DISCLOSURE APPENDIX AT THE BACK OF THIS REPORT CONTAINS IMPORTANT DISCLOSURES, ANALYST
CERTIFICATIONS, LEGAL ENTITY DISCLOSURE AND THE STATUS OF NON-US ANALYSTS.US Disclosure: Credit
Suisse does and seeks to do business with companies covered in its research reports. As a result, investors should be aware
that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report
as only a single factor in making their investment decision.
5 July 2017
Global
Equity Research
Strategy
Global Equity Strategy
Research Analysts
Andrew Garthwaite
44 20 7883 6477
andrew.garthwaite@credit-suisse
Marina Pronina
44 20 7883 6476
marina.pronina@credit-suisse
Robert Griffiths
44 20 7883 8885
robert.griffiths@credit-suisse
Nicolas Wylenzek
44 20 7883 6480
nicolas.wylenzek@credit-suisse
Alex Hymers
44 20 7888 9710
alex.hymers@credit-suisse
Mengyuan Yuan
44 20 7888 0368
mengyuan.yuan@credit-suisse
STRATEGY
Upgrade mining, benchmark oil
Mining upgrade to overweight: We see some upside to the oil price, and
mining stocks tend to be more correlated with oil than IOCs; mining has
abnormally lagged the performance of GEM equities; the best lead indicators
of industrial commodity prices (China PMI and global IP) now imply modest
upside; valuations look attractive on P/B and P/E relatives and Rio Tinto has a
6.6% FCF yield even on a $40/t iron ore price, a level which would put 25% of
production below cash cost; we don’t see a slowdown in Chinese infrastructure
investment from here (Chinese loan growth has slowed only moderately); the
sector is structurally better positioned than oil; the sector is oversold; and
speculative positions in metals on SHFE are below their average. Our top pick
is Rio Tinto, which is on the Credit Suisse European Focus List. However, in
spite of our more positive stance on mining, we remain underweight non-
financial cyclicals, having upgraded defensives to benchmark in February.
Upside to the oil price: While we might not be quite as optimistic on the oil
price as our house view ($62pb by the end of 2017), we see the following
supports: i) speculative positions are close to 18-month lows; ii) at current
levels of compliance by OPEC and non-OPEC signatories to the supply deal,
and assuming supply disruptions move up closer to average levels, 2.3mb/d
would be taken off the market, and we don’t expect US shale (which accounts
for c.7% of global supply) or demand growth disappointments to fully offset
this; and iii) the current oil price is below the average inflation-adjusted oil price
of $55pb. In our opinion, the two key catalysts for higher prices will be the
Baker Hughes rig count (where the second derivative of growth is slowing) and
the energy high-yield spread (which has started to rise). The risk is that Saudi
Arabia may wish to preserve a degree of volatility in the oil market thereby
making planning decisions for higher-cost producers more difficult.
How to play a higher oil price: We would focus on i) banks, as inflation
expectations are positively correlated with the oil price; ii) GEM equities in
aggregate, which are positively correlated with the oil price; and iii) Russia,
which has the highest correlation with the oil price of any country (our GEM
equity strategy team upgraded Russia on 23 June). We like non-Russian
stocks with high Russian exposure (e.g. Japan Tobacco). The most correlated
trades with the oil price (in order): Russia, E&P, OFS, mining, IOCs and banks
(the second most correlated non-energy sector).
IOCs – stay benchmark: Despite the worst 1H performance for US energy for
40 years, an oil price of above $60pb is needed to deliver an attractive FCF
yield (at $50pb the oil majors' 2018E average FCF yield is only 3.6%
compared to 5.8% for the global market). Furthermore, the sell side's earnings
estimates appear to price in an oil price of $58pb, and the industry is
structurally more challenged than that of mining. We prefer OFS companies to
IOCs.
