Following the bloodbath experienced by the mining sector, a friend asked me whether or not I thought it was a good opportunity to buy the stocks on the cheap?
After all, the best time to buy shares is when they fall and some of the S&P/ASX 200’s (Index: ^AXJO) (ASX: XJO) best performing stocks from the last eight months are now trading at much cheaper prices.
For instance, Fortescue Metals Group Limited (ASX: FMG), Australia’s third largest miner, has dropped 11% since Friday while Arrium Limited (ASX: ARI), BC Iron Limited (ASX: BCI) and Mount Gibson Iron Limited (ASX: MGX) have also plummeted between 8.2% and 10.6%. Not even BHP Billiton Limited (ASX: BHP) or Rio Tinto Limited (ASX: RIO) could escape, falling 4.7% and 5.7%.
I think my answer disappointed them a little. They had been hoping I would say “yes, now is the time to buy”, implying that I thought it was simply a temporary dip and that the shares would climb again in the near future.
Unfortunately, I do not believe that will be the case. You should never blindly throw your money into an investment based solely on the price. It is vital that you also look at the companies themselves as well as their prospects and their overall operating environment.
It is that last point that I am not comfortable with. As Motley Fool analyst Mike King highlighted on Monday, “miners are beholden to the commodity price, over which they have little if any control.”
Although I have been impressed with the improvements in productivity and the cost cutting initiatives undertaken by companies like Rio Tinto and Fortescue, it is their reliance on sustained high commodity prices that make it hard to justify buying the stocks.
While some analysts believe that the fall in price will only be temporary, I can’t look past the likelihood of supply growth continuing to outpace demand growth in years to come, which will continue to have a downwards effect on the commodity’s price, and therefore on the companies themselves.
I told my friend that the company I would be most comfortable holding is BHP given its much higher level of diversification compared to the other miners. While iron ore is its primary revenue generator, it is also heavily focused on other areas such as coal, copper and petroleum, thus spreading the risk.
Despite the fact that the stock has dropped almost 11% in the last two-and-a-half weeks, I will still be waiting for a much lower price than $35.50 to consider hitting the “buy” button.
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Motley Fool contributor Ryan Newman does not own shares in any of the companies mentioned.
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