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3 reasons why resource stocks are still cheap even after their super surge

Mining and energy stocks have left the rest of the market in the dust as their share prices raced ahead over the past several months with sentiment towards commodities rebounding sharply.

No matter how you look at it, being overweight on stocks leveraged to metals and oil & gas prices have been a winning trade with the S&P/ASX 200 Materials (Index:^AXMJ) (ASX:XMJ) index surging 28% while the S&P/ASX 200 Energy (Index:^AXEJ) (ASX:XEJ) index jumped 20% over the past year compared with the 3% plus increase of the S&P/ASX 200 (Index:^AXJO) (ASX:XJO).

Investors will have to ask themselves if this is the time to be taking profit and rotating into other sectors given that resource stocks have resoundingly beaten the broader market on just about every timeframe going out to two-years.

It’s been the mining heavyweights BHP Billiton Limited (ASX: BHP) and Rio Tinto Limited (ASX: RIO), as well as Origin Energy Ltd (ASX: ORG) and Santos Ltd (ASX: STO), that have led the charge.

But fund managers interviewed by the Australian Financial Review believe there is still further upside for the sector despite the strong run-up in the share prices of these outperformers.

There are actually three reasons for investors to stay bullish on energy and mining and the ongoing rally in commodity prices is only but one.

The Bloomberg Commodity Index (which measures the price performance of a basket of commodities) has gained 11% over the past year although gains made by key commodities are more impressive. Crude oil has surged by 50% as the West Texas Intermediate (WTI) price retook US$70 a barrel for the first time since November 2015 and copper rallied by 23% over the past year.

The real winners from this may actually be the Turnbull government as it prepares to announce a much stronger than expected budget position later tonight, but that’s another story.

The second reason is the Australian dollar, which seemed unstoppable only a few weeks ago as it continued to climb against the US dollar even in the face of rising global risks and a widening interest rate gap between the two countries.

But that uptrend is broken and the Aussie is giving up ground quickly to the greenback. This is normally bad news for commodity prices as they are denominated in US dollars. A stronger US dollar usually means weaker commodity prices, but not this time.

Experts are generally bullish on commodities while at the same time they are predicting further US dollar strength. That’s a double win for our resource stocks as their Australian dollar bottom line will be bolstered by the exchange rate.

Those with mainly onshore operations, such as Oz Minerals Limited (ASX: OZL) will wear an even bigger smile as their cost-base is priced in the weaker currency.

The final reason is valuation. Even with the strong appreciation in their share prices, there’s still value to be found among this group of stocks.

For instance, BHP and Rio Tinto are trading on consensus FY19 price-earnings (P/E) of around 18-20 times. This is still comfortably within the range of 12 times to 30 times that they’ve traded over the past five years.

Further, consensus is based on much lower commodity price assumptions. If current spot prices are factored into analysts’ forecasts, you can expect big upgrades across the mining and energy sectors.

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Motley Fool contributor Brendon Lau owns shares of BHP Billiton Limited and Rio Tinto Ltd. 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 Scott Phillips.

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