Warren Buffett avoids mining stocks and you should too

Falling commodity prices…    Iron ore hammered…   Copper smashed…  Worries about China and its shadow banking system…

Concerns about a potential war between Ukraine and Russia…  And where the hell is the Malaysian Airlines’ missing plane?

It’s a virtual smorgasbord for worrywarts, pessimists, doomsters and gloomsters. If Tony Abbott was still in opposition, he’d be having a field day.  No wonder then the S&P/ASX 200 has seen three consecutive down days… although it is bouncing back a little in morning trade. Mr Market doesn’t take kindly to all this negativity either.

Mark my words… and those of Warren Buffett

Of course, a “wall of worry” is nothing new.  The old saying goes that the market climbs a wall of worry. Today’s wall has a light covering of moss… yes, it’s a little slippery. But over time, it will continue its inexorable and inevitable rise.  Mark my words.

And for those of you looking to sell out, or even sit on the sidelines, recent wise words from Warren Buffett are always  soothing…  “The last thing you want to do during a war is hold money. Even during World War II, the stock market advanced, and stock markets advance over time.”

This is not quite war… although it must feel like it at times for investors in iron ore companies, with even the Big Kahunas Rio Tinto (ASX: RIO) and BHP Billiton (ASX: BHP) not being spared, their shares down 8% and 5% respectively so far in 2014. Amidst all the despair, as Commsec tweeted yesterday, when you zoom out and look at the bigger picture, all is well… “Despite the All Ords being down 2% this week, shares are still up 5.6% from lows hit in last 30 days.”

Even better, outside the commodities sector, where Scott Phillips likes to play, some stocks have had a stellar start to 2014. To highlight but one, Motley Fool Share Advisor recommended company SEEK Limited (ASX: SEK) is up 33 per cent so far in 2014 and up a whopping 160 per cent since Scott first made it an official Motley Fool Share Advisor recommended stock. It looks like a case of SEEK and you shall prosper.

The raging bull

Market commentator Peter Switzer is also optimistic and reckons we are in a raging bull market that still has a number of years to run. He says to keep an eye on the possibility of rising inflation and therefore higher interest rates, but with the RBA indicating low interest rates are here to stay for some time yet… the raging bull market could just be getting started. Yes Foolish readers, the party’s only just getting started! Dance all night or cry into your term deposits. It’s your choice.

As ever, however, it’s a case of buyer beware. A rising tide carries all boats, but your job as an investor remains the same… ignore the rubbish companies floating higher and focus on the quality companies that may have been temporarily left behind.

Speaking of duds… For many years I had viewed resources stocks as pretty much similar to industrials stocks. They invest some money, sell a product, generate revenues and in some cases profits… and some even pay dividends.

Now I’m not talking about explorers who have yet to see one cent of revenue. The vast majority are nothing more than highly speculative pieces of crap. As with everything, there are exceptions… like the rags to riches stories like Fortescue Metals Group (ASX: FMG)Atlas Iron Limited (ASX: AGO) and Newcrest Mining (ASX: NCM).

But here’s the problem with resources stocks… Miners are highly capital intensive – it’s not cheap developing a mine and getting it into production. And you have to consider the years and years of drilling and study of samples before the miner even has a commercially viable mine.

For bulk commodities like iron ore and coal, miners then have to make massive investments in infrastructure to transport their goods to market including railways, ports and all the other associated infrastructure. It’s no wonder then that Fortescue racked up over US$12 billion in debt to become the fourth largest iron ore miner in the world.

The massive punt that made Twiggy a billionaire

It was one massive punt on the iron ore price. In this case, the punt paid off. Early Fortescue Metals shareholders are millionaires, and Twiggy Forrest is a billionaire. But most punts don’t pay off. Rare earths producer Lynas Corp (ASX: LYC) is teetering on the brink of financial calamity as its punt on higher commodity prices unravels faster than a Mitchell Johnson bouncer.

And the worst thing of all about being a miner? Your mine is in a constant state of depletion. One it’s gone, it’s gone. Nothing left but a big giant hole in the ground. So here’s my question to you.

Why does anyone bother to invest in resources stocks?

It’s not as if you can stick Fortescue in your portfolio and forget about it for 20 years, like you could say Woolworths Limited (ASX: WOW) or Commonwealth Bank (ASX: CBA). Ever wondered why Warren Buffett has never invested in a miner?

Over the long term the price of a commodity is unknown – it could be higher or lower than today’s price. And commodity companies have no pricing power — falling prices and rising costs can rapidly turn a big profit into a significant loss. No wonder Motley Fool Share Advisor stock picker Scott Phillips recently said on Sky Business News, in reference to the iron ore miners… “The current price is NOT an opportunity.”

I’ve seen the light and don’t currently hold any resource stocks, apart from a small speculative position in four gold miners — but probably not for much longer.

Small and speculative… but not a miner, and does pay a dividend

Instead, I may switch my funds into some smaller speculative industrial stocks such as Coventry Group (ASX: CYG). With a market cap of just $99 million, Coventry holds $53 million in cash, and is paying a fully franked dividend of 8.4%. The company is a distributor of industrial products, such as fasteners, fluid hydraulics, as well as a manufacturer and distributor of automotive gaskets.

While Coventry Group has been struggling with a downturn in the infrastructure and construction sectors, it has diversified into IT Business solutions and cabinet hardware. The last six months result was disappointing, but the company says it is confident the second half will be an improvement.

With an improving outlook, no debt, plenty of cash, decent dividends and trading at a 25 per cent discount to its net asset value, you may want to give Coventry a closer look. Just be aware that this is NOT an official recommendation and shares are fairly illiquid.

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Of the companies mentioned above, Mike owns shares in Woolworths.

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