Mining stocks are, at their core, leveraged plays on metals. Higher prices boost earnings by raising the selling price of output, and by enabling companies to increase production. Then there’s the leverage inherent in cost structure. A company producing copper at USD3 per pound, for example, will earn USD1 per pound when copper costs USD4 per pound. Those profits, however, will double to USD2 on a move in copper prices to USD5 per pound.
Leverage means that mining stocks move much more jaggedly than even the highly volatile prices of what they produce. When the price of their products drops even a little, mining stocks crash, as most have this summer. On the other hand, when metals and minerals prices start to rise, the gains are magnified compared to what happens to the actual commodities.
As long as Asian demand for resources remains solid, it’s only a matter of time before their prices rebound. And that means some monster gains for the picks in this article.
The common denominator for the 10 picks we track for our metal and mining portfolio in the Global Investment Strategist, is a rising production profile. There are many mining and resource stocks sitting on dwindling reserves with stagnant output. And they’ll do quite well when prices rise. So will the scores of “penny” mining stocks of companies with little more than a stock symbol, a logo and what likely amounts to a moose pasture in some remote area of the far tundra.
Companies that can reliably boost production over time, however, fare the best in any environment. They’re by far the most reliable wealth builders, and the only sure way to profit from the bull market.
What about Rio Tinto (NYSE: RIO)?
Rio Tinto’s stock is down 15 percent this year and trades at barely half its early 2008 high, when it was a takeover target of BHP Billiton (NYSE: BHP). This means that the USD123 billion company’s stock is once again looking cheap.
First-half 2011 results disappointed some, due to weaker-than-expected output of iron ore and aluminum. With fears of tightening global credit markets running high, a joint bid with Mitsubishi Corp (Japan: 8058) for Coal & Allied Industries for approximately AUD$10.6 billion (USD11.3 billion) also apparently spooked some investors, as has been the case with nearly every corporate acquisition.
Rio Tinto, however, also generated some USD18 billion in cash flow during the first half, nearly twice the year-ago tally. The company also posted a 35 percent jump in profit. And it has the least exposure to Europe and the most to China of all major mining companies, meaning that growth should continue apace.
An ongoing USD7 billion stock repurchase program is a clear demonstration of the company’s financial power. So is Rio’s portfolio of expansion projects, including a now-accelerated plan to boost annual iron ore output to 333 million tonnes in Australia and Africa by 2015. Some USD6 billion in capital expenditures are planned for the rest of 2011 alone. The company is also ramping up output of alumina, copper and coking coal, among other resources. Check out out Seeking Alpha contributor, Elliott Gue’s article, Proving Their Mettle, for another good pick for investors seeking to profit from tightening supply-demand balances for industrial metals
The 2007 purchase of Alcan left Rio with a fair amount of debt. That has now been whittled down, with only USD500 million left to finance between now and the end of 2012. And with the company’s 30-year debt yielding barely 5 percent, it should have no problems rolling it over at a rock-bottom rate. There’s even a twice-annual yield of nearly 2 percent, with payments made in March and September.
Disclosure: I am long RIO.