SPDR S&P Metals and Mining: 5 Questions, One Conclusion – Buy (NYSEARCA:XME)

The Metals & Mining industry is part of the Materials sector, but it behaves nowadays more or less like it is rather part of the (well performing) Energy sector.

Points they have in common are a capex discipline that limits supply, an increased demand due to the energy transition, a high inflation sensitivity, a nice stock performance, and they are in an uptrend (unlike most stocks).

Metals & Mining will not only get additional demand from the energy transition, but also from an increase in infrastructure spending.

The capex discipline will lead to a less cyclical environment and this should result in a re-rating for this cheap industry: buy the SPDR S&P Metals & Mining ETF (NYSEARCA:XME).

Five questions

Question 1: What are the three best performing industries in the US?

When we look at the sector performance, one would expect that the best performing industries are part of the energy sector, given its vast outperformance. There are only two industries in the energy sector – Oil & Gas Exploration & Production and Oil & Gas Equipment & Services. These two industries are indeed the two best performing ones.

The third industry will probably be part of the Consumer Staples or Utilities sector?

The answer is no. It’s an industry from the Materials sector: Metals & Mining!

Question 2: Which three industries scored worst on a risk/return level in the past decade?

It might come as a surprise given the nice recent performance, but the answer is again: the two energy industries and Metals & Mining.

Question 3: Thanks to which three industries has the MSCI UK Index regained recently a positive YTD performance?

As you can see in Figure 2 S&P 500 is down more than 15% year to date. The MSCI UK Index is on the contrary in positive territory.

You probably guessed the answer to the question already: again the two energy sectors and Metals & Mining. Compared to the S&P 500 the MSCI UK Index has less technology exposure and much more energy and mining stocks.

Question 4: Which three industries have the highest inflation sensitivity?

You guessed it already probably: the two energy industries and Metals & Mining. The SPDR S&P Oil & Gas Exploration & Production ETF (XOP) has a beta to inflation of 0.58, the SPDR S&P Oil & Gas Equipment & Services (XES) has a beta of 0.56 and XME of 0.47.

This is important because inflation will probably cool, but it will not return quickly to the 2% FED-target.

Question 5: Which three industries have the best long term trend score?

You probably guessed it already: two energy industries and Metals & Mining.

Metals & Mining

It comes actually as no surprise that Metals & Mining joins the two energy industries in the above Q&A.

We can draw a clear parallel between the energy and the mining sector: capex discipline.

Historically, miners increase capex and production when metal prices are high. And at a given point supply becomes bigger than demand and prices collapse. This results in a cut in capex and at a given point demand surpasses supply and prices start rising again and the cycle starts over.

As is the case in the energy sector, the focus is also in the mining industry more on leverage reduction and returning cash to shareholders and less on capex and growth for the sake of growth.

This capex discipline puts a break on supply.

And as is the case in the energy sector, there is also the impact of the energy transition on the mining industry. The electrification will cause a huge increase in the demand for metals, as do the expected infrastructure investments.

Slower growing supply and higher demand will support metal prices and lead to a more stable and less volatile price environment.

And there is a clear link between metal prices and the share price of metals and mining companies.

To quote Robert Friedland, co-chairman of Ivanhoe Mines (IVN:CA): “After years of underinvestment now is the revenge of the miners.”

XME

There aren’t many ETFs dedicated to the Metals & Mining industry and the SPDR S&P Metals & Mining ETF is the one with the lowest expense ratio (0.35%). The benchmark is the S&P Metals and Mining Select Industry Index, a so-called modified equal weighted index. This results in an un-concentrated exposure across large, mid and small cap stocks. The biggest sub-industry is steel.

XME has a low valuation. The forward P/E is only 7. Increased M&A activity is an accident waiting to happen when you have the combination of capex discipline and a low valuation. Recently BHP Group (BHP) offered nearly $6.5 billion for the Australian copper miner OZ Minerals Ltd. (OTCPK:OZMLF).

What could go wrong?

A strong drop in demand caused by e.g. a recession could lead to lower metal prices. If the situation in China would worsen this will have a negative impact on demand and prices. But China is already taking measures to address the crisis in the real estate sector and this may boost the metal industry in general and the steel demand in particular. And when the flu season ends (around March next year) China can be expected to ease the stringent Covid-measure and this would give the economy a boost. Around the same time the current rate hikes of the FED might end.

This month the best performing commodities are base metals and precious metals.

Conclusion

We can draw a clear parallel between the energy sector and the mining industry. After years of underinvestment the restrained supply meets a rising demand. This creates a kind of stability that replaces the past “boom and bust” environment with its wild swings in metal prices and share prices of mining companies.

The high inflation sensitivity and the low valuation are additional reasons we are positive: buy the SPDR S&P Metals & Mining ETF.