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The last couple of months have been fairly hairy for investors as resource stocks have sped up and down the charts in response to commodity prices swings. As you can see from the table below, the S&P/ASX 300 Resources index has tumbled by 8.6 per cent over the past three months, performing a tad worse than the S&P/ASX 200 index, which slipped by 7.8 per cent.

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Volatility is the major downside of investing in resource stocks; but provided that the long-term average is up, then investors can withstand a couple of occasional bumps along the way.

But are these occasional bumps, or is a downtrend settling in?

The answer to this question depends on who you speak to, and how you interpret the available information. As far as those in the industry are concerned, stockbrokers, fund managers and the like, the bulls still outnumber the bears.

Based on a recent ABARE report, the commodities market should continue to perform well. It predicts that the value of Australia’s iron ore, metallurgical coal and thermal coal exports will increase 17 per cent, 31 per cent and 31 per cent respectively in 2012, accounting for 60 per cent of Australia’s total commodity exports.

Patersons Asset Management, which specialises in buying resource stocks in its Australian Resources Opportunities Fund, thinks along a similar vein.  Although there’s plenty to be bearish about – the sovereign debt issues in Europe and imploding debt levels in the US – the Patersons team says: “Sentiment will remain cautious but we continue to remain of the view that growth will begin to be restored later this Calender year.” Adding: “We continue to be buyers in the market where we see opportunities.”

Patersons is targeting stocks in the LNG, coal, iron ore, copper, rare earths and gold sectors.

During the recent downtrend in commodity prices, the fund took the opportunity to stack up on their holdings in resources stocks. The fund added Atlas Iron (AGO) to the portfolio, a company that TheBull has written about increasingly over the last few weeks, and is this week’s Bull of the Week. To read this article click here.

Just recently journalist Bob Kohut noted in a feature on Atlas Iron: “AGO looks like an attractive opportunity for Growth or GARP (Growth at a Reasonable Price) investors.  The PEG Ratio suggests AGO may be undervalued in terms of its growth potential.  This ratio and the P/E are particularly impressive when you consider AGO has only recently begun to turn a profit.” You can read the article here.

Atlas Iron is an iron ore producer and explorer with large tenements in Western Australia’s Pilbara region. With two fully-operational mines, the company produces six million tonnes of direct shipping ore annually. Production is expected to double by 2013. The company’s likely acquisition of junior miner FerrAus will lift AGO’s iron ore reserves by about 300 per cent, making it a very good deal for both parties.

Patersons adds: “Atlas and FerrAus have recently executed agreements that will consolidate its South East Pilbara iron ore assets and create an entity worth in excess of $3 billion. Atlas has a strong balance sheet and a mix of cash flow producing assets and both near term and medium term development assets. The combined group will have approximately 1 billion tonnes of direct shipping ore resources with production targets of 12Mtpa by the end of 2012, 22Mtpa from the North Pilbara projects by 2015 and 20Mtpa from its South East Pilbara projects by 2016.”

Paterson thinks that on the back of recent strategic acquisitions, Atlas Iron now has the size and scale to immediately benefit from the high iron ore price.  

And on the takeover front, Peter O’Connor, resources analyst with Merrill Lynch, pinpoints Atlas Iron (AGO) as an attractive takeover target for local suitors. China and India-based bidders may also be interested in acquiring the stock.

The Patersons Resources Opportunity Fund used the recent market dip to add more shares to its holdings in Metal X and Grange Resources. The fund also holds shares in gold miner Kingsgate, which operates mines in Thailand, South Australia and Chile; other holdings include uranium plays Extract Resources and Energy Metals; coal producer Cockatoo Coal and Platinum Australia, which operates a mine in South Africa.

As at 30 June 2011, the fund’s top 10 holdings in order of size were Santos, MacArthur Coal, Fortescue Metals, Independence Group, Woodside Petroleum, Lynas Corporation, Grange Resources, Orocobre, Origin Energy and Aquarius Platinum.

Another specialist resources fund, the Colonial First State Global Resources fund, thinks that volatility in the resources sector will continue in the short term. The fund recently lifted its exposure to Newcrest Mining following the company’s strong exploration results in Papua New Guinea – and also added to its holdings in high-quality coking coal producer Mongolian Mining.

The third resources specialist fund is Pengana Global Resources Fund. This fund is upbeat on the longer-term outlook for resources. “Whilst challenges for the global economy remain in a post Global Financial Crisis environment the outlook for resource equities continues to be appealing,” it notes.

The fundamentals for an ongoing commodities boom are sound, believes Pengana. “Longer term trends of industrialisation and urbanisation continue in developing economies and as a result support continued demand growth for commodities. Growth in supply of commodities is being impacted by skilled labour shortages, escalating input costs, changing regulatory and fiscal regimes. Valuations on the whole, remain at compelling levels and merger and acquisition activity should continue to underpin market confidence in valuations moving forward.”

In June the Fund exited its shareholding in platinum producer Aquarius Platinum, that operates mines in Southern Africa, and reduced its holdings in copper/cobalt company Tiger Resources. The Fund also initiated a new long position in mineral sands and gold explorer Mineral Deposits. Back in September last year, when the share price was sitting at $1.05, TheBull featured Mineral Deposits as a stock to watch. Today, the share price sits at $5.23.

>>Back to the newsletter to view other articles – July 16th 2011

Please note that TheBull.com.au simply publishes broker recommendations on this page. The publication of these recommendations does not in any way constitute a recommendation on the part of TheBull.com.au.You should seek professional advice before making any investment decisions.