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Reasons To Start Buying Mining Stocks

Date post:23-Aug-2014
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This Invast Insights report last October 21, 2013 explained why it may be time to start buying mining stocks. We also shared which stocks were worth buying based on our table data last October 17, 2013 and our initial impressions on the Telstra AGM and their growth forecast.

Invast Insights Week Commencing October 21, 2013 www.invast.com.au | 1800 468 278 This week we look at the following topics: 1.0 Why it may be time to start buying mining stocks 1.1 Reasons to start buying mining stocks 1.2 The future of Chinas railways 1.3 Rio Tinto deserves a pat on the back 1.4 Which stocks are worth buying? 2.0 Initial impressions on the Telstra AGM 3.0 Revisiting the 15 hidden gems 4.0 September jobs report new release date www.invast.com.au | 1800 468 278 www.invast.com.au | 1800 468 278 1.0 Why it may be time to start buying mining stocks One of the best ways to have blown money over the past two years would have been through buying and holding Australian resource and mining companies. Its been a disaster with the exception of a few large names like BHP and Woodside Petroleum (which we hold in our wealth preservation portfolio). There has been huge value destruction in small to mid tier mining companies over that period, mainly due to the slowdown in the pace of Chinese consumption. Its not that Chinese demand has completely evaporated but instead the huge investment into infrastructure post 2009 was not replicated in 2012-2013. China is finally starting to increase its rate of minerals consumption and the iron ore price has been a great example of the ongoing demand picture.Weve discussed our view on China in prior reports. www.invast.com.au | 1800 468 278 www.invast.com.au | 1800 468 278 There is an age old Chinese proverb that goes along the lines of dont try to catch a falling knife. The relevance to markets is that it is always extremely difficult to pick an upturn in a particular stock or sector after it has been battered. The economists will still caution against buying mining companies but we know that economists and most market analysts are always behind the curve, moving their estimates after the horse has bolted. We think mining stocks are about to turn on the Australian stock market for the reasons outlined below. Before you continue reading on, please take into consideration the fact that we might have our timing wrong. Any investment in mining stocks needs to have at least a three to five year time horizon. Most of the stocks have been decimated in terms of their share prices and valuations. Private equity is yet to pounce, merger and acquisition activity is still dead and most directors are yet to start aggressively buying their own shares. A very well-respected stock broking colleague, who specialises in the mining and resource space and someone who at the height of the market was earning seven figure salaries, recently told us that he is barely earning minimum salary. Meanwhile, clients who have been buying mining stocks from their stock brokers are probably sitting on steep losses. www.invast.com.au | 1800 468 278 1.1 Reasons to start buying mining stocks Supply is struggling - Copper producer Oz Minerals (OZL) disappointed the market when it recently released its quarterly production report. While most of the discussion was around how poorly the miner has performed, our interest was more around the trends within copper mining. Oz Minerals owns the Prominent Hill mine which is located 650km North West of Adelaide in South Australia. It is perhaps one of the most attractive geographies for mining an open pit mine, a newly developed underground mine, access to railway and low sovereign risk. The mine was first discovered in 2001 and has been in production since early 2009. Oz Minerals has spent many years and plenty of cash to get the mine up and running but over the past year the rate of production has fallen from above 1000,000 of contained copper down to around 70,000-75,000 tonnes this year. www.invast.com.au | 1800 468 278 www.invast.com.au | 1800 468 278 It is very important to get the full scope of Oz Minerals operations please watch the following corporate video to get an idea of the scope of the mining operations and growth plans already in place. We arent talking about an insignificant copper producer at all. This business matters. The problems Oz Minerals are seeing in its production capacity are consistent with what others are reporting in the industry. Press the Ctrl key on your keyboard and click on the image to the left of this text to open the video. Our rationale is that if a world-class deposit like Prominent Hill located in Australia is struggling to grow production, the