The last month has been superb for the mining sector, with a number of its incumbents posting stunning share price rises. As such, many investors are becoming rather excited and optimistic about the prospects for the sector and the potential profit there is to make. However, the wider resources sector may not be out of the woods just yet and risks remain.
For example, Rio Tinto (LSE: RIO) has surged by 15% in the last month as investor sentiment towards the sector has improved dramatically. However, Rio Tinto remains highly focused on iron ore and isn’t particularly well-diversified in this respect. As such, a fall in iron ore prices could dent its profit outlook and send its shares falling in the short-to-medium term.
Of course, this doesn’t mean that Rio Tinto should be avoided. Quite the opposite, since the company continues to have a relatively wide margin of safety included in its share price. This means that even though it does come with a significant amount of risk, the potential rewards on offer seem to make it a worthy purchase at the present time. For example, Rio Tinto trades on a price-to-earnings-growth (PEG) ratio of just 1 and this indicates that its shares could continue to rise following their recent run.
High risk
Similarly, Glencore (LSE: GLEN) has also performed exceptionally well recently, with the diversified commodities company recording a share price rise of 92% in the last three months. Clearly, this rate of growth is highly unlikely to continue unabated and with Glencore continuing to have a balance sheet that’s highly indebted, it remains a relatively high-risk stock.
However, Glencore appears to have a sound strategy through which to overcome concerns among some investors that it has over-leveraged its balance sheet. And as with Rio Tinto, it offers a relatively wide margin of safety so that its risk/reward ratio remains highly favourable. For example, Glencore trades on a PEG ratio of just 0.4 and while earnings forecasts could easily be downgraded if commodity prices come under pressure, Glencore seems to be a worthy purchase for less risk-averse investors.
Too much uncertainty
Meanwhile, Genel Energy’s (LSE: GENL) share price has also performed well recently. Over the last month it has soared by 39% and this may cause investors to be optimistic about future prospects. Certainly, Genel has a high quality asset base and could deliver rising profitability in future years. However, with it having downgraded reserve estimates earlier this year, it’s expected to record a $1bn impairment in the current financial year and this could hold back its share price performance over the medium term.
Furthermore, Genel operates in a region with relatively high geopolitical uncertainty and while it has been able to produce during a challenging period, this is a risk to consider. And with Genel owed millions for past production, its financial outlook remains relatively uncertain. As such, it may be prudent to look elsewhere for more favourable risk/reward ratios – especially when the likes of Rio Tinto and Glencore are so cheap.
