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2013 is a brand new year that should leave far behind all the misery that the Resources Sector endured from the April 2011 highs into those abominable lows of August 2012.






DAWES POINTS

2013 is a brand new year that should leave far behind all the misery that the Resources Sector endured from the April 2011 highs into those abominable lows of August 2012.

The foundation for the year ahead was pointed out in a positive Paradigm Outlook from October 2012 which suggested that investors should "Heed the markets, not the commentators''.  So many market indices (Germany, India and several in the US) were then pushing all-time highs and others (Shanghai, Hong Kong, FTSE, Nikkei and the All Ords) had broken downtrends from the 2007-08 highs and were clearly looking over the horizon to some sort of better times.  Commodities were holding up OK whilst PE ratios for many stocks and markets were at the lower end of the ranges of recent times and dividend yields were looking very attractive.

However, the major issues of a China recession, European depression and US "fiscal cliff" were dominating the media and sentiment.  In contrast, the underlying market strength was ignoring all that and the markets were moving to challenge these all time highs. 

For the Resources Sector, the concerns over China led to a hammering of the iron ore price from U$180/t down to below US$90/t and weakness in mining stocks but the recovery back above US$150/t has been remarkable.  My "Dawes Points" on iron ore in December suggested that the cost structure of iron ore and the underlying firm demand for iron ore would generate a price recovery soon and that new highs in iron ore prices might yet be achieved in the near future.  Maybe and maybe not.
 
The stock selection from within the many iron ore players has given some encouraging gains  since then and a lot more should be coming.  These gains are such a welcome relief from endless savage falls.  It is nice for clients to be making money again.

Coming back to the markets, it has been very encouraging to see in the US indices such as the Russell 2000, the Wilshire 5000  and the Dow Transports making new all time highs (so I guess we really are in a Bull Market!) as well as the Dow Industrials and the S&P500 pushing on to long term resistance levels that go back over 12 years to 2000.  Should these upmoves go just a little higher then confirmation of the "Optimism Upleg" should be achieved.  The markets are really responding in a major liquidity driven global reflation after all the central bank injections so the next few years could be very strong.
 
The global economy has had its ups and downs but the problems haven't been anything like those that so many commentators have feared.   And it has been the steel industry data that has given strong support to a firm underlying global economy and so many commodity prices (other than coal) have remained quite firm.  Gold, copper, oil and silver have all been good performers although not as strong as we would all have liked.  Platinum and Palladium are also making new 6 month highs. The strength of the A$ has matched commodities and this will also be reflecting the likelihood of a weaker US$.
Better markets should lead to recoveries in the prices of so many of the 1000+ resources companies on ASX and as the declines have been so savage (and uneccessarily so for most, in my view) the bounces should be very healthy.

The current lack of liquidity in many stocks reminds me of a similar time in 2002 prior to the start of the last Resources Sector run that led to spectacular gains into 2007/8 so the opportunities are very attractive.   The volatility of the resources sector strongly advises for a portfolio approach to investing and the portfolio should be broad.  This is against the advice of most advisers but small resource stocks are a very different asset class to most other investments.  The sector has a very high risk/reward profile but it can be uneven so a portfolio approach does pay off.

At MPS a model portfolio was established each year from 2004 for the `Excellence in Mining and Exploration Conference’ on the basis of investment only (dividends, no trading, no reinvestment of cash from takeovers and no interest income) to take advantage of the improving prospects for the resources sector. The portfolio returns were quite spectacular and even after the GFC the gains were outstanding.   

The 2004 portfolio (18 October 2004) had 23 stocks diversified into mining and petroleum and today (18 January 2013) still looks good as follows:-

  Weighting % Gain %
Market Leaders 35 177
Midcaps 25 263
Micro Caps 20 382
Early stage 20 1170
Total 100 452
ASX Small Resources   83.8
ASX 300 accum   80.4
 
 It was a good time to invest and the concept of buy and hold did very well here.  The portfolio had seven stocks that were taken over (cash sent to deposit accounts and not reinvested) and one went off the board.  Note that the 20% in Early Stage companies gave us 1170% over the 8 or so years and the entire portfolio was up over 450% against 80.4% of the All Ords Accumulation Index and 83.8% for the ASX Small Ordinaries Index.

The ASX Small Resources Index itself has had very impressive long term gains despite the volatility of the past five years.  Note that the 2011 post GFC highs were within a few percent of the 2008 highs and also that the ASX 300 Gold Index made new highs in 2011.
XSR.ASX

 

ASX Small Resources, Industrials, ASX 300 Metals and Mining, ASX 300

Everyone should stand back and review this against the performance of the ASX 300 and the Small Industrial Indices because these are the reasons for investing in the Resources Sector.  Higher volatility but outstanding long term returns.
Having been professionally active in the markets for over three decades I see markets as having some degree of patterning.  The inputs to that patterning vary from true economic activity to geopolitical actions, central bank-fed market liquidity and also the very basic issues of just fear and greed.
The period from 2002-2007 was an excellent time of strong resources sector performance but most investors did not participate because they kept on expecting it to quickly end.  It did have a sharp ending but recall that resources bottomed in Nov/Dec of 2008, about 4 months before the March 2009 lows in the broader markets and many resources stocks made new highs in 2011.  However, the past five years is for many people in the market is all they have ever seen - high volatility with emphasis on the danger and sharp falls in share prices.

