Analysis - European oil, mining shares set to outperform in 2011

LONDON (Reuters) - Share prices for energy and mining companies look set to outperform in 2011 as a result of strong commodity prices, underpinned by demand in emerging markets for basic resources and stronger U.S. economic growth.

A recent Reuters poll of 12 top oil-tracking analysts showed that oil demand is expected to slow in 2011 from last year but will still reach a new all-time high. Meanwhile Quantitative Commodity Research expects the price of copper to climb above $12,000 (7,634.07 pounds) a tonne by the end of June, from some $9,660 currently.

"If you are concerned about rising input price pressure, commodity price pressure, resources exposure (in equities) is a nice hedge on that," said Robert Parkes, a strategist at HSBC.

Parkes said equity valuations showed that fears of a double-dip economic recession have already been dispelled but they have still not fully factored in the prospects of economic recovery this year and interest rates in mature economies remain relatively low.

Consequently European oil and gas sector .SXEP share prices, also backed by cheap valuations and robust dividend yields, are expected to fare well this year after sharply underperforming the broader market index and crude prices in 2010, which rose more than 15 percent.

The oil and gas gauge rose just 0.6 percent last year, which compared with an 8.6-percent rise in the broader STOXX Europe 600 index .STOXX, largely because of a 22.4-percent drop in BP's (BP.L) shares after its Gulf of Mexico oil spill.

"We have seen an improvement in oil prices but we haven't seen any follow-through in oil stocks. They are still deeply discounted to average valuations," said Mark Bon, fund manager at Canada Life, adding that he expected oil shares to do well in 2011 and favoured Spain's Repsol (REP.MC).

The STOXX Europe 600 oil and gas sector index .SXEP carries a one-year forward price-to-earnings of 9.1 times, below a 10-year average of 11.9 and cheaper than the broader STOXX 600 .STOXX European market index's 10.8, Thomson Reuters Datastream shows.

Dividend yield is also supportive for the oil and gas sector, standing at 3.1 percent for the European sector index, the sixth highest among the 18 sectors in the STOXX Europe 600 universe, Datastream shows. The telecoms index .SXKP carries the highest yield of 5.5 percent.

"We also like the energy sector in Europe for its very strong cash flow and yield characteristic," HSBC's Parkes said.

UBS also recommends investors take positions in energy and mining firms, with miner Rio Tinto (RIO.L) and oilfield services firm Technip (TECF.PA) among its top picks.

VALUATIONS

As with oil stocks, shares in mining companies are expected to benefit from strong demand for basic resources. Recent data shows economic growth in the United States is finally starting to pick up steam while growth in the so-called rapidly developing economies such as China and India, continues apace.

The Chinese economy is expected to have expanded 10 percent in 2010, moderating to 8.9 percent growth this year as Beijing tries to tackle inflation, the latest Reuters poll of economists showed.

"Urbanisation will continue to remain a key focus of Chinese (and Indian) government policy in its next five-year plan," said JPMorgan in an investment note this week on the UK mining sector, which it rates as 'overweight'.

"Supply in key commodities remains constrained/interrupted and powerful restocking may be just around the corner," it added.

Although there is the risk of further monetary tightening in China, analysts and investors believe the country's leaders will be careful not to weaken growth too far, too fast, which could lead to unemployment and possibly social unrest.

"So long as China moderates growth rather than reverses growth, the materials sector will still be alright. We will start to worry a little bit maybe next year or the year after as global tightening becomes a feature," Bon said.

Miners, constituents of the STOXX Europe 600 basic resources index .SXPP, remain historically cheap despite hefty gains last year when the basic resources index surged nearly 27 percent, with the one-year forward P/E for the sector at 9.9 times whereas the 10-year average is 11.4 times.

Share prices in the natural resources sector are also expected to benefit from another strong year of merger activity after the sector accounted for nearly a third of all deals last year.

Most recently, for example, London-listed Xstrata (XTA.L) is widely tipped to win a $8 billion auction for Colombia's second-biggest coal miner.

(Editing by Greg Mahlich)