ability of new copper over the next few years to fill the growing demand picture will see spot price appreciation. Emerging copper producer Discovery Metals (DML) which set an ambitious goal of becoming the next Australian mid tier producer out of Botswana has seen its share price fall from a 52 week high of $1.76 to $0.06 as of the time of writing. Discovery had been the talk of the industry as it ramped up into production from development, even attracting a takeover offer from Hong Kong based Cathay Pacific Group which its board rejected. www.invast.com.au | 1800 468 278 Today, the business is struggling for survival, at the mercy of its banks as lower copper prices and production problems have caused a cash crunch. Even in the gold space, large producers like Newcrest Mining (NCM) have issued several rounds of production downgrades and rising costs, eating into their margins. We spoke about Newcrest Mining and the gold price in our Invast Insights report published on 30 September 2013. Rio Tinto recently reported solid growth in its Escondida copper mine but this has come after several years of disappointment and huge amounts of capital expenditure. We think the copper price is bound for a breakout before the years end as stockpiles are drawn down and the supply side continues to weigh on market fundamentals. When copper moves, all other industrial commodities take the same direction. A US$4/lb copper price is not out of the question by the end of 2015 from US$3.25/lb or thereabouts currently. www.invast.com.au | 1800 468 278 * Mining stocks have cash Not all, but some are starting to build their coffers. Take another Australia mining company Mount Gibson Iron (MGX). The stock halved in share price value between February and April this year. The reason you might ask? Stock broking analysts and investment banks reduced their outlook on the iron ore price from around US$120 per tonne to as low as US$85 per tonne and guess what? The iron ore price not only held up above US$120 per tonne, but shot up to as high as US$150 per tonne. Mount Gibson saw its stock price rise from a low of $0.405 in late June to around $0.83 as of the time of writing. Investors and traders out in the market realised that the forecasts were nonsense and valuations needed to be reset. The most interesting point about Mount Gibson is that its cash balance grew to $420m during the same quarter which saw its share price collapse then recover. The business is on track to produce around 9-9.5m tonnes of iron ore. Atlas Iron (AGO) is also in the iron ore space and comparable to Mount Gibson in terms of production, sitting on around $120m in net cash when netting out its debt obligations. Atlas has previously been aggressive on the merger and acquisition front but a similar fate to its share price has seen a more conserva- www.invast.com.au | 1800 468 278 tive approach in its growth. Once the market optimism returns, both these businesses can put their cash to use and start spending on buying competitors or developing their assets.The point here is that despite all the fear and gloom, iron ore producers are sitting very comfortably in terms of their balance sheets. * Mining index continues to lag The Materials Index (XMJ) has lagged by a large amount relative to the ASX200 (XJO) and the Financials Index (XFJ) over the past two years.The index is currently sitting at 9,706 points having reached a high of 12,147 points in November 2011 and a low of 8,203 points in June this year.The index was well above 15,000 points in April 2011.The chart below shows the performance of all three indices over the past two years. Charts have been taken from Invasts share trading platform where the advanced charting tool can be expanded to perform detailed analysis.The red line indicates the Materials Index, green line the Financials Index and the blue line the broader market as measured by the ASX200 Index. www.invast.com.au | 1800 468 278 Image: Chart via Invast share trading platform XJO, XMJ, XFJ indices as of 16 October 2013 www.invast.com.au | 1800 468 278 1.2 The future of Chinas railways During the September quarter, Brazilian iron ore giant Vale and Rio Tinto added over 40 million tonnes of annualised capacity into the market each while BHP and Fortescue Metals added around half that each also. The expectation was that iron ore prices would tumble under such extreme supply growth and guess what the investment banking analysts were wrong again. The iron ore price has held up very well. In Invast Insights published on 16 September 2013, we spelled out our thoughts on China basically remaining bullish. We said that steel production in China continues to charge ahead at an annualised rate of around 700 million tonnes per annum, growing year by year. Most of th

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