If the current market actions are suggesting that we are to move to more steady markets then resources shares should also start to better reflect the current reasonable commodity prices and a great increase in production in iron ore, gold, copper, hydrocarbons and coal.

The Emerging Economies of China, India, Brazil, SE Asia, South America, the Middle East have been expanded to the stage of now absorbing more than half of the world’s energy, minerals and food so that demand for raw materials is following rising populations and living standards and not the actions of central banks in the OECD. 

The growth has come on steadily from the late 1990s and has underpinned the rise in commodity volumes and prices.  The Small Resources has reflected this and so the past ten years on balance has been good with the Small Resources up a net 216%   and a compound growth rate of 13.5%pa.  The patterning suggests that 2007-2012 was a correction to the build up of the prior five years or so to that great upmove to 7000.  The volatility has been very high but I see this volatility due to a lack of participation by the traditional participants.  Low participation means few players and thin markets so that means valuations are not reflecting true underlying value.  All holders of resources stocks would agree that their shares are way too cheap.  Why such low prices for resources companies from BHP to Zamia Metals when the underlying commodities are strong?  New participants are needed.

As the A$1,450bn of bank deposits (and households having over A$700bn of this) slowly begin to flow back into the share market and property and consumer spending picks up then share market valuations should better reflect reality.
If market patterns do means something then the volatility of the past five years should be replaced by a renewed upleg of less volatility but with an upward bias that should run several years before running into trouble from overvaluation and project risk.   The is the `Optimism Upleg’ after `Disbelief’ and `Pessimism’.

The macro view of expanding Emerging Markets raising living standards against capacity restrained commodities and with OECD countries still expanding monetary aggregates whilst debasing their currencies still holds.  Higher commodities, a strong A$ and rising global stock markets are the most likely results.  The past five years ignored so much of all this.

And here, do not ignore that the Peak in conventional oil production is well behind us and that OECD central banks are probably still jittery about their leased out gold reserves.  Oil and gold will be amongst the best performers over the next few years.

 To conclude, a Paradigm Portfolio has been prepared and incorporated here.  28 stocks have been selected with 30% large caps, 24% Mid caps, 24% Microcaps and 22% Early stage.  Petroleum makes up 24% of the portfolio, Gold 20% and Iron Ore 14%.

Resources Portfolio

 

       
  Price Shares A$ Sub Total Weighting
BHP 36.41 330 12000   12%
FMG 4.71 1274 6000   6%
WPL 34.66 173 6000   6%
OSH 6.98 860 6000   6%
      30000 30000 30%
CDU 4.28 935 4000   4%
WSA 3.45 1159 4000   4%
SLR 3.00 1333 4000   4%
WHC 3.61 1108 4000   4%
IGO 4.00 1000 4000   4%
AWC 1.07 3738 4000   4%
      24000 24000 24%
GBG 0.33 10390 3429   3%
ABY 0.50 6857 3429   3%
ALK 0.60 5714 3429   3%
DLS 1.60 2143 3429   3%
ERA 1.34 2559 3429   3%
NST 1.18 2906 3429   3%
ABU 0.05 68571 3429   3%
      24000 24000 24%
CTP 0.13 16000 2000   2%
CNQ 0.09 21739 2000   2%
TRO 0.06 32258 2000   2%
LNG 0.36 5556 2000   2%
PSA 0.18 11111 2000   2%
SAY 0.05 44444 2000   2%
TAM 0.61 3279 2000   2%
RMS 0.46 4348 2000   2%
BLK 0.15 13333 2000   2%
KBL 0.15 13333 2000   2%
GRX 0.15 13333 2000   2%
      22000 22000 22%
Total     100000 100000 100%
Note: Paradigm Securities has recently completed capital raisings for both SAY and BLK.  Mr Barry Dawes  and/or his associates hold interests in most of the above securities.

For newcomers to the Resources Market note the portfolio approach because no one can be sure which stocks will run at any time.  For those who suffered during 2008-2012 and particularly from April 2011 to August 2012, do not despair.  The past five years of misery is probably an aberration and it just could be the time to go back into the market.
The possibility of an early election in Australia is still high and those interested in following tremors in the fabric of the current anti-business ALP Federal Government should follow the daily revelations in www.michaelsmithnews.com andwww.pickeringpost.com


Barry DawesConsultant Head of Resources
B Sc F AusIMM(CP) MSDIA

Barry Dawes’ expertise in the Australian resources sector is based on his knowledge as a geologist combined with over 30 years’ experience in the resources investment sector. Prior to founding Boutique Investment Firm “Martin Place Securities” in 2000, Barry had worked in senior executive roles of investment management with BT Australia, equities research for Bain Deutsche Bank and equities research and corporate finance for Macquarie Bank. He is currently a Director of a number of unlisted public operating companies. Barry has a substantial depth of knowledge and experience in the international resources industry and is well known for his views on the sector.


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