Could 2025 be the year of resource stocks, including small-cap miners?

Financial Journalist
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In the wake of the Trump victory, a timely question is could 2025 be the year of resource stocks, including small-cap miners?

Yes, it seems early to publish ‘year ahead’ stories, even though the end of 2024 is rapidly approaching. My local council has just put up its first Christmas tree!

But debate about the outlook for resource stocks is rapidly building among institutional investors. Some believe it’s time to take profits on overvalued Australian banks and rotate into undervalued mining companies.

I share that view, with caveats. I have argued several times in this column in the past few months that it’s time to reduce exposure to overvalued Australian bank stocks and increase exposure to undervalued global banks.

Commonwealth Bank, for example, trades on valuation metrics more than double those of high-quality banks in the United States or Europe. That’s a sign of ‘peak bank’ valuations in Australia, although CBA continues to defy the sceptics.

On resources, I have argued we are still in the early stages of a supercycle, principally on supply-side issues. It continues to get harder, costlier and take longer to discover new mines or expand existing ones.

Growth in Environmental, Social and Governance (ESG) investing in the past decade has dampened investment in new fossil-fuel projects. This points to commodity supply constraints and thus higher mineral and energy prices over this decade.

With resources, my preference has been copper, oil, coal and, more recently, lithium, which has been belted in the past year. I’ve steered clear of iron ore and suggested investors rotate from gold bullion, which has boomed, to gold equities that have badly lagged gains in the gold price.

As I write this column, it looks almost certain that Trump has won the US presidential election. As I wrote earlier this month, the energy sector should benefit from Trump.

Although I am bearish on Australian bank stocks, and bullish on parts of the resource sector, I have not written on the banks-to-resources rotation before now.

I can see why this sector, which has been described as the ‘trade from hell’ in financial media, is attracting interest.

Led by CBA, banks have been a key source of alpha (a return greater than the market return) for institutional investors. Rotating out of banks and into resources too early could crunch portfolio performance.

There have been false starts. China’s efforts to stimulate its beleaguered economy in September unleashed the resource bulls, although that optimism has since faded. China’s stimulus plan is unfolding but doesn’t look like enough to address its deep-rooted economic malaise.

Still, falling interest rates worldwide should be good for global economic growth and commodity demand – and not as good for bank net interest margins (the difference between interest paid and received), on balance.

Elsewhere, I have made the case this year to increase exposure to small-cap equities, principally global ones. That said, I’m becoming more bullish on Australian small-cap equities, of which there are many resource companies.

Decreasing portfolio exposure to banks and increasing exposure to resources makes sense. So, too, does a modestly higher allocation to small-caps, including mid-cap miners that have been badly out of favour, yet have improving prospects in 2025.

I mentioned earlier that this idea has caveats. The first is that bank and resource index comparisons in Australia are skewed by the high weighting of stocks such CBA, BHP Group and Rio Tinto in indices. Strip CBA out of the bank index and Australian banks don’t look nearly as overvalued.

Another caveat is the size of portfolio asset-allocation rotations. I’m not suggesting investors dump Australian banks and load up on miners, including speculative junior miners.

Rather, that investors who have made good profits through the bank rally take a little money off the table and put that to work in the resource sector for 2025 through an increase in portfolio allocation to mining stocks.

Those seeking resource exposure through managed funds have limited choice in Australia. This market doesn’t have many specialist resource funds, which is surprising given the importance of mining here. Also, some larger unlisted resource funds are only available to wholesale investors and there aren’t many specialist resource sector Exchange Traded Funds (ETFs) on ASX.

Retail investors seeking exposure to junior miners can consider a few Listed Investment Companies (LICs) that specialise in this space. Some trade at a large discount to their Net Tangible Assets (NTA), meaning investors can buy into a sector that trades at a discount through an LIC that trades at a discount.

In theory, that provides a cheaper entry point to a higher-risk sector – and thus a greater margin of safety. I like using funds for diversified exposure to mining companies, to reduce individual company risk and lift sector allocation.

Three LICs and Listed Investment Trusts specialise in the resource sector: the Tribeca Global Natural Resources (ASX: TGF), Lion Selection Group (ASX: LSX) and Lowell Resources Fund (ASX: LRT)

Some good LIC judges rate the Tribeca fund at its current valuation, which trades near a 20% discount to its NTA. But the fund’s NTA has lagged its share price for a long time, frustrating investors and no doubt its manager. Also, my focus in this column is small- and mid-cap Australian miners. Tribecca tends to invest in larger global resource stocks.

Chart 1: Tribeca Global Natural Resources

Source: Google Finance

 Lion Selection Group is the pick of the resource LICs for those seeking small-cap exposure. Lion has been around a long time and trades at around a 20% discount to its NTA, even after its recent rally. In theory, that means buying $1 worth of mining stocks for 80 cents.

Lion has a high cash weighting in its portfolio with $52 million to put to work and focuses mostly on earlier-stage listed and unlisted mining companies. Some junior miners Lion invests in are not available to the public.

Lion’s timing is good. The LIC’s latest shareholder presentation notes that micro-cap Australian resource equity valuations are down 75% since April 2022, such has been the negativity towards small Australian miners and liquidity concerns.

Lion has a high-conviction strategy, targeting 10-20 portfolio stocks. As such, it suits experienced investors who seek a more diversified (although concentrated) approach to junior mining stocks, compared to buying them directly.

From a technical perspective, Lion appears to be breaking out of a long accumulation period and price resistance – a potentially positive sign for chartists.

Chart 2: Lion Selection Group

Source: Google Finance

 Lowell Resources Fund completes this week’s column on small resource LICs, or in its case, a listed investment trust.

Lowell invests in small mining and energy companies, mostly in the exploration phase. Lowell trades at a 17% discount to NTA, according to Morningstar research.

Even by LIC standards, Lowell is tiny, capitalised at $45.7 million. It has low daily turnover and an even lower market profile.

Lowell hasn’t been on my radar before. That said, I was surprised at its compound annual growth rate in NTA over the past five years, which is shown in its latest investor presentation and the quality of its portfolio.

Lowell feels like an LIT the market has completely overlooked. That’s not surprising: investing in a micro-cap LIC that invests in micro-cap junior miners – in two sectors that have been hugely out of favour – is a tough ask.

My preference remains Lion, but Lowell might be worth closer inspection for speculators if the junior end of the mining sector improves in 2025. The underlying fund had been going for more than 20 years and listed on ASX in 2018.

Chart 3: Lowell Resources Fund

Source: Google Finance

Tony Featherstone is a former managing editor of BRW, Shares and Personal Investor magazines. The information in this article should not be considered personal advice. It has been prepared without considering your objectives, financial situation or needs. Before acting on information in this article consider its appropriateness and accuracy, regarding your objectives, financial situation and needs. Do further research of your own and/or seek personal financial advice from a licensed adviser before making any financial or investment decisions based on this article. All prices and analysis at 6 November, 2024.

 

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