After all the recent carnage in the resources sector, surely there must be some bargains out there now! Today, I’m looking at Rio Tinto (LSE: RIO), Antofagasta (ANTO) and Pan African Resources (LSE: PAF).
Investing in the miners will be a good idea
At some point, buying into mining firms will end up looking like a good idea. Eventually commodity prices will stop falling and so will the mining companies’ share prices. When commodities bottom out, miners that still survive will be well placed to benefit from any upside potential that may develop from rising commodity prices in the future.
I’m singling out Pan African Resources as the firm most worthy of further research from this collection of three. Let me explain why.
The hurdle of surviving the current rout could yet prove insurmountable for some mining firms — some have high loads of debt that could prove unserviceable if those firms’ profits evaporate completely.
How can we tell when to time a jump into the miners? Perhaps traditional valuation indicators such as price-to-earnings ratios, dividend yields, and price-to-asset values could serve well. I’m sceptical about that. How can such metrics deliver a meaningful solution to the valuation problem when nobody knows what commodity prices will do next? Will the price of iron ore, copper and other resources flat-line from here, will they rise, or will they halve and halve again? The mining firms’ directors don’t know, nor the City analysts and private investors like us.
How I’d time the jump into the miners
We could try to work out what supply and demand for commodities is likely to do for commodity prices going forward. However, that approach seems fraught with difficulty and potential to arrive at inaccurate results.
Company-specific economic factors and investor sentiment drives share prices, so one way of timing an entry into the resources sector is to look at the charts for commodities and mining firms. Charts show us the picture on the ground. They tell us where prices have been. They indicate, for example, if prices are trending down, up, or whether they are flat. The full weight of opinion from the wider investment community drives share prices, so we should observe, I’d argue — even then, charts won’t tell us what will happen next.
That said, when it comes to out-and-out cyclical firms such as the mining companies, buying into a share price that is still falling seems like a poor idea, no matter how tasty those traditional valuation metrics become. I’d argue that we should wait for a price fall to stop, and for the share price to bottom-out and stay there, before even thinking about buying. Right now, we see a bear market in commodities. So, perhaps it’s even better to see an uptrend develop with a few higher lows in place as the shares start to wiggle back up. If we allow for that, there’s at least some chance that the underlying business’s operational convulsions might have settled down a bit, and we can start to gain a clearer picture of how well the firm is coping. Perhaps we can then start to take notice of those valuation metrics again.
To sum up, my rule-of-thumb criteria before investing in the miners now is:
1) Survivability — what is the magnitude of the firm’s debt burden?
2) A change of trend — is there a clear and tested bottom in place for both the underlying commodities that the firm relies upon for its living and in the company’s share price?
This kind of approach doesn’t look very intelligent, I know, but does seem like a pragmatic way of attempting to preserve capital — it’s dead easy to be wrong for a long time with a contrarian mindset. These are cyclical firms, which means they make dangerous buy-and-forget investments.
How these three firms compare
The debt loads and price-chart movements look like this:
|
|
Gross tangible gearing |
Share price chart characteristics |
|
Rio Tinto |
58% |
In downtrend |
|
Antofagasta |
29% |
In downtrend |
|
PanAfrican Resources |
15% |
Flat-lining |
Pan African Resources has the smallest load of debt, which ticks the box for survivability. The firm also has a share price that seems to have stopped falling, unlike the other two firms, which currently have no such indication on their charts.
That’s why I’d start my research with Pan African Resources from this assembly of three. First, I’d dig into the underlying charts of the resources the firm produces and then visit the traditional valuation indicators that carry more weight now the chart, and operations, no longer appear to be in freefall.
