One of the more interesting debates that we regularly re-visit during our asset allocation discussions revolves around when is the right time to be allocating back into commodities and resources stocks within our client portfolios.
The inverse correlation between a strong US Dollar and resource stocks (as well as Emerging markets and physical commodities) has once again been reinforced over the past 2 years and the damage to some of the more vulnerable companies within the sector has been significant. Last month, in a bid to raise much needed capital, Lonmin – one of the world’s largest platinum miners – announced a rights issue that could dilute its existing shareholders almost out of existence if they choose not to participate. Is this a Bear Stearns or Lehman moment for the commodity sector?
Under the terms of the USD 400million issue (more than its existing market capitalization), Lonmin’s long-suffering shareholders will be offered the opportunity to buy shares at a whopping 94% below the pre-announcement market price, at a ratio of 46 new ones for every one they presently hold. The massive discount is obviously designed to ensure investors cough up or be diluted to almost zero. Subject to a favourable outcome, the company’s creditor banks will then provide a US$370m loan facility to replace current debt arrangements. Even in the depths of the global financial crisis, many of the bank rescue packages weren’t this hectic!
If the capital raising fails and Lonmin goes into bankruptcy, more than 35,000 jobs would be in jeopardy. As such, the South African Government has a vested interest in this outcome and the PIC, or the public pension fund, has agreed not only to take up its rights, but will sub-underwrite HSBC, JP Morgan and Standard Bank as lead underwriters to the issue. According to the CEO there are “no holy cows” in this process!, but if the world’s third largest platinum producer couldn’t make money at $1800 per ounce, how are they going to do so at $900 per ounce?
The share price has fallen 95% over the past 12 months and many are selling this week to get something out rather than fund what they see as a bankrupt business even after the rights issue. The shareholder vote is on Thursday, so by the time this weekly comment is circulated you will know the result.
But Lonmin isn’t really the point of this article. Many clever and respected investors have been calling resources stocks and physical commodities a buy from as far back as the end of last year. Yet, despite offering hope to those investors by rebounding from further weakness (and multi-decade lows) during Q2, the downward trajectory remains in place (see Bloomberg Commodity Index chart). So presumably, having been an enticing proposition in January, these assets look even more attractive today?
Indeed, if one heeds the advice of the great Warren Buffett to: “Be fearful when others are greedy and greedy when others are fearful”, then should we perhaps be lacing up our buying boots, because there are certainly plenty of fearful people about in the resources space? Moreover, though their cyclical nature means that they do not make good long term buy and hold investments, experience suggest that most things that have fallen 95% are worth more than a cursory look. As stated earlier, however, many clever people have thought this at levels a lot higher; on that basis, maybe waiting for evidence of improvement is a safer way to play this game.
Resouces and Commodities