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Commodities crash: A better option than resources stocks

Commodities prices are crashing, taking resource stocks with it.

Overnight, the iron ore price fell 0.7% to US$102.80 a tonne, while gold lost 0.8% to US$1,295.91 an ounce. Nickel prices crashed more than US$1,000 in just 25 minutes yesterday, its biggest fall in 31 months, while copper lost 0.7%.

In the past month, Fortescue Metals Group (ASX: FMG) has dropped more than 13%, Atlas Iron Limited (ASX: AGO) more than 22% and Mount Gibson Iron Limited (ASX: MGX) 7%. Arrium Limited (ASX: ARI) has lost 23% over the same period. Nickel miner Western Areas Ltd (ASX: WSA) has dropped 7.5% in early trade this morning.

The biggest concern appears to be China. Worries that bad debts and slowing growth in the world’s growth engine could stunt demand for commodities are growing. According to the Sydney Morning Herald, companies are waiting longer and finding it harder to get paid for goods and services they’ve already sold, leading to record amounts of receivables –and potential write-offs – on companies’ balance sheets.

Smaller, single-commodity companies like those mentioned above, are those most at risk especially if iron ore prices continue to slide. Many would be barely profitable if the commodity price goes as low as US$90 a tonne, and would struggle to stay afloat at prices below that, without raising equity capital or selling off non-core assets.

For companies with significant debt obligations, like Fortescue, it could mean being forced to renegotiate debt commitments, potentially at higher interest rates and more stringent covenants.

As resources companies are mostly price takers, that is, dependent on the commodity price, they are generally much higher risk than industrial companies. Investors need to be aware of that significant difference, when choosing which companies to invest in.

And that’s one of the reasons why we here at the Motley Fool tend to prefer high quality industrial stocks that pay dividends, such as the following small-cap stock.

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Motley Fool writer/analyst Mike King doesn't own shares in any companies mentioned. You can follow Mike on Twitter @TMFKinga

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