Investment View: Rio or BHP could be the best betsfor a long-haul punt on mining

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The Independent Online

There are no two ways about it: the big four FTSE 100-listed diversified mining groups had a cracking start to the year. In the first two months of 2012, Rio Tinto and Xstrata's shares both jumped by nearly a third, while BHP Billiton and Anglo American turned in a relatively poor performance, up by a mere fifth.

Although Xstrata's share price jump cannot be entirely divorced from Glencore's mooted offer for the company, the performance of the other three showed mining to be most definitely where it's at in January and February.

These strong share performances reversed a slump in the second half of 2011, when fears that the commodity price boom may have been overdone prompted copper, iron and other industrial staples to tumble, taking mining stocks with them.

But the new year brought fresh optimism about the health of the global economy, for which the diversified miners are often seen as the ultimate barometers because they produce the building blocks of industry.

So it was that the rising economic optimism early this year boosted demand for key commodities such as copper, used for everything from pipes to wiring, and steel, which is made from iron ore and metallurgical coal and is vital for construction.

The rebounding commodity prices combined with investor concerns that the second-half slump in mining stocks may have been overdone, resulted in one almighty correction at the start of 2012.

In the past two weeks or so investors have corrected themselves again, although far more modestly this time – leaving each of the big four about halfway between their price at the start of 2012 and their February peak

The triggers for the latest share price decline are to profit taking after the huge, recent gains, persistent concerns about the eurozone crisis and China's recent downgrade of its economic growth target for the year.

That's all well and good, but what's the outlook for the mining sector now and which companies are the best bet?

BHP Billiton and Rio Tinto immediately distinguish themselves because they have large exposure to iron ore, which, as one analyst put it, "is very much the flavour of the month".

But unlike most flavours of the month, analysts argue that iron is likely to stay popular for at least the next few years. This is because iron ore is crucial to giant infrastructure projects in the emerging economies of China, India, Russia, Brazil and Turkey.

BHP and Rio also score highly for their geographical and metal diversity. This is important because different metals can be in vogue at different times, while large exposure to individual regions can leave miners at the mercy of flooding or earthquakes, political risks such as resource nationalism and exchange rate fluctuations.

Despite a large exposure to iron, Rio has strong copper and aluminium businesses, while BHP also has a hefty presence in oil, gas and metallurgical coal. And in both cases, their operations are scattered across the world.

Barclays has a 12-month price target of 2,600p on BHP Billiton (a hefty, 28 per cent jump on yesterday's closing price) and of 4,200p for Rio (a not insubstantial 19 per cent increase).

By comparison, Anglo American scores even higher on the commodity diversification front, with significant operations in iron ore, diamonds, platinum, nickel and coal.

However, with 55 per cent of its operating profit coming from South Africa and Botswana, Anglo looks like a more volatile bet than Rio and BHP.

Barclays has a 12-month price target of 3,000p on Anglo, a relatively small 16 per cent rise on yesterday's closing price. Meanwhile, with an estimated p/e rating for this year of 7.5, Anglo looks more expensive than Rio Tinto, on 6.2 – especially when Rio has a dividend yield of 2.6 per cent to Anglo's 2.0 per cent. Admittedly, with a p/e ratio of 8.1, BHP looks more expensive still – except that it yields a hefty 3.6 per cent.

For its part, Xstrata is a little difficult to value, depending as it does on whether its takeover by Glencore goes ahead – and at what price. At this point, it's probably best to wait until the deal is concluded, one way or another, before deciding whether to invest.

If it falls through, Xstrata might be worth a punt. The shares would plummet, but a replacement deal from an alternative suitor may not be far off.

The bottom line is that you can't go far wrong with big, diversified miners with broad shareholder bases.

Although commodities and mining can be quite volatile, the demand for the key, industrial ingredients will only rise over the next 10 years.

If you're looking for a quick buck, mining might not be your thing because, as recent months have shown, it can be a fairly volatile sector.

But if you are in it for the slightly longer haul, you can't go wrong with a meaty, diversified miner like Rio or BHP. Not least because they have so much cash, they can afford to keep investing even when times are hard.