The mining sector has had a torrid time of late, with commodity prices falling, largely due to the eurozone crisis and the slowdown in emerging markets. This has sent mining shares tumbling downwards.
In early 2011, copper producer Kazakhmys
Likewise, India-focused diversified mining company Vedanta
The falls have been deeper and faster than anyone could have predicted. But surely there has to be a point where contrarians start to take an interest. At some stage the falling knife must hit the floor. Is this that point?
Mining shares are different
Whereas I have generally been bold, and successful, in my contrarian predictions, I am rather more cautious with mining companies. Why? Because mining firms are different to other businesses.
This is something that I think has been glossed over in recent discussion of miners. People talk about cyclical and defensive companies. Mining shares are cyclical in the extreme. They are terribly prone to changes in supply and demand.
This is why a miner on a low price-to-earnings ratio is not necessarily the screaming buy that you might think. The reason why mining shares have reached such highs in recent years is the boom in emerging markets. The explosive growth in countries such as China and India has been incredibly resource-hungry as new homes, factories, roads and railways have been built.
This has resulted in a boom in commodities, the like of which we have never seen before. This has meant that mining shares -- which had been trundling along, steadily but unspectacularly, for decade after decade -- suddenly exploded.
Riding that roller coaster
In the space of the three years from mid-2005 to mid-2008, Rio Tinto's shares quadrupled: That's a compound annual growth rate of around 50%!
But, by the end of 2008, as the Great Recession hit, Rio promptly fell by three-quarters, and investors were at square one again. Experts call it "high beta." Think of it as the investing equivalent of the roller-coaster ride.
In brief, fortunes can be made, and lost, with miners -- they are investments for the brave.
So, what about now?
OK, so let's cut to the chase. What about now? Well, I think there are reasons to believe that the miners may have hit bottom.
One major reason is that the slowdown in China has prompted its leaders to pump in £98 billion of infrastructure spending. Now, the debate between the China bulls and bears rages on but, in my view, China is clearly slowing down, but the Chinese leadership has many levers at its disposal to correct the slowdown.
Pumping money into infrastructure spending is likely to boost the Chinese economy, and especially its demand for commodities such as iron ore and copper.
A second major reason is the prospect of further quantitative easing from both the U.S. and Europe. Ben Bernanke has opened the taps at the Federal Reserve, and won't turn them off until a genuine recovery takes hold. Likewise, Mario Draghi is throwing huge quantities of money at the eurozone crisis.
This is great for shares, and great for commodities. So, not surprisingly, mining shares have rebounded with amazing speed.
I have made 19% in one week
I bought in to Kazakhmys a week ago, when it was at 649 pence, on a forward P/E ratio of about six. At the time of writing this article, it is at 773 pence. I have made 19% in one week! That's the fastest return I think I have ever achieved.
So if you haven't yet bought into a mining firm, have you missed the boat? Well, you may have missed the best opportunity, but I think that there is the potential for more gains to come. Remember, a year ago Kazakhmys shares were valued at over 1,600 pence. And, looking into the future, I think the story of increasing demand for metals and minerals from fast-growing emerging and frontier markets remains intact.
Phew! These mining shares are certainly dynamite. Just don't stand too close...
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Prabhat Sakya owns shares in Kazakhmys, but in none of the other companies mentioned. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.