Are We Still The Lucky Country?

Australia is blessed with an abundant supply of natural resources and as such has been dubbed “the lucky country” by many economists and investors alike. The mining boom of the first decade of the 21st century has yielded handsome rewards for scores of Australian investors.  I hope you find this extract from an article written by Bob Kohut from thebull.com.au of interest.

As we enter the second year of the current decade, there are some who fear our luck may be running out. Commodity prices experienced steep declines in 2011; most notably in the crown jewel of Australian resources – iron ore. While many investors who fear the worst have moved to the sidelines, those who remain and those willing to get back in the game wonder whether the current slowdown is merely a temporary blip on the radar or a sign of worse things to come.

On the one side of the argument you have analysts from Moody’s Investors Service and Goldman Sachs predicting continuing downturn, with Goldman Sachs going so far in a recent report as to suggest the price of iron ore will be cut in half from its highs in a mere five years. Moody’s is not quite as pessimistic but both see overabundance of supply as a driving force. Moody’s also points out that increased automobile consumption in China has led to an oversupply of scrap metal. As demand ramped up, producers put substantial capacity expansion plans in place. Recent economic news out of China suggests demand may be slowing. It does not take a PhD in Economics to predict that increased supply in the face of decreased demand will cause prices to drop. The question on everyone’s mind is how much might demand actually drop and how soon?

In a bold and daring display of confidence, Fortescue Metals is going ahead with plans to triple its production of iron ore by the middle of 2013. Their confidence is shared by investors as their recent $2 Billion dollar bond sale to fund the project was oversubscribed

It has generally been an accepted maxim of commodities investing that to get outsized returns, pure plays are a better choice than diversified producers. And amongst the pure plays investors need to look for the lowest cost producers. Low production costs mean a miner is more likely to survive price drops. Typically the lowest cost producers are the companies that control all aspects of the production process from excavation to processing to distribution.

If you are at all concerned about commodities slowdowns, the above maxim is reversed and diversified miners offer more protection against the risk of substantial price declines in a single commodity. The following table represents the Top Ten mining stocks by market cap on the ASX, categorised in the Materials Sector. Let’s have a look.