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Interview between Allan Trench and Tony Featherstone
Tony: Allan, could you explain what is driving the resource boom this time around?
Allan: Three factors stand out: First, the post-GFC economic recovery of the major economies continues. Second, China punches well above its weight on the demand-side of metals markets - and China, along with Australia, weathered the GFC very well. Third, bank lending constraints slowed the progress of new mine supply, which has acted to mitigate the build-up of metal stocks. Indeed, warehouse stocks have been falling in 2010 for industrial metals such as copper and tin, with tighter inventories predicted for 2011. A special additional factor driving the gold market has been the purposeful weakening of the US dollar as a means to kick-start the US economy. A weakening US dollar has seen gold again viewed by markets as a proxy reserve currency that will hold its long-term value.
Tony: How far has the boom come this year? What are the key trends and best areas in which to invest?
Allan: By some measures the 2010 boom remains modest. For example, the bellwether metal of global markets, copper, is up only around 10 per cent since the start of the year. But we are seeing some shifts elsewhere of greater magnitude. Tin is a standout - up around 50 per cent this year and having traded to more than US$27,000 a tonne. Among the minor metals, the rare earth oxides that are used in diverse high-tech applications have received considerable market attention, with year-on-year rises of several hundred percent for the 17 rare elements that, believe it or not, are now becoming well known to investors who are focused upon junior resources. Examples are lanthanum (up 750 per cent since October last year), cerium (up 850 per cent) and samarium (up more than 600 per cent).
Tony: Which sub-sectors within mining are doing the best?
Allan: The juniors as a whole are seeing the benefits more than the majors - reflecting the 2010 trend towards greater risk appetite of investors. Right now, there are many stories among juniors that have seen their share prices increase by more than 100 per cent on a year-on-year basis. Average returns among juniors are more modest of course - and it is hard to be definitive there - but my own estimation sits at around 35 per cent year-on-year (through to mid-October) looking at a basket of more than 60 companies.
That compares to an ASX 200 index that has been flat over the same period and a materials index, which is weighted towards the larger resources companies, having risen around 15 per cent year-on-year. Within the ranks of the juniors, some of the biggest gains have been among selected gold companies, development-stage iron ore companies and copper juniors with exploration upside. Given the strong rise in rare earth metal prices noted earlier, those companies with exposure to rare earth metals exploration are receiving very strong market interest also.
Tony: How is the strength of the Australian dollar affecting the boom?
Allan: Producers with Australian mining operations would prefer a weaker Australian dollar because their revenue is derived from metals markets that trade in US currency. Currency movements always create opportunities, of course. Among winners from the strong Australian dollar are Australian-based resources companies seeking to import mining and processing equipment for projects here. Similarly, Australian companies with overseas operations, where costs are often linked to the US dollar, are winners from that currency weakening.
All that said, many of the recent market gains among junior resources companies have been for explorers rather than producers. These companies are largely immune to exchange rate movements because they do not have cash flows.
Tony: How can investors benefit from the boom and not be hurt by it if some valuations have become stretched?
Allan: It is an old adage, but doing homework in selecting companies is critical, which I realise is far easier said than done given that quality research coverage of junior resources companies remains scarce. My counsel to investors interested in the sector is to attend investment forums and conferences where emerging resources companies present their stories. Many of the companies are very skilled at selling their story, so be wary not to invest in just the first you happen to listen to. Weigh up several presentations before making any decisions.
My present assessment is that the junior resources market is somewhat mixed. By this I mean that several companies have experienced share price runs to the point where valuations have become stretched. As a result, their respective management teams will need to work very hard to deliver market expectations. Also included in this category are those early-stage rare earth metals explorers who have seen their market values jump sharply on the back of preliminary rock chip assays.
Simultaneously, however, there are also junior resources companies that remain attractive when looking at their asset base and which are seemingly ignored by the market. The key, of course, is to identify the shares that are cheap (the relatively easy part), but critically to also spot the future events that will drive a re-rating (the hard part).
The best advice is to do plenty of research or talk to your financial adviser before buying into small and mid-cap resource companies. Returns can be high, but they come with higher risk. Valuation risks for some small-cap explorers are much higher since recent share price gains. Remember that small exploration companies are speculative and may not suit investors with lower tolerance for risk.
About the interviewee
Allan Trench is Adjunct Professor at the Western Australian School of Mines, an independent director to four ASX Listed resources companies, and author of a number of books on investment and business management. These include the Insider's Guide series published by Wrightbooks-Wiley and the Top Resources Stocks series.
ASX Resources has useful information on investing in the resources sector.
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