* European YTD sector performance chart: bit.ly/2grRpFK
* European basic resources index up 70 pct in 2016
* Extension of rally into 2017 rests on China, Trump
* Stocks expensive relative to historical standards
By Atul Prakash and Peter Hobson
LONDON, Dec 9 European miners are in a race for
the title of the best sector performer this year, a sharp
turnaround from a slump in 2015, although the rally extending
into 2017 rests on U.S. president-elect Donald Trump and China.
A recovery in commodity prices, better balance sheets and
brighter global economic growth prospects have underpinned the
rally in so-called 'cyclical' stocks - which tend to follow the
fortunes of the wider economy - that were beaten down to low
valuations at the end of 2015.
Glencore's move to join a consortium taking a stake
in Russian oil giant Rosneft suggests some companies
are getting more confident about their balance sheets, analysts
But with several blue-chip mining shares surging, a lot of
optimism may already be in the price, they said.
Companies such as Anglo American and Glencore
, up 315 percent and 235 percent respectively in 2016,
have helped the mining index to surge 70 percent this
year and be on track to snap a three-year losing streak. In
contrast, the pan-European STOXX 600 is down 3 percent.
The sector is also relatively expensive, with its
price-to-earnings ratio now at 14.6 times forward earnings,
against a 10-year average of 11.5, according to Thomson Reuters
With valuations not so supportive, any sign of fresh wobbles
in China, or that an expected fiscal stimulus from Donald
Trump's incoming U.S. administration may not be as big as hoped,
risks derailing the current rally.
"The main risks for miners are indeed Trump and China. A lot
of the rally is built on him delivering on his lofty promises.
If he fails, it will hurt materials disproportionately," said
Philippe Gijsels, head of research at BNP Paribas Fortis.
"The same goes for China. The country continues to stimulate
its economy. If the efforts are mismanaged and China end up in a
hard landing scenario, it would have a profoundly negative
impact on commodities-related stocks."
CHINA, TRUMP AND THE DOLLAR
Analysts said any economic stress on China, the world's
biggest metals consumer, could change sentiment.
Chinese economic growth is more reliant on government
spending, state-owned firms and "old economy" industries like
steel and mining which Beijing has been trying to restructure
via capacity cuts.
Analysts warn a property boom, which has generated a
significant share of the growth, may be peaking, dampening
demand for building materials from cement to steel.
"Trends in earnings have been turning to the upside.
However, the biggest risk is a significant growth deterioration
in China," UniCredit analyst Christian Stocker said.
Analysts said Trump is also seen as a risk for the sector.
After his election win, Trump said U.S. infrastructure will
become "second to none". He has pledged to allocate $500 billion
to $1 trillion to rebuild dilapidated roads and bridges.
There was no certainty that his vague plans would go ahead
in the way a lot of investors were anticipating, analysts said,
adding that any diversion from the pledge could result in a
sharp sell-off in metals, which in turn would hit mining stocks.
A firmer dollar on expectations of U.S. rate hikes is
another potential risk as a stronger dollar makes metals
expensive for other currency holders.
KEEPING THE FAITH
However, some investors are sticking with their bullish
views seeing potential for dividends.
"I think we are near the end of a commodities downturn.
There is scope for dividends to rise from here over the coming
years," said Stephen Macklow-Smith, head of European equity
strategy at JPMorgan Asset Management.
"Capex expectations have been reset and balance sheets don't
look particularly stretched. If demand continues to recover in
emerging markets, then commodities prices will continue to
recover," he added.
Dividend yield at miners listed in London has slumped 1.4
percent to its lowest in five years just as cash flows in the
sector improve following a recovery in metals prices, prompting
some analysts to call for higher payouts as early as next year.
Prices of commodities such as copper and aluminium have
recovered this year, partly on the back of capacity cuts in
China, further improving profit margins of producers.
Credit Suisse predicts free cash flow yield, a measure of
balance sheet health, of large-cap firms at 10 to 11 percent in
2017 and 8 to 9 percent in 2018. Dividend yields are forecast to
almost double to 4 percent.
(Reporting by Atul Prakash; Editing by Vikram Subhedar and Toby