3 risks to consider before buying into resources stocks

Credit: glyphwalker

Last week, it was announced that The Philippines’ Department of Environment and Natural Resources had ordered the suspension of another 20 mines due to environmental regulation violations. This was on top of another ten mines that had already been shut after an audit only a month ago.

This decision had an immediate impact on the share price of Australian-listed gold producer OceanaGold Corporation (ASX: OGC) with the price falling almost 15% since last Tuesday.

On the other hand, there’s Red 5 Limited (ASX: RED), another Philippines gold producer, which appeared to have passed the Philippines Government’s audit and its share price rose in response.

Not only that, the Philippines Government’s crackdown has affected many nickel miners operating in that country with the result that the price of nickel has reached seven-week highs in response to the fear of supply disruption. The share prices of Australian nickel sulphide producers Grange Resources Limited (ASX: GRR) and Western Areas Ltd (ASX: WSA) have followed suit and risen.

And when such political situations again affect the supply/demand equation of key commodity prices, who knows where key commodity prices are going next?

There are three main risks with investment in resources companies:

  • First, you have the risks of cyclical rises and falls in the pricing of these resource companies’ key products (pricing volatility).
  • Second, if that isn’t enough, because of the variability in world commodity prices (whether this is gold, nickel or something else), you’ll find analysts aren’t really able to forecast or project prices with any real accuracy leaving the investor to ponder … what’s a fair price to buy shares?
  • Finally, you can add geopolitical risk to the risk-menu.

All of the above are reasons why I don’t invest in these sort of companies, and the Philippines situation is a stark reminder of the risks that resource-stock investors sometimes are unwittingly taking on.

The Philippines Government’s recent decision to suspend mines over environmental concerns seems to be a part of a trend that I feel may only intensify over time. I’m sure the political fallout from the failure of BHP Billiton Limited (ASX: BHP) to adequately ensure the structural integrity of the Samarco Dam is going to invite much tighter government scrutiny over these types of operations in the future.

There are easier ways to invest on the ASX, and it doesn’t include investing in any of the companies or industries referred to above.

What I prefer to do is not worry about the variability of commodity prices and the lack of pricing power that resources companies exhibit. Trying to figure out what’s next is simply a hurdle that’s too high for the average investor and, quite simply, I think it’s best to just avoid the tricky question of trying to determine what the direction of world nickel, gold, oil, and iron-ore prices is going to be.

The cyclical nature of resources companies more-or-less forces buyers of shares in this corner of the market to take a short-term view in their investing approach.

Maybe I’m being lazy, but I do prefer to take a longer view which can be justified when one invests in high-quality industrial companies such as Bapcor Ltd (ASX: BAP), Technology One Limited (ASX: TNE) and Pro Medicus Limited (ASX: PME) which, operationally, are belting it out of the park (and have a great deal of control over the pricing of their own products).

These are stock you can safely hold for a number of years.

You don’t need to complicate things; look for quality and hold the shares of great businesses for the ultra-long term and the price you pay today, even if it’s considered a little expensive when compared to today’s earnings, could look cheap in a decade’s time.

Unless you have deep knowledge of the resources companies you’re investing in, and unless you have the stamina and fortitude to keep abreast of the economic and political environment all resources companies operate in, I’d steer clear and simply focus on industrial companies that are reasonably priced, have some sort of competitive advantage, and have bright prospects for future growth.

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Motley Fool contributor Edward Vesely owns shares of Bapcor. The Motley Fool Australia owns shares of Bapcor. 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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