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For years we have all known the commodities boom propping up our economy was largely driven by Chinese infrastructure spending and their seemingly insatiable demand for that which we have in abundance – iron ore.

Our mining troika of Rio Tinto, BHP Billiton, and Fortescue Metals have rewarded shareholders richly and benefited numerous companies that provide services to them.  What began as a hushed whisper that the mining boom might be slowing down swelled to a cry that it might be over and now we hear a deafening chorus of opinion claiming it is over.

When you couple this with a potentially troubling property market, declining consumer confidence, and global macroeconomic nightmares, you get what we have seen in recent days – irrational panic selling in equities markets.  Despite the fact that research shows that equities outperform fixed income investments over time, money is flowing out of equities at an alarming rate.

Yet every retail investor has heard time and time again that fortunes are made when there is blood in the streets.  Where are the investing opportunities right now?

The Miners

Conventional wisdom says the miners will fare the worst from the expected China fallout.  Market participants agree, as evidenced by a three month share price movement chart for our big two – RIO and BHP:

However, major analysts at firms like Deutsche Bank, UBS, and CITI are maintaining their BUY ratings on both BHP and RIO in broker recommendations issued in April and May 2012.  Fortescue Metals, as our only pure iron ore play, is the only one of the Big Three Miners to earn a broker SELL recommendation.

The following table shows share price range year over year for the Big Three:

Company

Code

Share Price

52 Wk Hi

52 Wk Lo

P/E

P/EG

BHP Billiton

BHP

$31.99

$45

$31.01

9.08

.88

Rio Tinto

RIO

$56.36

$84.53

$54.50

7.18

.97

Fortescue Metals

FMG

$4.48

$6.77

$3.95

8.55

.46

 

All three of these companies hit new 52 Week Lows earlier in the trading week of May 21st, yet their Price to Earnings and Price to Earnings Ratios suggest they are cheap.  Conversely, some believe they represent classic value traps, as the shares have yet to reach bottom.

You would be hard pressed to read an article about the mining slowdown here that does not cite American investor Jim Chanos who is aggressively shorting FMG.  Chanos gained fame for noting the impending doom of Enron while others clung to the belief that stock could do no wrong.

There is something wrong with this picture that is difficult for the average retail investor like you and me to figure out.  If indeed the sky is falling in on the mining boom, why are both FMG and RIO plowing ahead with expansion plans?  While BHP has announced it will be slowing down its expansion, they have yet to release details as to where and how.  The world’s largest iron ore miner, Brazil’s Vale, is also planning to proceed with expansion plans.  Do they know something we don’t or are they just not that bright?

At an investor conference held in Rio de Janeiro in the week of 21 May 2012, a Vale spokesperson claims they are still selling iron ore as fast as they can get it out of the ground.  A Goldman Sachs mining analyst, Marcelo Aguiar, sees an average price for iron ore of around $150 per metric tonne for the remainder of this year with the price rising to $165 in 2013.  In his opinion, the current price of around $130 a ton reflects excess Indian capacity and over stocking of inventories in China. 

In response to the growing economic evidence of the storm brewing in China, outgoing Chinese Premier Wen Jiabo is calling for new measures to spur growth.  Based on past history, experts anticipate economic measures the Chinese government will put in place could favor steel and thus iron ore consumption.  Reuters News Service in Shanghai is already reporting that a state backed Chinese newspaper released news that the Chinese government will fast track approvals for infrastructure investments to stimulate economic growth.  Remember some experts have predicted a hard fall for the Chinese dragon for some time and it has yet to happen.

Value play or Value trap is the question you should ask yourself about the miners.  The value trap argument is fueled by the daily whipsawing reaction to market news about Greece and the rest of the Euro zone and on and on.  But remember, people like Chanos have a vested interest in doom and gloom spin – they stand to profit handsomely if they are right. 

While high risk-takers might want to place their bets with iron ore company executives who seem to know something that prods them to push on with expansion, there are other opportunities out there for the more risk-averse.

Oil and Gas Producers/Explorers

There is one resource China and other major Asian nations are looking to for relief from the pollution stemming from coal-fired electrical generation plants.  That resource is natural gas that can be imported in a liquid state – LNG (Liquefied Natural Gas).  You have probably heard the predictions of an impending “golden age of gas” and Australia could see LNG usher in a new resources boom that could make us look back at the iron ore boom as only one step in profiting from our abundant natural resources.

There are three major Australian players in this sector and all have major exposure to oil production and exploration as well.  Here are three companies whose shares have been dragged down in the panic.

Company

Code

Market Cap

Share Price

52 Wk Hi

52 Wk Lo

P/E

P/EG

Woodside Petroleum

WPL

$25,632M

$31.11

$46.75

$29.76

14.16

.81

Santos Ltd

STO

$11,357M

$11.92

$14.88

$10.11

21.04

3.06

Oil Search Ltd

OSH

$9,053M

$6.80

$7.55

$5.43

45.16

10

 

At first glance it would appear that OSH is significantly overvalued, yet analyst opinion disagrees.  In the most recent broker recommendation (23 May 2012), Citi upgraded OSH to BUY from Neutral, citing an improving story in their involvement in the PNG LNG project in partnership with Exxon Mobil.  Since 20 April 2012 seven other major analyst firms have chimed in, all with BUY, OUTPERFORM, or OVERWEIGHT recommendations.  The JP Morgan Chase recommendation was an upgrade from NEUTRAL, citing again the progress in the PNG LNG project.  Here is how market participants have viewed OSH over the last six months:

Note the share price has dropped in the last several weeks with no apparent change in company fundamentals.  While there is nothing certain in equity markets these days, it would appear the dip is due to market news and represents a potential buying opportunity.

The picture is less clear with the other two players, especially Woodside.  There have been delays in the start up of their Pluto LNG project and the news of the commencement of production has not been enough to counter the general market panic selling.  Here is a six month chart for WPL and STO:

If you believe in the golden age of gas, these companies are worth a look.  While the more cautious among you may wish to wait for a bottoming process once the next chapter in the Euro zone horror story unfolds, all three of these companies merit at least a place on your watch list.  With Greek elections in the offing and debates over some form of Euro-bonds in the news, share price volatility is not going away.

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