Stock Market Smarts: Commodities – A Falling Knife
Resource stocks look cheap right now. But don’t rush to buy– they may be even cheaper next week.
A little over a year ago, a financial professional suggested to me that it was time to start buying commodity stocks.
His rationale was very clear. The general consensus among economists at that point was that we were finally emerging from the after-effects of the Great Recession. World GDP growth was accelerating, led by the United States, which was seen to be undergoing a kind of economic renaissance. A return to normal growth patterns would lift moribund commodity prices and the shares of producer companies would follow suit. Get them while they’re still cheap, he advised.
I was skeptical and told him so. The so-called recovery looked very fragile and there were signs that China was slowing down. It didn’t seem like the kind of climate to fuel a commodities boom. As it turned out, it wasn’t.
Commodity stocks are highly cyclical. When growth is strong, demand for raw materials rises, squeezing supply and driving prices higher. Producing companies see margins widen and their bottom lines fatten up. Stock prices soar accordingly.
The profits can be mind-boggling, even from blue-chip companies. So can the losses, if you buy and sell at the wrong time. Take a look at the history of Teck Resources (TSX: TCK.B, NYSE: TCK), Canada’s largest diversified mining company and a major global producer of copper, zinc, and metallurgical coal. In July 2000, in the midst of the tech crash, its shares traded as low as $4.38 on the TSX. Eight years later, in June 2008, they hit a high of $51.24, a gain of 1,070 per cent!
The management of Teck Resources signalled as much with the release last month of the company’s second-quarter results. After noting that current markets are “challenging” and that the prices for some of its products have declined, the company issued this warning:
“Commodity markets have historically been volatile, prices can change rapidly and customers can alter shipment plans. This can have a substantial effect on our business. Demand for coal, particularly in China, has weakened substantially. Increased supply from Australian mines has also put downward pressure on coal prices. The weakness in some of these markets may persist for some time and, if of a long-term nature, could affect the fair value of our operating assets, which could require adjustments to company values.”
That last statement is worrisome. “Adjustments to company values” could involve writing down the valuations of some of Teck’s assets. The balance sheet released with the second-quarter results shows almost $30 billion worth of property, plant, and equipment assets. The company regularly performs impairment tests for all major assets and did not find anything of significance this time. But that could change quickly if conditions don’t improve.
Ironically, Teck reported year-over-year production increases in zinc, copper, and coal despite significant price declines in the latter two commodities. Copper production was up almost 7 per cent over the second quarter of 2014 even though the realized price per pound dropped 10 per cent from US$3.07 to US$2.76. Coal production rose 3 per cent while the price fell from US$111 per tonne to US$95.