Resource stocks bring returns for gold-diggers

Resource stocks have been the darlings of the stock market this year. Zilla Efrat asks if the good times will continue to roll.

Resource stocks have been the darlings of the stock market this year. Zilla Efrat asks if the good times will continue to roll.

When it comes to resource stocks right now, it seems that if you've missed the boat, you'd best just let it pass, but not for too long.

Resource shares are suddenly back in vogue and have outperformed other parts of the market this year. However, head of resources at BT Funds Management Steve Giubin says: "We are in for a bit of a rest until, maybe, some time in December."

This is because there's still some uncertainty about the direction of interest rates and economic growth. And, there's the chance of "a Christmas Box rally" (Commodity prices often tail off towards the end of the year and then jump again just before Christmas).

Nonetheless, Giubin believes that there's room for some commodity prices to rise into the new year, although not at the same rapid pace as seen this year.

Paul Redfern, assistant manager of equities at Australian Portfolio Managers, says: "Estimates of global industrial production growth continue to be revised upwards, which holds out the prospect of higher prices and more volumes shipped.

"Even though resource stocks appear expensive, they have the capacity to get more expensive and to show good profit growth next year."

And, Deutsche Asset Management Australia senior resources portfolio manager Lawrence Grech says: "The prospects for resource stocks over the next 2-6 months are good and they are likely to outperform the broader market."

This is because it will take a few months to assess whether inflation in the US is a long or short-term threat.

He says moderate concerns about rising inflation and interest rates could make resource stocks look more attractive compared to others, such as banks. But, he notes, it's a high wire act. If interest rates rise too much, they will hurt resource stocks.

He expects resource stocks to benefit as the location of economic growth moves from the US to Europe and Asia next year. But he says: "Because we have seen some large moves in resources, I would be looking to be selective in exposure."

Giubin believes that diversified resource leaders like BHP and Rio Tinto may have already had their runs and may be fully priced.

"These big companies are considered less risky and more liquid. And, they usually do well at the beginning and end of a cycle," he says, noting that as confidence in resource stocks improve, more money will flow into gold and base metals companies.

Giubin says oil prices are likely to remain relatively high next year and that after being the worst performer over the past 15 months, the oil sector's fortunes must be about to turn.

He does not expect coal and iron ore companies to be star performers over the next year. And, he says, it is definitely far too early to even look at exploration stocks.

"There would have to be a spectacular rise in commodity prices and one or two good finds to encourage people back into these shares," he says.

After lagging in the doldrums for two years, gold has rallied on recent news that 15 of Europe's central banks have imposed strict limits on themselves in terms of bullion sales over the next five years. But market players appear unsure as to whether the recent gains can be sustained.

Nontheless, most pundits believe that merger and acquisition activity - like South Africa's AngloGold recent announcement of $832 million takeover of Acacia Resources - could add spice to gold shares.

Grech notes, however, that the gold price is not in the hands of the market, but rather in that of central bankers, making this a problematic sector.

But, like Giubin, he expects base metals, which are more geared to global demand cycles, to perform better in the short to medium term.

Later plays into next year, according to Giubin, could be the second tier companies including, perhaps, Western Metals, MIM, Capral Aluminium and Centaur.

"As the cycle unfolds, high cost producers will start to get good returns and second tier companies tend to be high cost producers," he says.

But he warns: "I wouldn't be adding a lot more money to the resources sector right now. We've already had a big move up and any move from here on is less likely to be as good, although certain areas will do better than others."

But, as Godfrey Pembroke's group manager of broking investment services Glen Castensen cautions, resource stocks are not for everyone.

"This is a difficult part of the market because of its cyclical nature. Over the long-term we question whether we can really get true value from exposure to it, except through timing," he says.

He says if you believe that you can pick the timing; good and well. Otherwise, it is probably best to have a small direct exposure to these stocks and then leave the rest to fund managers.

Lowest price to earnings ratios*

Company PE (times)

GPG 1.92

Macq Infra 4.09

Orogen 4.26

Orica 5.35

Prime Prop 7.16

Prime Ind 8.11

Austrim 8.74

PMP Comm 9.38

Foodland 9.71

Caltex 9.95

*Table lists lowest price to earnings ratio for Top 150 ASX listed stocks at close of trade on October 15.

Highest dividend yield*

Company yield (per cent)

PMP Comm 9.62

United Energy 8.25

HIH Insurance 7.95

Caltex 7.39

Bat Aust 7.23

Mayne Nickless 7.01

Macquarie Infra 6.94

Ten Network 6.70

Coal & Allied 6.44

Pac Dunlop 6.22

*Table lists highest dividend yield for Top 150 ASX listed stocks, excluding property trusts, at close of trade on October 15.

The top five long-term resources stock picks from Steve Giubin, head of resources at BT Funds Management.

1. Newcrest Mining

The outlook for gold is the best that it has been for some time. This company also has a suite of potential projects which could be given the green light within the next six months. And, it also has a good hedge book with large non-limiting cover.

2. Western Mining

It should benefit from the pick up in commodity prices. It also offers unique exposure to alumina which is extremely tight. All new projects will also be contributing to earnings in the next year.

3. Woodside Petroleum

Its Laminaria project will contribute fully next year, which should lead to a quantum increase in cash flow generation. The company also has good quality long life reserves and the outlook for oil prices are pretty good.

4. Iluka Resources

The outlook for mineral sands are positive and rationalisation is expected to benefit this company.

5. North

This stock, which has underperformed the resources index, should score from a pick up in iron ore demand next year.