October 13, 2015 / 8:34 AM / 5 years ago

LMEWEEK-Funds bet on beaten-down basic resources stocks

* Some funds, analysts stay positive on mining stocks

* Cheap valuations, higher yields attract investors

* Analysts see positive results of China policy measures

By Atul Prakash

LONDON, Oct 13 (Reuters) - Some brave investors are taking a risk by betting on a sharp rebound in European basic resource shares, which have mounted a fledgling recovery recently after slumping more than 40 percent in just five months.

Investment management and share dealing firm Redmayne-Bentley has been increasing its exposure to the mining sector, while wealth manager Crossbridge Capital continues to hold its investments in Glencore, Rio Tinto and Alcoa. HSBC maintains an “overweight” rating on the sector.

Cheap valuations, attractive dividend yields and hopes that policy action from China, the world’s top metals consumer, would prevent its economy from derailing have been prompting investors to take advantage of weak share prices.

Shares in miner and trader Glencore crashed about 80 percent in five months to a record low in late September, while global diversified miners BHP Billiton and Rio Tinto fell more than 30 percent during the period, before partially recovering.

“We have got a contrarian view on the materials sector, which is deeply out of favour at the moment,” Robert Parkes, director of global equity strategy at HSBC Bank, said.

“The sector is very sensitive to the global demand outlook, which we don’t believe is falling off a cliff, and we expect further policy stimulus in China to deliver an upside surprise to growth in the coming quarters.”

Morgan Stanley upgraded the mining sector to “overweight” from “underweight”, saying macro momentum in China could start to improve in coming months in response to a faster pace of new policy initiatives.

CHEAP VALUATIONS, STRONG YIELDS

Analysts said the timing was perfect for investors who had more appetite for risk and a relatively longer investment horizon as valuations were pretty attractive. Rock-bottom profit margins could also suggest more mine closures, boosting metals prices.

According to Thomson Reuters Datastream, profit margins of European miners have been hovering near record lows, having fallen to about 11 percent from 17 percent at the start of the year and from a high of 45 percent in 2011.

“I recently increased my exposure to the mining sector and intend to buy more. I don’t see much downside in commodity prices as production cuts will give a fresh boost to metals prices. Valuations are also quite attractive,” David Battersby, investment manager at Redmayne-Bentley, said.

The 12-month forward price-to-earnings ratio for the STOXX Europe 600 Basic Resources index is now 12.5, down from 16 in mid-May, due to a sharp fall in share prices and their poor earnings outlook. In contrast, the telecommunications and technology sectors trade at 18 times and 16 times respectively.

The dividend yields of BHP Billiton and Rio Tinto stood at a high level of nearly 7 percent.

“Their earnings are under pressure because of a sharp fall in commodity prices, but what they are giving you in return is a good diversified exposure at a very cheap price,” Edmund Shing, global head of equity derivative strategy at BNP Paribas, said. “Their dividend yields are also pretty high.” (Reporting by Atul Prakash; Editing by Veronica Brown and Dale Hudson)

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