4 reasons the mining bust may be done and 2 large-cap stocks to hold onto

In any industry or market going from boom to bust, the last few stages show where it is in the process. Once the downturn starts, first there is denial that it has started and fear follows. Next, investors capitulate, or give up, and start to sell into the downturn. Finally despair brings on heavy selling and a bottom is formed. Looking at a chart of the S&P ASX All Ordinaries Index (ASX: ^XAO) for 2008-2009, you can see these stages vividly.

But all busts are the seeds of the next bull market. The mining pullback has shown similar steps and although there will still be more belt-tightening, project delays and job losses, the despair stage may be past.

Here are four reasons the mining pullback may be at or past the end and two large-cap stocks that you should hold onto.

1) Mining majors are up from lows

Mining giants BHP Billiton Limited (ASX: BHP) and Rio Tinto Limited (ASX: RIO) are up about 22% and 18% respectively from their July 2013 lows. They increased their latest underlying net profits and project higher revenue into the next financial year. Other smaller miners may be in for some lean times still, yet these two stocks can improve from here.

2) Turning from expansion to production

During the mining boom, BHP, Rio Tinto and Fortescue Metals Group Limited (ASX: FMG) started expansion programs that have massively increased iron ore production. Iron ore prices have weakened again, but this time these three have much lower production costs. This helps protect earnings margins and higher sales volumes can help offset lower commodity prices.

3) Stockbroking house Morgans calls the end of the bust

The stockbrokerage issued a client update stating it believes the mining bust has ended and one sign of it is the interest that Chinese companies have in investing and taking over smaller miners. Recently there have been takeover offers for companies like Aquila Resources Limited (ASX: AQA) and PanAust Limited (ASX: PNA) in both iron ore and coal. They want to be the owners and not just buyers of the resources.

4) Operating costs lower after expansion phase

Now that major parts of the big miners’ expansion projects are done, the capital expenditures will decrease as production rises, with the net effect of lower operating costs and more funds for improving margins. The construction phase is a big cost, so completing that frees up capital.

Stocks to hold onto: I believe the three top miners – BHP, Rio Tinto and Fortescue Metals- all should improve from here on out. BHP and Rio Tinto have the best prospects because of their scale and low costs.

Fortescue has to pay down its huge debt more to calm investors’ concerns, though its much higher production capacity helped reduce it by US$3.1 billion. If it can keep that up, its financial strength will greatly increase. However, I think for now I would hold onto BHP and Rio Tinto for their stability.

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Motley Fool contributor Darryl Daté-Shappard does not own shares in any company mentioned. 

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