Outlook bright for Australian resource stocks

Jitters about China’s growth outlook amid a resurgence of Covid-19 have created a buying opportunity in Australian shares, resources companies and the Australian dollar.

Shares in iron ore miner Fortescue Metals jumped 8.1 per cent to $21.73 after US fund manager Capital Group bought more of the stock.

Jitters about China’s growth outlook amid a resurgence of Covid-19 have created a buying opportunity in Australian shares, resources companies and the Australian dollar as more economic stimulus from China will follow even as the US dials back, according to Macquarie Equities.

The Aussie dollar dipped to an almost three-month low of US70.75c as the US dollar soared to a two-decade high of 130.66 yen as the Bank of Japan vowed to defend its yield curve target.

But the materials sector led a fight back on the local sharemarket. After falling 4.5 per cent in the past three days as the materials sector dived, the S&P/ASX 200 rose 1.3 per cent to 7356.9, scoring its biggest one-day rise in three months even after Wednesday’s release of blowout CPI data for the March quarter ramped up expectations of rate hikes.

Macquarie continues to expect a lasting impact from the Ukraine war in terms of accelerated investment in deglobalisation, decarbonation and defence, all of which should drive up demand for commodities, and it sees disruptions to Russian commodity supplies to last long after the war ends.

The broker is also sticking to the view it took five weeks ago that global investors will allocate more to Australia for exposure to commodities.

Because of those factors the war is positive for the local market, according to Macquarie’s Australian equity strategist, Matthew Brooks. Macquarie has continued to see “inbound interest in ASX stocks from global investors”, he said.

As a case in point on Thursday, Fortescue disclosed that active US fund manager Capital Group increased its shareholding in the iron ore miner to 6.65 per cent on Tuesday. The US fund manager emerged with a 5.08 per cent stake in Fortescue on April 6.

Capital Group’s stake in Fortescue shows US institutional investors are increasing their exposure to Australian resources despite recent jitters about the impact on global growth of rampant inflation, US plans for rate increases and China’s zero-Covid strategy.

“I suspect there is a wall of buyers of resource stocks on any pullbacks,” said Bell Potter’s head of institutional sales and trading, Richard Coppleson.

“Local institutions were I think looking to buy – most have held back and were waiting for more, just waiting until the dust settled – while Capital Group pounced hard just when it all looked dire and have done well.”

Fortescue shares rose 8.1 per cent to $21.73, also helped by upgraded shipping guidance.

Brooks noted that since the Australian dollar was floated in 1983, the local sharemarket has been the second-best performing developed market after Norway in US dollar terms during commodity booms and the best performer in the Asia-Pacific region.

It’s no surprise then that Australia has been the second-best performing developed market since the Ukraine war began on February 24. But relative returns are below levels implied by commodity prices.

Brooks said the recent sell-off in the resources sector – the ASX 200 Materials index fell 11.5 per cent in five days – was largely due to increasing Covid shutdowns in China. But the experience over the last few years is that Covid-driven sell-offs do not last long.

“We also expect China to increase stimulus as they emerge from lockdowns, and that this stimulus is likely to provide support for commodities and resource stocks,” Brooks said.

Also worth noting is that resources equites weren’t fully pricing in high commodity prices.

“Whether you look at Australian stock prices relative to developed markets in US dollars or local currency there is a gap between equity and commodity markets,” Brooks said.

“If we are right about the positive backdrop for commodities, resources-related stocks should outperform, even in a slowdown, and China stimulus supports this outcome.”

In contrast, he noted software equities often underperform in commodity booms as the 1970s, 2000s and potentially the 2020s booms all followed regimes where investors were more willing to buy growth at any price.

Tighter central bank policy via rate hikes and quantitative tightening and a slowing cycle remain a headwind for equity valuations, especially in a commodity boom.

But while a fall in bond yields as growth slows provides at least some offset, a de-rating is a bigger risk for high valuation sectors of tech and healthcare than the low valuations sectors of energy, mining, insurance and banks.