Should you buy Australia’s small resources companies?

Despite a resilient iron ore price, investors are still avoiding Australia’s small resources companies with the index now trading below its levels during the global financial crisis.

A combination of a crumbling spot gold price, project financing issues, uncertain demand from China and a poor medium-term outlook for various major commodities has seen the ASX Small Resources Index plunge 41% in the last 12 months to 2209 points. This is marginally lower than its level when the market dived in November 2008.

While Australia’s bigger miners, including BHP Billiton (ASX: BHP), Rio Tinto (ASX: RIO) and Fortescue Metals Group (ASX: FMG) are all trading above where they sat 12 months ago, smaller companies including Whitehaven Coal (ASX: WHC), Western Areas (ASX: WSA), Evolution Mining (ASX: EVN) and OceanaGold Corporation (ASX: OGC) have all fallen significantly. Their performances have helped drag the index down 68% from its five-year high of around 7000 at the beginning of 2011.

According to Morningstar senior equity analyst Gareth James, the index’s poor performance is justified given the poor records of many of the company’s within it. The firm found that 91% of companies with a market capitalisation of under $100 million reported a loss last year while roughly 60% of companies with a market cap between $100 million and $500 million also failed to recognise a profit.

The index’s performance over the last 12 months reflects the volatility still facing the sector and highlights the importance of investing in quality companies that have proven to be successful, as opposed to being purely speculative.

Foolish takeaway

Iron ore has proven resilient over the last 12 months, despite a number of analysts forecasting the price to fall along with demand. While Rio Tinto and Fortescue could be good bets for investors who believe the price of the steelmaking ingredient will remain strong in the long-term, BHP represents a safer and more diversified option.

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Motley Fool contributor Ryan Newman does not own shares in any of the companies mentioned.

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