Commodity price recovery could be years away – is your portfolio safe?

It is a terrible time for resources companies.

Even the global giants, Rio Tinto Limited  (ASX: RIO) and BHP Billiton Limited  (ASX: BHP), which operate low-cost and long-life assets, are struggling to earn a decent return in this environment.

Australia’s key commodities of iron ore, coal, copper and oil are all trading at their lowest price since 2009, but will they improve in a significant way anytime soon?

Rio Tinto coal and copper boss Jean-Sebastien Jacques says thermal coal prices are likely to stay depressed for five to seven years, according to a recent article in The Australian Financial Review.

On a slightly more positive note, he mentioned that copper could stage a recovery in two years. Maybe.

Here at The Motley Fool, we take a long-term view toward investing, aiming for a minimum holding period of three to five years (preferably longer!) which gives a business time to do its thing. By reducing the emphasis on the daily gyrations of the market, we can focus on the fundamental performance of the business, which ultimately drives shareholder returns.

Be careful

The primary profit driver for a resource company is the commodity price and judging by the latest forecasts, it could be a long time before investors see any improvement.

In the meantime, the mine sites need to keep operating – expensive machinery has to be maintained and replaced, additional drilling is required to replace resources once extracted, and staff don’t work for free.

Some analysts suggest resources companies such as South32 Ltd  (ASX: S32) are cheap due to its low price to book ratio (currently trading at a 50% discount to its tangible assets). I disagree and expect to see further asset impairments over the next few years (reducing book value) as commodity prices stagnate, making this a risky investment strategy.

Foolish takeaway

Resources companies operate in a fierce and competitive industry subject to the brutal nature of commodity prices, which look unlikely to improve over the next few years.

The rising US dollar has helped countless mining companies reduce their operating costs, prolonging the commodity price pain in an over-supplied market. The collapse of higher-cost mining companies is inevitable, but the time frame is unknown.

For better returns over the next five years, I would suggest investors look to other sectors that aren’t reliant on commodity prices.

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Motley Fool contributor Mitch Sonogan has no position in any stocks mentioned. Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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