Is this the start of a resources rally?

The S&P/ASX 200 Resources Index (ASX: XJR) has risen 10% over the last 10 trading days. Here are some of the big winners from some quality companies, based on their rise from January 30 to February 18:

According to broker UBS, the mining sector is set to generate around U.S. $40 billion in free cash flow in 2014. In 2012, free cash flow fell U.S. $10 billion. This turnaround is largely due to management wanting to keep both fund managers and investors happy by increasing dividends or buying back the shares.

So a step change may be occurring whereby mining companies, formerly not known for dividends, are caught up in the ongoing hunt for yield. The demographics of the aging population and the increasing use of self-managed superannuation funds may dictate that yield will remain a primary objective for resource companies.

As reported in the Australian Financial Review earlier this week, Rio Tinto’s decision to lift its annual dividend by 15% last week is a sign of what is to come from BHP, which does not adjust its dividend payout policy in the interim period. The company’s final dividend for the June half will obviously take advantage of the strong cash flows and strengthened balance sheet.

BHP is readying shareholders for a new round of capital management as it steps up its productivity and cost-cutting, while banking increased cash flows from world-class resources. The final decision on whether BHP will go with a buyback or special dividends will involve a tussle between the demands of London-based investors and those in Australia, who prefer to grab the franking credits. That tension helps explain why the issue of delisting the company’s shares in London was re-examined in 2013

Foolish takeaway

In my opinion, a fundamental change in resource company capital management policies could lead yield-hungry investors to take a new look at resource stocks.

From the above list, my long-held preference has been for Fortescue Metals Group due to an increasing production profile, reduced capital expenditure and an unexpected 10 cent dividend (consensus 4 cents) in the prior profit reporting season.

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Motley Fool contributor Mark Woodruff owns shares in Fortescue Metals Group.

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