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Mining Stocks: Good Value, But Recovery Pushed Back to 2016

By Yiannis G. Mostrous, on Dec. 23, 2014

The massive decline in oil prices has dominated financial headlines in recent weeks. There’s no shortage of theories regarding the future direction of oil prices and the causes of the recent decline. Our Take: Saudi Arabia has learned from its missteps in the early 1980s and will seek to maintain its share of the global market by competing on price.

In this competitive environment, marginal producers—those with higher operational and financial costs—will find themselves pushed to the edge, while even the integrated oil companies will need to reduce capital expenditures and base future investment decisions on implied returns instead of growth for growth’s sake.

Until strong evidence emerges otherwise, investors should assume that Saudi Arabia will succeed in its goal, leading to major structural shifts in the energy sector that will create big winners and losers.

Meanwhile, lower oil prices will benefit or hinder various economies and industries to different degrees, including miners. (My colleagues Elliott Gue and Roger Conrad address the best opportunities in The Demand Side BeckonsConsumption Junction and Game Plan for Lower Oil Prices.)

At the start of 2014, we cautioned that improvement in the mining industry would be an investment theme for 2015 and suggested that investors buy high-quality, diversified miners during selloffs and wait for better times. (See Mining for Value: A 2015 Story.)

To enhance near-term returns, we also highlighted Petra Diamonds (LSE: PDL, OTC: PMDMF), a mid-tier producer that offered exposure to company-specific upside catalysts; we ultimately booked a 58.9 percent gain on this stock in June 2014. (See Mining Stocks: Unloved, But Not Unlovable.)

The same strategy applies today, as the mining industry continues to offer excellent value for investors with a longer time horizon. Patience eventually will pay off. The collapse in iron ore prices and the supply overhang in many commodities markets will take time to dissipate.

Although the global mining complex continues to do the right thing and transition away from a strategy that privileged production growth at all costs, economic developments in China remain the most important factor on the demand side. For many commodities, the Mainland accounts for a significant portion of global consumption.

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