Resource sector negativity is almost deafening. China’s mixed economic signals, fears about iron ore and expectations of rising commodity supply are pummelling the industry. Among junior miners, funding concerns and shrinking cash balances have heightened survival risks.
Rising geopolitical risks in former mining hotspots, such as West Africa and Mongolia, and North Korea’s nuclear ambitions, are other investment turn-offs. And the US shale gas and oil boom will be a game-changer for Australian coal producers as it lowers energy prices.
For mining service companies, the slowdown in the resources investment boom is causing more projects to be trimmed, deferred or cancelled, and even greater price competition. Service companies exposed to riskier exploration projects and smaller mining companies may not survive.
This unrelenting negativity raises the question: is it time to buy mining stocks? The investment maxim to buy when everyone else is selling, and vice versa, sounds great in theory, but hard to do in practice when share prices and indices tumble and gloom spreads.
The S&P/ASX 300 Metals and Mining index has lost 15 per cent over one year; the S&P/SX 200 index has gained 20 per cent (including dividends). Over five years, the sector index has an average annual total return of negative 8 per cent compared to a 2 per cent annual gain in the ASX 200.
Led by Newcrest Mining, the S&P/ASX All Ordinaries Gold Index has shed a remarkable 31 per cent over one year. Gold bulls who punted on more global central bank quantitative easing and expectations of rising inflation have been badly burnt by falls in the precious metals and poor gold company performance.
By any measure, that is incredible underperformance. Who could have thought mining stocks could perform so poorly, given the commodity price and mining investment boom up to mid-2010? Or that the sector could find new lows this year.
Long-term investors who can hold mining stock for five to 10 years might one day look back on current price weakness as an opportunity that only emerges every decade or two. But they will need to resist intense volatility and the prospect of further significant losses in the short term.
Make no mistake, risks in resource sector investing are immense, despite signs of a slowly improving US economy, stability in China and arguably the worst of Europe’s economic meltdown behind it. This is not, nor has it ever been, a sector for risk-averse or income-seeking investors.
Portfolio investors, such as self-managed superannuation funds (SMSFs) that buy resource stocks need a multi-year view and a focus on the highest-quality resource companies that will be left standing – and prosper – when the cycle inevitably turns.
BHP Billiton. Rio Tinto and Woodside Petroleum are the obvious standouts among large mining stocks. BHP, in particular, is starting to attract more accumulate and buy recommendations from brokers, based on consensus analyst forecasts, as price falls create better value.
Another option is investing in a commodity rather than mining company – a strategy made much easier through the introduction of more exchange-traded commodities on ASX. By providing pure commodity exposure, ETCs eliminate company risk. Choosing a hedged ETC, over gold for example, eliminates currency risk and provides purer commodity exposure.
True believers in gold have been better off buying a hedged gold ETC than investing in gold stocks, which on balance have a frustrating habit of destroying shareholder wealth and underperforming gold bullion.
In a research note this week, Macquarie Equities Research identified coking coal, tin and lead and its preferred commodities over 12 months. Over three to five years, it favours coking coal, tin, lead, uranium, nickel, platinum and palladium. Macquarie has a negative short-term view on the gold price and said the medium-term outlook was mixed. Most bulk commodities have poor price outlooks.
Another option is investing in larger, high-quality mining service stocks. Macquarie upgraded its recommendation on Boart Longyear to “outperform”, with a 12-month price target of $2.10, compared to recent prices around $1.15. Macquarie wrote: “The global exploration outlook has not improved since we neutralised our recommendation in February, but nor has it deteriorated to the extent implied by the current share price.”
This column has argued this year that mining service stocks, notably NRW Holdings, Monadelphous Group and Calibre Group, offer reasonable long-term value.
Boart Longyear has been a disappointing stock, but a forecast price-earnings (PE) multiple of less than 10 times, on Macquarie numbers, is a few points below several other large mining service companies and under the sector average. Macquarie says the market is overestimating the extent of potential earnings downgrades for Boart Longyear.
Click on the links below to read other articles from this week’s newsletter
Tony Featherstone is a former managing editor of BRW and Shares magazines. All prices and analysis at Feb 14, 2013. The author implies no stock recommendations from the above commentary. Readers should do further research or talk to their financial adviser before acting on themes in this article.