Mining shares have been among the big winners in 2014.
The FTSE All-Share index is up a miniscule 0.4% so far this year.
But look how these FTSE 100 miners have motored:
- Randgold Resources – Up 37%
- Fresnillo – Up 28%
- Anglo-American – Up 25%
- Glencore – Up 19%
Sure, not every big mining company has dug up great returns for shareholders this year.
Investors in Rio Tinto and Antofagasta may wish they’d backed different horses, with their companies cantering at the back of the pack – though still ahead of this stubborn-as-a-mule market!
It’s true, too, that seven months since New Year’s Day is a short and arbitrary time period over which to measure your returns.
We Fools usually think in terms of years, not year-to-dates.
Have years of decline for miners ended?
But it’s actually the longer-term view that I find most intriguing here.
You see, shares in the mining sector plunged between 2011 and the end of last year. Investors feared the commodity boom had burst.
In fact, this year’s big winner, Fresnillo, saw its share price fall 55% between 1 January 2011 and 31 December 2013.
Even sector stalwart BHP Billiton was down 27% during those years.
As so often happens, it looks like investor pessimism set the stage for the massive rebound we’ve seen in mining shares in 2014.
But how did investors get so pessimistic?
Partly because of worries about China slowing.
Partly because the gold price had fallen.
But mainly because they got too optimistic before.
Let me tell you a story about a man who walks into a pub…
One wet evening in 2011 I headed out from The Motley Fool’s office to a gathering of Fools in a nearby pub.
I was pretty excited, to be honest.
Despite being a member of the Motley Fool community for eight years, I hadn’t actually met many real-life Fools.
And while it was billed as a social event, I was sure I’d be able to indulge in my favourite pub pastime – talking shares – with like-minded investors.
But I was disappointed.
It wasn’t that Fools weren’t interested in investing – far from it!
They were very keen to discuss developments at their chosen companies. Some even had contact with board members of their favourite firms.
Many had the confident air of those who expected to do very well from their investments.
So why was I disappointed?
Well, summer 2011 was the peak of the bull market in commodity companies – the firms that dig stuff up, drill and pump it, or grow it on plantations.
And those were the only companies my fellow Fools – almost to a man and woman – were interested in.
I couldn’t believe it.
I’d grown up on the Foolish discussion boards learning about investing in everything from small-cap restaurants to exciting growth companies to dividend-paying blue chips.
But all anyone cared about were gold miners and wildcatters.
Eventually, I protested as much. One person said he was sympathetic and had enjoyed success outside of commodities in his previous investing efforts, but he argued the world had changed.
Apparently, small-cap retailers, tech start-ups and the like were yesterday’s news.
As for blue-chip dividend payers, forget about them. Look what happened to the banks!
This was the commodity super-cycle, and it was going to dominate how all businesses would fare for years to come, in his view.
More importantly, it was where the profits were for investors.
And with that he turned back to talking about some tiny Canadian oil explorer.
The warning signs were there
I was flabbergasted by the unanimous mindset on display that night, but I shouldn’t have been surprised.
For months, most of the Fool’s discussion boards had dried up, as everyone’s focus turned to miners and drillers.
Veteran small-cap investors who’d never looked at the commodity sector were asking for pointers.
Even popular competitions sprung up, aimed at predicting which junior oil explorer would go up by 20% or more in the next month!
This is what a mania looks like – and that’s not just hindsight talking.
Bubble trouble
I’d noticed worrying signs long before I sat silently with my pint in that pub where everyone else plotted their fortunes.
In April of 2011, I’d warned that the $11 billion listing of mega-commodity trader Glencore looked suspiciously like the smartest people in the business calling the top of the market.
And before that I’d spotted another telltale sign of bubbly conditions…
I’d reported on a music production company called Zest that was – bizarrely in my opinion – changing its name to Rare Earth Minerals and getting into mining.
You might laugh now.
But this company’s shares quadrupled in six weeks after declaring that shift in strategy!
By definition, cycles turn
It’s clear that by summer 2011, the commodity boom was over, although we only knew that for sure in retrospect.
And I’m happy to say my intuition largely kept me out of resource companies – though I admit I was wary much too early, and at times I felt stupid for missing out.
Mostly, I believe the experience made me richer as an investor in terms of knowledge and perspective.
I don’t blame my fellow Fools for being enthusiastic about mining in 2011.
The underlying story – which is that a wealthier and expanding global population will demand ever more of our finite resources – is persuasive, and I think true.
And some investors made a lot of money as commodity companies led the way from the lows of 2009.
However, I do think the risk/reward equation was out of kilter by 2011.
Perhaps that’s a lesson for the future if we’re to avoid losses the next time investors get giddy about a particular sector.
- At the start of 2011, the P/E ratio for Fresnillo was 40.
- By the end of 2013, it was 15.
Paying too high a multiple for a cyclical stock when things look about as good as they can get is a very risky strategy.
But paying much less when most people have given up the sector for dead may offer a far better chance of rewards.
