While the share prices of diversified mining giants BHP Billiton Limited (ASX: BHP) and Rio Tinto Limited (ASX: RIO) are still up slightly over the past 12-months – although both have still underperformed the S&P/ASX 200 Index (Index: ^AXJO) (ASX: XJO) – the same can't be said for many single commodity producers, nor the mining service companies that are reliant on the resource sector for work.
Despite the many knocked-down share prices which could look like tempting bargains, here are three reasons why investors should remain cautious.
As investors in iron ore stocks such as Atlas Iron Limited (ASX: AGO) and Fortescue Metals Group Limited (ASX: FMG) are fully aware, the iron ore price recently fell below US$90 per tonne, seriously squeezing the profit margins of producers. While the initial response to the iron ore price falls has been to ramp-up production volumes to maintain revenues the fact is, if the commodity price drops further, it will be near impossible to increase volumes even further to maintain profit levels.
Picking the bottom of any cycle is difficult and most investors will acknowledge they are usually 'too early' – buying before the bottom has been reached. This alone should not scare you away from buying cyclical stocks but it should certainly make you think twice before jumping head first in to a beaten-up cyclical sector. In other words, the resource boom was many years in the making and likewise it could take many years to unravel. Mining stocks which look cheap today may look even cheaper in a couple of years from now!
The mining services sector is equally dangerous! While the price many stocks in the sector are selling for looks appealing, there is definitely danger lurking here too. Low commodity prices mean cost-saving measures by mining firms. This situation has affected many service providers including Seven Group Holdings Ltd (ASX: SVW) which sells Caterpillar earth moving equipment. Once again, picking the bottom here is tricky.
