The Important Issue for Resource Investors

It’s a good time to find new ways to profit from new markets. The old ways are under siege. Iron ore prices hit a seven-month low last week. At $113 per tonne, the iron ore price is still above last September’s lows of $86. But if the Aussie industry produces around 550 million tonnes of ore next year as expected, lower iron ore prices could cost it $18 billion in revenue, according to an article in last week’s Australian.

Lower prices won’t help BHP Billiton, Rio Tinton, or Fortescue. But lower prices will really hurt the mid-tier producers who have lower ore grades and higher transportation costs. The marginal firms will get clobbered. This is exactly what Greg Canavan has been talking about in his latest report on China.

Speaking of China, it’s the Chinese steel producers who need to lift their game for Aussie ore stocks to be valued as growth stocks again. On that score, the news is not promising. True, China’s May PMI reading of 50.8 showed expansion and eclipsed April’s 50.6 reading. But for the ASX/200 to get a real lift from China, it’s going to require a bigger surprise.

Perhaps there will be other surprises forthcoming this week. It’s a big week. We’ll learn the first quarter GDP figure. There is also a raft of other economic data, including jobs and inflation numbers that will tell us how the Australian economy is travelling.

The more important issue for resource investors is whether now is the time to be a buyer or seller.  For example, Rio Tinto is shopping some of its Canadian iron ore assets to commodities trader Glencore, according to the Wall Street Journal. Private equity firm Blackstone has also been sniffing around for resource assets on the cheap.

And over in the UK, Aussie-listed Eden Energy reached a deal to sell its Welsh-based coal seam gas and shale gas assets for $15.7 million to a UK company called Shale Energy. Eden Energy has a market capitalisation of about $8.1 million. It was a pretty tidy piece of business, then, to sell its assets for nearly double its market cap.

Therein lies a ray of hope for resource investors. Companies that have real assets are always going to be worth having a punt on when the assets on the balance sheet exceed the market cap. This was the premise of Alex Cowie’s latest report, where he went back and revisited the cash/market cap ratio in the resource sector to come up with a short list of candidates. He tipped three of them.

The trouble is — and it’s the same trouble it’s always been in the resource industry — you can never tell who is lying. Some companies exist to mine the pocket book of the public. They’re good at issuing convincing press releases. But they’re not very good at extracting resources.

If the grand cycle of Chinese urbanisation that’s supported the resource sector for the last ten years is over, it won’t much matter anyway. Foreign capital will pack its bags and head for the exits, looking for more attractive returns, probably in technology or energy stocks. The Aussie dollar will go much lower than anyone expects.

Then again, your editor is inclined to see things in the worst possible light. It’s a habit of being prepared for the worst so you’re pleasantly surprised when things turn out alright. But pessimism is to be expected when you talk about politics and finance, two areas that seem to bring out the worst in human nature.

By contrast, most of the news in the technology sector is optimistic. If all you did was read trade journals and technology magazines, you’d be convinced that technology is making life better and that we’re on the verge of some true breakthroughs. More on that tomorrow.

Regards,
Dan Denning
for Markets and Money

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1 Comment on "The Important Issue for Resource Investors"

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Jason
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Demography must be considered when examining China’s future economic growth and it never is considered in Australia. Too many ‘panda huggers’ running our mining sector and government.
China is already running out of working age people, it has one of the lowest fertility rates in the world and soon its population will be declining. These demographic changes will affect China’s economic growth and by extension, Australia’s economic growth.

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