One of the first things investors learn about investing in commodities is that this is a highly cyclical sector.
The cycle remains in full swing today, as long-term investors in mining giants BHP Billiton plc (LSE: BLT) (NYSE: BBL.US) and Rio Tinto (LSE: RIO) (NYSE: RIO.US) will unhappily testify.
It has been moving against them for the past five years, during which time their share prices have fallen 25% and 10% respectively, against a 30% rise on the FTSE 100 as a whole.
Life Goes In Cycles
This knocks the theory of the commodity supercycle, which suggested that voracious demand from rising giants such as China would drive prices upwards for decades.
This time it wasn’t different… again. The cycle remains intact, which makes now a tempting time to buy BHP Billiton and Rio Tinto.
Today, the cycle is working against them, but it should eventually swing back in their favour.
Stimulating times
The European Central Bank’s €1.1 trillion blast of quantitative easing gave both stocks a short-term lift this week. China is also giving its slowing economy another blast of infrastructure stimulus worth around $1.1 trillion.
That said, as the world deflates and the financial crisis drags on, hot money won’t be enough to revive BHP Billiton and Rio Tinto on its own.
Production Values
Both miners have responded to falling prices by increasing production, with BHP Billiton on track to deliver 16% growth over the two years to the end of 2015. Coal, iron ore and petrol are all up, although copper has fallen slightly.
Combined with greater productivity, this has helped to keep the cash flowing despite the sharp drop in prices for its shipments (32% in the case of iron ore).
Iron Men
Rio has also just posted a “robust” Q4 production performance, including a 17% year-on-year rise in global iron ore shipments. It is also leveraging its “low-cost position” to maintain revenues in the face of falling prices.
Ramping up production may seem counterintuitive as the subsequent glut has only driven prices lower, but just like the Saudi oil play, BHP Billiton and Rio Tinto seem to be calculating that this will eventually work in their favour, as low prices drive out smaller marginal producers.
Buy Low
If cheaper oil help to revives global economic demand just as commodity supply withers, the cycle could swing back in favour of FTSE 100-listed miners. The time to get on board is at the bottom of the cycle, rather than the top.
With BHP Billiton trading at 8.7 times earnings and yielding 5.5%, and Rio trading at 8.1 earnings and yielding 4.3%, you could argue that we are close to the bottom now.
