After the clear-out of poor managers could over-extended resource stocks perform again?

12th April 2013

This is an interesting little note from Tim Gregory, Head of Global Equities at Psigma Investment Management considering China, commodities and previously badly run  resource stocks all from the vantage point of Western Australia.

We run it in full below.

“If I’d told you a year ago that global stock markets could go materially higher without the benefit of strong performance from either Apple or the resources sector, it may well have been that you would have called for the men in white coats or just handed me a long overdue P45. However, the fact is that Apple is down 16% this year and the S&P 500 is up 11% (as at 09.04.13) and the resources sector has endured a massacre that began on the 14th of February and as I write shows little sign of relenting.

“Stationed here in the Wild West of Australia the price of iron ore is probably discussed as often as the price of a gallon of petrol is mulled over in the UK. Back in November 2012 the iron ore price slumped to $85 from a peak of around $180 as sentiment was dominated by destocking in China and concerns for the future of the infrastructure projects that have been a key driver behind the long mining super cycle that has been an integral part of the markets mood in the last decade. From the lows of $85 the iron ore price all but doubled in the next three months and has now, as many experts expected, fallen back to around $135. In the meantime stocks in the mining sector have been completely torched; Rio Tinto has subsided from nearly 4000p to just over 3000p today and higher cost producers have seen their shares all but halve to levels below where they traded in the dark days of November.

“From being the most loved part of the market, which was perceived as crucial to all market rises because of its correlation to the continued growth in the Chinese economy, resources are now clearly the most loathed of investments that investors feel they can apparently ignore.

“Ironically, contrary to normal stock market rules these stocks performed well at the same time as managements were making ill-judged decisions on expansion projects that have largely proved ill-timed at best and totally disastrous at worst. Most of these managers have now been fired and replaced by a new breed of leaders with a clear brief from shareholders to get back to basics, improve return on capital, generate cash and return money to shareholders.

“At the moment the macro drivers of a perceived slowdown in China and the end of the super cycle mean that the sector is the most heavily shorted by hedge funds and as ever stocks will surely overshoot to the downside just as they did to the upside at the height of the boom.

“Make no mistake, the super cycle for the mining industry is largely over but China will still make substantial investments in targeted infrastructure projects that will ease congestion, reduce air pollution and speed up transport and a sustained recovery in the US housing market will surely absorb plenty of copper. Low cost producers with managements increasingly focused on shareholder value could ultimately do well in an environment where newfound capital discipline and previously planned expansion projects are mothballed or scrapped forever.”

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