Last week iron ore prices broke downward through the US$50 per tonne level, causing at least one contrarian securities analyst to say it may be time to buy the major iron ore miners. The Australian Financial Review reported a strategist at Pengana Capital as saying, “We can’t ring the bell and tell you when commodities are going to rally but common sense suggests there’s more upside than downside.”
This common sense might also reveal the possibility that iron ore prices and, therefore, mining stocks could just as well stay low for a number of years. Perhaps a “V”-shaped recovery might occur, but that’s all dependent on the demand.
As for iron ore supply, we know where that is going up. BHP Billiton Limited (ASX: BHP), Rio Tinto Limited (ASX: RIO) and Fortescue Metals Group Limited (ASX: FMG) are all raising iron ore production.
An experienced investor will know that commodity markets are led by the lowest-cost producers, so when the market is going down, the safer bets are the market leaders with the biggest profit margins.
Should Foolish investors steel themselves and take a position in BHP Billiton now because “it probably won’t get much worse” as the analyst implies?
1) The stock offers a 4.8% yield fully franked. Over the past 10 years, BHP Billiton has raised dividends an average annual 15%. If an investor could hold the stock for the long term through bust and boom, it might be worth it.
2) Buying at the bottom of a cyclical downturn gives investors the best chance of large returns because they are buying cheaply when everyone else is avoiding the market.
1) A potentially big gain stretched out over many years may not be so great after all. BHP stock was about $18 a share ten years ago and now it’s $30.22. That works out to be an average annual 6% share price gain excluding dividends. There are other stocks like REA Group Limited (ASX: REA) that could offer much more than that.
2) Mining will always be a commodity business that is driven by price. In boom times, you can make money, but the bust eventually comes again. It is better to hold companies that provide specialised products or services that demand premiums like CSL Limited (ASX: CSL).
I don’t think investors who don’t have much experience in the mining industry should dabble or bottom-fish in iron ore when there are so many other stocks with easier gains to be made.
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Motley Fool contributor Darryl Daté-Shappard does not own shares in any company mentioned.
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