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This article appeared in the February 2011 ASX Investor Update email newsletter. To subscribe to this newsletter please register with the MyASX section or visit the About MyASX page for past editions and more details.

Understand key themes for the resource sector in 2011. Oil could surprise.

Photo of Gavin Wendt By Gavin Wendt, MineLife

Much of the resources sector performed strongly last year and I believe the key themes will continue through 2011. The pace of the resource sector's recovery after the global financial crisis has been extraordinary, especially against the background of the S&P/ASX 200 index falling 3 per cent in 2010.

Overall it was a year for the nimble-footed investor - a take-profits-while-you-can type of market. And if you bought-and-held shares you probably lost, the resource sector excepted.

Commodities demand should remain very strong in 2011, with clear outperformers. The bulk commodities, in particular iron ore and coking/thermal coal, should shine because of firm Asian demand and supply issues caused by the Queensland floods.

At the start of 2010, I correctly forecast strong price gains by the three big commodities, gold, copper and oil. I expect another sound performance from gold this year as it pushes above US$1500 an ounce, which will be its 11th consecutive year of gains. The US economy is by no means out of the woods and that means a difficult path for the US dollar. (Editor's note: investors often buy gold when they are worried about the global economy and the threat of higher inflation).

Copper is also a bellwether commodity for economic health and I expect a strong price performance, fuelled by continued demand from emerging nations. Demand for crude oil in emerging markets should push its price above US$100 a barrel.

Iron ore and coal should also perform strongly as demand for key steel production inputs remains robust, and energy demand continues to surge. Any weather-related impact in Queensland will only add to supply-demand pressures.

Ever-increasing consumption

All these commodities are staples of economic growth and are being consumed on an ever-increasing scale by the world's emerging economies, particularly China and India, which have seemingly insatiable industrial, residential and energy demand for resources.

Nevertheless, despite an ever-changing and volatile financial climate, gold and oil remain the most significant of all commodities in terms of their importance, profile and capacity to influence market sentiment.

At the beginning of 2010 I predicted US$100 a barrel for oil and US$1500 an ounce for gold by the end of the year. With oil trading at around US$90 and gold at around US$1350, I was a little optimistic. But demand for both gold and oil is at record levels.

Particularly interesting is the positive oil price movement. Global demand for oil has never been stronger, with third-quarter 2010 growth of 3.7 per cent representing the fourth-straight quarter of growth.

This oil consumption growth has taken place at a time of demand weakness in two of the traditionally biggest markets for oil, the United States and Europe. The demand has come from the escalating growth of the world's burgeoning new economies.

The International Energy Agency predicts global energy demand will grow by 36 per cent between 2008 and 2035, with China, India and the Middle East leading the charge. The three biggest contributing factors for this demand in the emerging economies will be economic growth, population growth and heavy fuel subsidies, which in many countries will provide a buffer against rising oil prices.

I believe the market for crude oil is representative of the entire resource sector. Surging growth and flow-on commodity demand from the emerging economies is offsetting, to some degree, economic stagnation in the mature economies of Europe and the US. Not surprisingly, Chinese oil demand is expected to grow at the fastest rate of any country in the world this year - 10.4 per cent.

The other continuing themes during 2011 will be takeover/consolidation activity in the resource sector, with Chinese investment at the forefront. The growing influx of Chinese cash into the resource sector is going to be an even more pressing issue on which governments, particularly Australia's, will have to reiterate and present clear policy positions.

Some companies to keep an eye

(Editor's note: Do not read the ideas below as share recommendations. Do further research of your own or consult your financial adviser before acting on these ideas. Remember that small and mid-cap resource companies, especially those yet to produce, have a higher risk/reward profile than most companies. This level of risk generally does not suit long-term conservative portfolio investors or those new to the market).

As for shares to follow in 2011, I like one of 2010's best performers, Bathurst Resources (ASX Code: BTU) and see no reason why it will not outperform again this year. Coal is one of the key commodities fuelling the growth of the world economy, particularly in the emerging powerhouses of China and India. Coking coal in particular has been on an extraordinary growth trajectory because of the huge increase in steel production in both countries.

Bathurst Resources made a strategic move into New Zealand coal in mid-2010 by entering into an agreement with L&M Holdings to acquire the Buller Coal Project, in the South Island. The project contains a well-defined resource of 47.1 million tonnes of essentially premium coking coal, which complies with the Joint Ore Reserve Committee Code (JORC) with an overall exploration target in the vicinity of 60-90 million tonnes.

Bathurst recently completed a definitive feasibility study that confirmed the project's sound economics and production is planned by the end of this year. The project is based on a low-risk, conventional open-cut operation, initially producing around a million tonnes a year of premium coking coal before ramping up to around two million tonnes as other mining sites are brought on stream.

The capital expenditure of US$64 million compares exceptionally well with similar projects elsewhere. Operating costs, originally estimated by the company at US$103 a tonne, have been reduced to US$84.

In terms of value, Bathurst is trading at a clear discount to even a modest net present value (NPV), largely because of its pre-production status and the potential risks in project development and commissioning. Bathurst estimates an NPV of $1.63 a share.

Silver very attractive

Elsewhere, I like emerging silver producer Cobar Consolidated Resources (CCU). Silver was relatively the best performer of all the precious metals in 2010, surging by 83 per cent to a 30-year peak of US$30.92 at the end of the year. 

Silver's attraction is best summed up in this recent comment we came across: "You buy gold when you think the world is going to hell in a hand basket. You buy copper when the economy is booming. In between those two, if you're a bit confused, you buy silver."

Cobar Consolidated owns the Wonawinta silver project south of Cobar in New South Wales. Wonawinta has Australia's largest undeveloped silver resource of more than 50 million ounces, and with feasibility work already completed, it has the potential to become a globally significant, low-cost silver producer by the end of 2011.

About the author

Gavin Wendt is Founder and Senior Resource Analyst at MineLife. He is responsible for the research and publication of the MineLife Weekly Resources Report, which focuses exclusively on the resources sector and emerging resource opportunities.

From ASX

ASX Resources has useful information on investing in the resources sector.

There are also Listed Investment Companies that specialize in the resource sector and Exchange Traded funds and Commodities listed on ASX that provide exposure to this sector.


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