Volatility Creating Opportunity

Written on the 5 June 2009

Shares in companies involved in sectors with cyclical attributes, such as the resources sector, frequently display a high level of volatility, creating opportunities for investors.

INDEPENDENT researcher Stock Resource says shares can provide spectacular returns. But how do you select the winners?

Resource shares frequently display a higher level of volatility than industrials, due to the myriad of issues that can influence the performance of a company. Key issues include the upside from exploration discoveries, operational performance, the growth available through new development projects and the high earnings leverage to cyclical commodity prices. Global economic activity, as well as supply and demand issues drives commodity prices.

Stock Resource director Stephen Bartrop, says this presents equity investors with potential high rewards, but with a set of risk factors that need to be carefully considered. He believes that the bottom of the market has passed and the risks now depend on the timing of a recovery.

“This is not to say that there will be no further corrections to the recent rally that may have been too bullish given the economic backdrop, but we are unlikely to test previous lows late last year and earlier this year in both commodity and stock markets,” explains Bartrop.

“In fact there remains continued optimism by some authors that we remain in an extended bull market for commodities and we have just been experiencing a correction in a long-term uptrend.”

Bartrop, who is also the managing director of LimeStreet Capital and a director of the ASX listed Icon Resources Limited, says a salient point occurred in late April with the release of the International Monetary Fund (IMF) World Economic Outlook.

“The downgraded outlook potentially creates a scenario where the global economic outlook cannot look much worse – hence the market then assumes that all the bad news is factored in,” he says.

In its latest World Economic Outlook (published April 22), the IMF states that in the most severe recession since World War II, it forecasts the global economy to shrink by 1.3 per cent this year, with a slow recovery expected to take hold next year.

“Importantly, while the rate of contraction should moderate from the second quarter of 2009 onward, output per capita is projected to decline in countries representing three-quarters of the global economy. Growth is projected to re-emerge in 2010, but at its 1.9 per cent forecast, this is deemed sluggish relative to past recoveries,” he says.

Stock Resources will present at the third annual Gold Coast Resources Showcase from June 11-12 at the Surfers Paradise Marriott Resort.

PERFORMANCE DRIVERS
Shares in resource companies display a relatively high level of volatility. This relates to a myriad of issues, with the predominant share price drivers being:

The Global IP Cycle
Demand for commodities have a strong correlation to global industrial production, reflecting expected increase metal and energy consumption. This expected increase in demand starts to reflect in the price of bulk, metals and energy commodities.

Supply of Commodities
The other key determinant in metal and energy market balances (and hence pricing) is the primary and refined productive capacities. Whilst capacity is more easily quantified than demand, it is frequently subject to disruption, and is also influenced by secondary markets.

Resource Company Fundamentals
Mines and oil fields are finite assets and the quality and duration of operations will largely determine the sustainable earnings potential of a company, and hence its market valuation. Short-term earnings and cashflow are driven by operational performance, as well as sensitivity to specific commodity prices and exchange rates.

Exploration Opportunities
Tremendous value can be added or destroyed by companies during the exploration phase. Valuation of exploration assets can be complex and volatile. Timely and insightful interpretation of exploration results can add tremendous value for investors.


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