Three Rules for Buying Resources Stocks
For the oil consumer, the news from around the world is not good. Oil fields are depleted. There are few promising new discoveries. The Chinese are muscling into Canada’s Tar Sands. And most importantly, the price is up seven times in the last ten years.
But wait.
“The resource business is not a cyclical industry. It is an extremely cyclical business. More cyclical than you can imagine,” says our old friend, Rick Rule.
“In natural resources you only have two choices,” he continues. “You can be a contrarian or you can be a victim. And yet, many people still buy resource companies after they have been run-up. They still sell them when they get disgusted after they have fallen down. That is no way to make money.”
So...does that mean it is time to sell oil? Maybe.
Rick says there are three rules to buying resource stocks.
First, you have to be contrarian. You have to buy them when others don’t want them.
Second, you have to buy the good ones. Most resource companies are run by incompetents, he says, or worse - “people who would normally wear a mask when they go to the 7-11”. The 80-20 rule applies here as elsewhere. Only 20% of the companies will make 80% of the profits. And the 80-20 rule applies to the 20% too. So only 20% of the 20% of companies will make 80% of 80% of the profits. You have to do some serious research and analysis to figure out which those companies are.
“I look for serial and sequential winners,” says Rick. “I look for the people who have proven that they can produce profits.”
Finally, Rick says you need to look for projects in places where most people don’t want to go. Political risk is always a problem for resource companies. But the political risk is not what most people think. Most investors judge the risk high in the Congo, or in Mayanmar, and low in California. “Actually, the opposite is true,” Rick explains. “California is so rich that it can afford to treat mining projects badly. But these poor, basket-case countries need them. They are much more respectful to miners.
“What you want is a place where people have misjudged the political risk, as they did in Thailand after the general’s coup d’etat last year. So when you see those scary stories on TV - those places that look dangerous and too backward to want to visit - that’s where I’ll be.”
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The Daily Reckoning offers an independent and critical perspective on the Australian and global investment markets. Slightly offbeat and far from institutional, The Daily Reckoning delivers you straight-forward, humorous, and useful investment insights from a world wide network of analysts, contrarians, and successful investors. Founded in 1999, The Daily Reckoning is published in 7 countries with a worldwide readership of almost 1 million people.
Comment by Craigh on 27 July 2007:
Many thanks for your insightful posts.
One thing that I’m finding interesting at the moment is the belief ( I would think unrealistic ) in continuing strong or rising commodity prices.
I as search back to my days as en exporter of real product I remember living and dying on exchange rates. Sure I could cover for a limited time to take me over fluctuations however what we have seen over the past few years and particularly in the past few months is ringing alarm bells with me.
As the US Dollar drops and the Chinese currency with it does not a new group of competing forces come into play?
If the Australian economy is riding on the Chinese tsunami of raw material requirements ( in volume ) and we are madly investing to support that volume are we seeing an exchange rate that will erode the margins in that volume. There can be nothing worse than being committed to volumes and finding the more you produce the more you hurt.
I’d be interested in knowing how you see this playing out.