http://www.reuters.com/article/marke...

Sun May 24, 2009 10:30am EDT

By Cameron French

TORONTO, May 24 (Reuters) - Canadian base metals stocks took it on the chin last year, losing more than two-thirds of their value after getting drop-kicked by plunging materials demand and a wave of panic selling on stock markets.

Now, they are back with a vengeance, more than doubling since early March.

Despite the speedy ascent and some doubts about demand, analysts said stock fundamentals and the longer-term prospects for economic recovery suggest there's plenty more upside in the sector.

"Exiting this year and into 2010 you want to be overweight the metals for sure, and in fact we could have quite an exciting summer," said John Hughes, a mining analyst at Desjardins Securities in Toronto,

Hughes said he favors base metal stocks over gold miners despite a 103 percent rise in the base metals-heavy S&P/TSX mining subgroup .GSPTTMN in just over 10 weeks, a gain that would seem overheated compared to the steadier 20 percent rise of golds over the same period.

While base metal shares may be due for brief period of flat trading, or even a pullback, Hughes said the sector will get a further boost as metals demand ramps up later this year. As well, valuations are still reasonable.

"Relative to a historical earnings multiple basis, these stocks are reasonably inexpensive," he said.

Hughes said a normal longer-term price-to-earnings ratio for the sector would be in the 7 to 9 range.

This compares favorably to base miners such as Teck Resources (TCKb.TO), which is trading at a price to 2010 earnings ratio of 6.6, while copper miner First Quantum (FM.TO) is at 6.7, and copper and zinc producer HudBay Minerals (HBM.TO) is at 7.0. Hughes rates all three stocks "buy".

PLAYING THE RECOVERY

Hughes and others point to the importance of the "macro" story -- the sensitivity of base metal prices and mining companies to economic growth.

In a recent report, CIBC World Markets chief economist Avery Shenfeld called base metal stocks the best way for Canadian investors to play an economic recovery.

He noted that, despite recent gains, the sector is still about 50 percent below levels hit near the height of the boom.

"Base metals historically have been among first resource movers, meaning that related equities have historically tended to outperform the market in the late stages of recession and early in the recovery," he said.

Analysts point to a price rebound for industrial metals from the lows hit last fall during the darkest days of the financial crisis.

Copper, considered a bellwether metal, is up 34 percent since the end of February, a key to the stock rebound. Cash copper MCU0 was at $2.09 a pound on Friday.

Evan Smith, who co-manages a resource fund at U.S. Global Investors, said signs point to a continued recovery in metals markets, and even at current prices, stocks are trading below where they should be.

"In general, at $2 copper or so, most of these (stocks) look pretty attractive still ... and most of these companies should be able to make money," he said.

Another reason for confidence is the continuing thaw of credit markets, key to the capital-intensive mining industry.

Just a few months ago, many smaller miners seemed at death's door, with few sources to fund construction of mines still months or years away from production.

Larger players also suffered, with many slowing or shutting mines. Others -- including Canadian heavyweight Teck -- struggled under heavy debtloads used to fund acquisitions made at the top of the market in 2008.

But both debt and equity financings have picked up in recent weeks, with Teck issuing US$4.3 billion in bonds to pay down a bridge loan that had been weighing on the company.

This has allowed some firms to put development projects back on track, adding some certainty to future cash flow predictions.

"Capital's not exactly freely flowing, but there's been a window of opportunity open for financing," said U.S. Global's Smith. "The risk appetite has returned. I wouldn't say it's completely open for risk, but there is a risk appetite."

That said, mining investment veterans warn a sudden retrenchment of copper and metals such as zinc and nickel could induce a wave of profit-taking in the stocks, turning the recent gains into a reason to sell.

Doubts about the depth of the demand recovery -- which hinges on the resumption of global economic growth -- are also lurking at the back of investors' minds, they say.

"(Demand) has all come from China recently. We need to see at least some stabilization in developed economies as well," Smith said.

($1=$1.12 Canadian) (Reporting by Cameron French; Editing by Jeffrey Hodgson and Rob Wilson)