort zone of historic averages” the mining companies - by their actions - are taking a far more realistic view, the report said. Many mines and mining companies are “materially undervalued,” which means that significant premiums have often been paid over market prices.

It noted that more than $100-billion has been spent on the Falconbridge, Inco, Phelps-Dodge and Alcan deals, as major mining industry players battle for a dwindling supply of low-cost production around the world.

The latest volley in the mining sector came Wednesday, as Rio Tinto PLC rejected a sweetened formal offer from mining rival BHP Billiton Ltd., saying the $147.4-billion bid still does not reflect the full value of the company. The proposed deal would create the dominant global player in iron ore and comes on the heels of a wave of consolidation in the mining industry.

Although the price tag seems expensive, the Ernst & Young report maintains that mining companies which have chased growth through acquisitions have consistently outperformed those who have chosen to grow organically. It foresees further transactions in the mining sector.

The report disputes the notion that metal prices are near the top of a traditional cycle, saying that stockpiles have been depleted at exactly the same time that global demand has rebounded. For one, consolidation in the mining industry has reduced the fragmentation of supply and left production in the hands of fewer larger mining companies.

In addition, the rapid industrialization of China will provide a long-term boost to the metal market.

Matthew Turner, an analyst with London-based metals consultancy VM Group, said his forecasts vary with each metal. In general, he expects industrial metals prices will decline in the event of an economic slowdown, while gold will likely continue to outperform as investors buy it for its safe-haven attributes.

“A lot of the base metals prices suggest that it is quite profitable to be a miner, but it means that prices are a little on the high side in the long run,” he said in an interview. “Most metal supplies are finally increasing, and that is a delayed response to price movements.”

Andrew Montano, director of precious metals at Scotia Mocatta in Toronto, said that in the short run, he does not see anything that suggests metal prices are not sustainable at current levels. Investors have displayed a huge appetite for precious metals, as can be seen in the popularity of exchange-traded funds.

“The investing public and professional funds have moved into the precious metals arena in a way they never have before,” Mr. Montano said. “We have not seen any evidence that funds want to liquidate from these precious metals.”