Why This Resources Stock Rebound Can Last

Iron ore mining

Between intermittent bouts of bullishness, your editor has warned about a stock market crash for years.

Our detractors have laughed at our warnings.

They’ve said we’re like a broken clock — that we’re right twice a day.

Your editor will count that as a win. At home we struggle to be right once a day, let alone twice.

But just as often as we’ve warned about a stock market crash, we’ve held out hopes of a rebound in the resources market.

You could have accused us of being a broken clock on that score too. Except, this broken clock had no hands, so we didn’t even get it right once. Each time we predicted a rally, resource stocks kept sliding.

That was until this year. In 2016, after years of promise, resource stocks have finally started to rebound. The only issue now is whether they can keep going.

We’ll give you our take below…

Most investors don’t realise it.

That’s because most investors are still in bank stocks, retailers, or telco shares.

But one sector has done better than all those sectors.

This sector used to be popular among Aussie investors. But now, most investors hate it. We can’t blame them. For five years, it has handed out a beating to those who stuck with it.

Not anymore. This year, this hated sector — resources — is the best performing on the Aussie market.

And even after such a strong start, there’s no reason why this cracking run has to end.

Beating the rest by 10 to 1

So far this year, the S&P/ASX 300 Metals & Mining index is up 32.3%. You can see the performance on the chart below:

Source: Bloomberg
Click to enlarge

The percentage gain is even better if you take the gain from the January low point. From there, the index is up 55.3%.

It’s nothing short of stunning.

Even more so, when you consider the blue-chip S&P/ASX 200 index is up a measly 3.2% since the start of the year. That means mining stocks have bested regular blue-chip stocks by 10 times.

As we say, stunning.

But here’s the thing. Don’t for a moment think mining companies are suddenly making a lot of money again. They’re not. In fact, revenue and profits are just about as bad as ever.

So, what’s the deal?

A fine speculation

Check out this report from Bloomberg:

Rio Tinto Group reported its worst profit since 2004 as depressed prices for iron ore, aluminium and copper eroded earnings at the world’s second-biggest mining company.

Underlying profit fell 47 percent to $1.56 billion in the six months through June, compared with $2.92 billion a year earlier, London-based Rio said in a statement on Wednesday. That matched the $1.56 billion average estimate from seven analysts surveyed by Bloomberg. The dividend fell 58 percent to 45 cents a share, reflecting a new policy that ties the payment to earnings.

That’s a big drop in earnings, compared to the previous year. Of course, that drop is nothing compared to the drop from the earnings peak in the second half of 2010.

You can see that in the chart below:

Source: Bloomberg
[Click to enlarge]

From the peak, earnings are down over 80%.


Yet, like the rest of the resources sector, Rio Tinto Ltd [ASX:RIO] shares have done pretty well so far this year. The stock is up 10.5%. That’s three times better than the blue-chip index.

So why are mining stocks going up, even as many mining company results are still among the worst they’ve ever been?

Actually, that’s easy to answer.

After years of bad news, investors and analysts are now starting to look at the sector. They’re wondering if perhaps the worst isn’t behind it.

We figure those investors could be on to something. That’s not to say revenue and profits will return to the heights of the boom years. That’s a lot to ask for as China’s economic growth slows.

But just as investors were too optimistic during the bull market, we believe they became too pessimistic during the recent bear market.

After all, even after the stunning start to the year, the Metals & Mining index is still down 56% from its 2008 peak.

Because of that, we’re prepared to back the resources sector for further gains. That’s not to say the gains will come easy. There are still plenty of risks to the Aussie and world economies.

But, if you’re looking for a place to speculate, in our view, the Aussie resources sector is just about the best place to start.


PS: Our colleague, Jason Stevenson has followed resources stocks through thick and thin in recent years. Now, thanks to his aggressive approach to the market, his subscribers are seeing some of the best gains the resources sector has produced in years. Check out Jason’s work here.

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Kris Sayce
Kris Sayce, dubbed the ‘Jeremy Clarkson of Australian finance’, began as a London finance broker specialising in small-cap stock analysis on London’s Alternative Investment Market (AIM). Kris then spent several years at one of Australia's leading wealth management firms. A fully accredited advisor in shares, options, warrants and foreign-exchange investments, Kris was instrumental in helping to establish the Australian version of the Daily Reckoning e-newsletter in 2005. He is currently the Publisher, Investment Director and Editor in Chief of Australia's most outspoken financial news service — Money Morning.

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