Resources and resource stocks will boom again – perhaps sooner rather than later

Despite the current gloom in the resource sector, resource stocks will boom again as the world pulls out of the current financial mire.

Author: Lawrence Williams
Posted: Wednesday , 29 Oct 2008

LONDON -

Despite all the gloom and doom in the industrial and precious metals sectors at the moment, there is little doubt that resource stocks will surge back into favour again, but the big question is when, and how much overall sentiment has been damaged by recent events, and how long such damage will continue.

History tells us that market memories are relatively short and serious effects tend to be measured at worst in a few short years rather than decades! The resource sector has seen this before. The most recent major example has been the gold sector post the Bre-X scam. It did take a few years to recover, but ultimately bounced back stronger than ever.

However the latest crash is somewhat different. It is not only resource stocks which crashed, but stocks in general, although admittedly the resources decline has been more severe than most. It is truly remarkable how quickly what had been a booming sector has turned to bust. But there is an argument that the collapse has been hugely overdone and that the upturn, when it comes, could be equally rapid, although perhaps not as steep.

This is, perhaps, an optimistic take on the situation. Special situations may exist which could see this more than likely happening in specific sectors of the resource industry. Precious metals - notably gold and silver - do not necessarily follow predictable patterns in the market and can buck overall trends quite dramatically as the normal laws of supply and demand do not necessarily apply. There are always other factors in play here.

For natural resources in general, and resource stocks in particular, there is little doubt that there has been a degree of overselling that bears little relevance to the true market situation. The recent price crash means that there will be a serious impact on new production in the immediate future as projects are slowed down, postponed or irredeemably cancelled, with a corresponding effect on future supply. Supply increase projections will in many cases be put back by three to four years or more.

What this means is that as soon as the world pulls out of the current financial predicament, and while this may not be a quick process it will indeed happen, commodities are going to be in short supply again - and in some cases seriously short supply. Those which were already heading that way anyway before the meltdown may be those which will benefit most in price terms - perhaps platinum, tin and zinc may be good bets in this respect. Forward production plans for platinum and zinc mining in particular are likely to have been decimated by the huge price falls seen which have made many operations sub-economic and put a rapid halt to many new projects under development or at the planning stages.

Nickel too is an interesting metal in this respect. Comments at Aspermont UK's 20:20 nickel meeting in London yesterday suggested that an important proportion of the world's nickel production is sub-economic at current price levels - notably in mining and processing of some nickel laterite ores - which has already brought some major projects to a grinding halt, and is likely to lead to closures elsewhere. Chinese pig nickel production has, in effect, shut down and estimates of nickel production taken off the market already is around 150,000 tonnes (around half from the Chinese pig nickel operations which need considerably higher prices to be profitable). If the price stays at the current level of around $5/lb for any extended period more closures and slowdowns are likely to be seen. BHP Billiton, for example, reckons its big Ravensthorpe nickel project in Australia needs $5-$6/lb nickel to break even at full production - and it's still two years away from achieving that status. Even a company like BHP, which is in it for the long term, is unlikely to run lossmaking operations indefinitely.

But what is being seen here applies to other metals and minerals too. Low prices are prevalent virtually across the board, and coupled with banks loath to loan anyone serious sums of money with even the smallest risk of disruption (which puts almost any project in areas of less stable political environments at risk - think DRC in this respect), future industrial metals supplies are in for a very tight squeeze indeed - and this has to have a huge effect on price prospects.

To an extent the speed of price recovery depends on countries like China and India maintaining demand growth while the rest of the world stagnates. If China does indeed continue to grow at 9 percent a year as many suggest (others downgrade this to 7-8 percent - but growth nevertheless), then the metals price recovery could be rapid and prolonged.

If we have seen the market bottom - and that is by no means certain until some more financial disasters are played out - then commodities and commodity stocks could well be a good place to be for above average gains as markets pick up. But as we have stated before you need to do your homework. Major miners should be good bets for growth from current levels, but it is in junior and mid-sized companies that the biggest returns could be made. But here one needs to make sure one chooses companies which are financially strong enough to survive whatever is left of the downturn or stagnant period. To mitigate risk, one would also suggest choosing those operating in low risk areas of the world - and there don't seem to be too many of these around these days!