Buying resources stocks at the moment may appear to be a foolhardy decision. That’s because the sector offers a tremendous amount of risk since there is a very good chance that commodity prices will continue their general downward trend, company profitability will decline and market sentiment will worsen as investors look elsewhere for capital gain potential.
However, as well as huge risks the resources sector could also offer vast rewards. A key reason for this is that global demand for a range of commodities is unlikely to remain at its current level, since the continued industrialisation of the emerging world is set to increase demand for oil, iron ore and various other natural resources.
In fact, global energy demand is forecast to rise by 30% in the next 20 years. This, coupled with the fact that exploration spend is on the decline across much of the sector, makes the oil industry an appealing long term buy right now. Certainly, the price of oil could fall further, but in years to come it may be significantly higher as uneconomical oil producers go out of business, new oil discoveries dry up and demand for black gold keeps on rising.
As such, buying Nostrum Oil & Gas (LSE: NOG) seems to make sense. Its shares may have fallen by 34% in the last year and it appear to be a highly risky punt, but the current margin of safety on offer indicates that the risk/reward ratio may be in the investor’s favour. For example, Nostrum is forecast to increase its earnings by 102% in the next financial year. And, with its shares trading on a price to earnings growth (PEG) ratio of just 0.2, the market does not yet appear to be pricing in such a high level of growth.
Certainly, Nostrum’s forecast are likely to change between now and the end of next year, but even if they are downgraded then the margin of safety on offer indicates that share price growth is still on the cards.
Similarly, precious metal producer Polymetal (LSE: POLY) is due to return to bottom line growth next year after what is expected to be a tough 2015, with the price of gold hitting a 5-year low earlier this year. With the company’s shares trading on a forward price to earnings (P/E) ratio of only 12.7, there appears to be considerable upward re-rating potential, even after they have soared by 32% in the last three months.
Clearly, the price of gold will have a major impact on Polymetal’s profit over the medium term, but with the global economy having an uncertain outlook, the precious metal may be viewed as a store of wealth, boosting its price.
Meanwhile, Sirius Minerals (LSE: SXX) still has clear risks, even though it now has the required planning approvals for its potash mine in York. For example, it must now obtain the £1bn+ financing for the project as well as develop customer relationships for the polyhalite fertiliser that it hopes to eventually produce.
On the financing front, Sirius may find it more difficult to raise the required funds now that the resources market has endured a hugely challenging period. Investors may be less keen on start-up projects, preferring to stick to already established and profitable entities. However, if it can obtain sufficient capital, crop studies have shown that the polyhalite fertiliser improves potato yields and, as such, demand could be high. Although very risky, Sirius Minerals could be a strong long term performer.