5 July 2017
Global Equity Strategy 2
Table of contents
Mining: raise to overweight ... 3
Where next for the price of oil ...... 14
What are the risks 19
We remain benchmark IOCs .......... 20
A few clear supports for the sector 20
However, we choose to remain benchmark 22
OFS: a play on oil capex 26
US OFS: more expensive but better quality 28
How to play a rebound in the oil price beyond the oil sector ........ 29
Banks: If oil rises, bond yields rise and banks outperform 29
GEM equities 31
Appendix ..... 38
Appendix 1 38
Appendix 2 39
Appendix 3 39
Appendix 4 40
Appendix 5 40
Appendix 6 41
Appendix 7 41
The team wishes to acknowledge the contributions made to this report by Pranali Deshmukh,
Neeraj Chadawar, and Swati Ramachandran employees of CRISIL Global Research and
Analytics, a business division of CRISIL Limited, a third-party provider of research services to
Credit Suisse.
5 July 2017
Global Equity Strategy 3
Upgrade mining, benchmark oil
In this report, we focus on four main issues: 1) why we upgrade mining to overweight; 2)
why the oil price should rise; 3) why we stay benchmark IOCs; and 4) our view that the
best way to a play a rise in the oil price is via OFS, Russia (in particular international
companies exposed to Russia) and banks.
Mining: raise to overweight
We remain underweight non-financial cyclicals in aggregate primarily because they have
decoupled significantly from the yield curve and have priced in PMI new orders of c59
(which would equate to annual GDP growth of around 3%, a level we think is overly
optimistic, as illustrated in the two charts below). We raised defensives to benchmark in
early February (seeFour areas of complacency, 2 February).
Figure 1: There has been a sharp divergence
between cyclical to defensives and the yield curve
Figure 2: The European cyclical to defensive ratio is
consistent with PMI manufacturing new orders at 59
Source: Thomson Reuters, Credit Suisse researchSource: Thomson Reuters, Markit, Credit Suisse research
We now opt to upgrade mining to overweight from benchmark, however, believing this to
be one of the best plays on a rise in the oil price.
1. Mining and oil are closely correlated
Around 20% to 30% of mining costs are energy related (more so for aluminum), and thus a
rise in energy costs tends to push up industrial commodity prices. As a result, there tends
to be a strong positive correlation between industrial commodity prices and oil prices, and
a weaker but still positive correlation between industrial commodity stocks and the oil
price. In recent months, metal and oil prices have diverged significantly and as explained
later on we think that the oil price can rise.
1.00
1.05
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1.25
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Jun-10Jun-11Jun-12Jun-13Jun-14Jun-15Jun-16Jun-17
US Yield curve
US cyclicals/defensive rel. performance,
rhs
25
30
35
40
45
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55
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30%
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40%
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20002002200420072009201220142017
Cont Europe cyclicals rel defensive
Euro area PMI manufacturing new orders, rhs
5 July 2017
Global Equity Strategy 4
Figure 3: Metals and oil are closely correlated…
Figure 4: …and hence so too are mining stocks and
oil
Source: Thomson Reuters, Credit Suisse researchSource: Thomson Reuters, Credit Suisse research
Interestingly, the correlation coefficient between the performance of mining relative to the
market andthe oil price is higher than for US and European IOCs.
Figure 5: Correlation of different potential oil plays
with the oil price
Figure 6: There has been a decoupling between
GEM and mining
Source: Thomson Reuters, Credit Suisse researchSource: Thomson Reuters, Credit Suisse research
2. There has been a significant decoupling between emerging markets and mining
There are explanations for this decoupling (namely, commodities have become less
important for GEM performance), but nevertheless the decoupling is worthy of note.
-1030
50
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90
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150
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199920022005200920122015
Metals
Brent oil, rhs20
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140
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199920022005200920122015
MSCI Met & Mining rel
Brent oil, rhs0.1
0.2
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10yr correlation coefficent with the oil price (rel.
perfromance)200
400
600
800
1000
1200
1400
150
300
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600
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1050
1200
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199719992002200420072009201220142017
MSCI EM
MSCI Met & Mining rel
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