Cyclical risks, but medium term re-rating potential。    While there are clear signs of a cyclical slow-down in China, the sector has deratedin anticipation of lower commodity prices and we think ongoing capital/supply discipline and a focus on cash flow over growth can re-rate the majorsover the medium term (~20% upside to our mid-cycle valuations). Stock picks:    Investors should focus on two themes - cash flow quality and commodityexposure; our top picks are RIO (valuation, cash returns) and GLEN (copper andzinc exposure, latent capacity growth).。    Theme 1: Where are we in the cycle?    Our commodity demand indicators peaked in July and we expect further slowingthrough Q4and 2018. Planned industrial production restrictions in China createdownside risks to demand over the winter months; lower steel production,seasonally weakest in Q4, could add pressure on the entire complex, particularlyiron ore and coal. However, we forecast slowing commodity demand in 2018,but no collapse. Supply side rationalisation should support some metals; see ournotes on this theme in steel , coal and aluminium and medium term we arebullish on copper given EV exposure and supply constraints.。    Theme 2: Capital discipline and use of surplus cash flows。    The large caps have de-rated against the market, partly due to China concerns,but we think the poor capital allocation track record is also a major factor. Ourvaluation framework, based around mid-cycle returns and cash flows, providesinvestors with a clear picture of what is 'in the price'. There is a significant gapbetween spot commodity prices and those discounted by the equities and themarket is discounting returns below our mid cycle estimates. We think mid cycleFCF yields of 8-11% are deliverable; if translated to a ~5% dividend would makethe sector one of the most attractive yielding in the market.。    Theme 3: Cash flow quality: Longer term reinvestment needs a differentiator。    On the M&A front, a lack of targets compared to the 2000s and competition fromChina Inc will put the emphasis on organic growth. Industry capex will need tostep up by 2019/20to sustain current production levels. We compare 'normalised'capex levels required from 2020to ensure stable production levels against currentspend levels and find large differences between the companies, with RIO in thestrongest position and Anglo in the weakest.。

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