ASX stocks in the resources sector have garnered a lot of attention from investors this year.
A surge in the iron ore price back in March saw the share prices of our biggest iron miners like BHP Group Ltd (ASX: BHP) and Fortescue Metals Group Ltd (ASX: FMG) go through the roof and even approach decade-old all-time highs.
At the same time, the mountains of cash that resulted from this spike saw BHP and Fortescue shareholders showered in dividend payments.
But in this Bacchanalian profit party, it's easy to forget how dangerous resource companies can be for investors. If you cast your mind back to the GFC in 2008, investors might remember FMG shares falling from over $10 to less than $2 in the space of five months. Rio Tinto Ltd (ASX: RIO) was just as damaging, falling from around $155 to $32 in the same period.
That's a hard capital loss to recover from.
To deal with these potential dangers, I always use two rules for investing in resources companies. Here they are:
Rule 1: Always choose the lowest cost producer
Mining companies are profit-takers, meaning they have no branding or pricing power over the commodities they mine. Every iron, copper, gold or tin miner plays by the same rules – and sells their commodities on the same market. Thus, I think it's important to choose the lowest-cost miner – as it will usually be able to weather downturns better than its competitors.
That's why if I had to choose an iron ore play, it would be either BHP or Fortescue – as these companies consistently deliver the lowest costs of iron production. BHP's cost of producing one tonne of iron ore was US$14.16 – whilst Fortescue's was just US$12.95.
Rule 2: Buy low, sell high
Although this phrase borders on cliché, it's vital when considering an ASX resource stock. All commodities experience pricing cycles, and a company's shares will reflect this. Fortescue shares are today going for $10.37 – which is still historically high and likely due to the price of iron ore also being high.
But if you had bought FMG shares just one year ago at $4 when there was a pricing slump in iron ore, you would be sitting on a very lucrative gain as well as huge dividend yields.
Foolish Takeaway
I still think investing in resources stocks is risky, but I also think that following these two rules would take some of the risk out of the equation. By picking a top-notch company whilst going against the mob, you can watch the money pile in (and the price of your shares rise) when the tide eventually turns. But constant vigilance is still always required for success – these rules aren't iron-clad after all.
