With a rapid rise in the price of nickel over the past year, you might think it's a good time to invest in the companies that produce it. But talk to your broker before parting with your cash.
A 227 per cent increase in full-year profit unveiled during the week by WMC Resources paints a pretty clear picture of the sector right now.
Consider this the company made a $120 million loss on its Olympic Dam project. Its fertiliser business made a loss of $36 million. But net profit trumped market expectations, topping $245 million.
How? Nickel. This division of the company earned nearly $429 million for WMC.
Like other base metals, the value of nickel has soared over the past year, and that strength is forecast to continue during the first half of this year.
In fact, commodity analysts are looking for the price of nickel to increase anywhere between 50 and 75 per cent by the middle of this year from last December.
A couple of nickel production projects in the Asia Pacific region that haven't met expectations have compounded a major tightening in supply.
But the biggest driver of the metal's value surge is China. A massive industrial building boom is happening across the country, meaning strong demand for nickel, aluminium, copper, steel, stainless steel and the bulk commodities, such as coal and iron ore, required to produce them.
Nickel is probably tipped as having the most upside, but, in general, resources prices are expected to lift about 30 per cent in six months.
Some of the benefits for Australian commodity producers have been offset by the jump in value of the Australian dollar, but it's largely good news.
So, the question is: how much share price upside is left and is now a good time to invest in resource companies?
Obviously there are pros and cons for each stock, but across the board the investment banks are upping their valuations for the sector based on the rally in commodity prices.
And, for many companies, they say at current prices stocks are cheap.
Let's take BHP Billiton as an example.
Based on increased long-term commodity prices, Macquarie Bank's resources team has upgraded its net present value by 13 per cent and, after crunching all the numbers, reckons the stock is trading at around a 2 per cent discount.
But here's where the investment decision gets tricky, especially if you're like me a buy-and-hold kind of investor.
Unfortunately, there's no simple formula for determining exactly how an increase in a commodity price will impact on earnings. And because the sector is cyclical, the prices of resources fluctuate.
Some brokers have actually downgraded their recommendations on the big mining stocks such as Rio Tinto and WMC Resources because of their exposure to the next stage of the cycle when commodity prices fall.
Another example, ABN Amro says WMC Resources is highly leveraged to the cycle as it is a base metal stock.
So, while earnings are forecast to surge this year, as its results suggested, in 2005 they'll be down 17 per cent, especially if our dollar continues to hold at current levels.
As a final tip, remember that the stage we're currently at in the cycle is where, historically, resource stocks trade on quite a big premium to their valuation.
So the long and the short of it is that you can't simply assume that because commodities are expected to jump 30 per cent in value, the share prices of the companies that produce them will follow suit. Ask your broker: a) What sort of premium the stock is currently trading on.b) What will happen when demand for commodities retreats.c) What sort of time frame you are likely to have to get out of a stock ahead of that retreat impacting on the share price.
David Koch is Channel Seven finance editor and hosts Sky Business Report on Sky News channel.
