ASX resources shares like BHP Group Ltd (ASX: BHP) have been on fire recently. But here’s why investing in this sector could be dangerous
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One of the biggest barbeque stoppers on the ASX at the moment is the rampaging commodities markets. Around the proverbial ASX water cooler, investors are abuzz with iron ore prices reaching US$200 a tonne. Not to mention the robust recovery we have seen in the crude oil price (currently above US$66 a barrel). We have also seen gold and silver prices stabilise after coming off of last year’s highs. And copper continues to push into record territory. And we won’t even mention the recent excitement over lithium and rare earths today.
All of this news is music to the ears of the shareholders of some of ASX’s biggest miners. ASX resources shares like BHP Group Ltd (ASX: BHP), Rio Tinto Limited (ASX: RIO) and Fortescue Metals Group Limited (ASX: FMG) are all pretty close to their record highs. Fortescue has doubled in value over the past 12 months (not to mention showering its shareholders with fat dividends along the way).
BHP hit a new all-time high of $50.93 last month and is trading mighty close to that level today at $48.21 a share at the time of writing. It’s a similar situation with Rio.
ASX resources shares like these giants have been a friend to ASX investors over the past year or so. These companies rebounded relatively quickly from the coronavirus-induced market crash last year, making a stark contrast with other ASX blue chips like the big four banks. And the dividends didn’t miss a beat either – again in stark contrast to bank shares.
But it might be time to consider the inherent value of these companies. The ASX resources sector is one of the most unpredictable on the ASX – something that the market doesn’t always price in.
Buffett’s warning on ASX resources shares?
To expand, let’s look at two quotes from the great investor Warren Buffett.
The first is this: “Only buy something that you’d be perfectly happy to hold if the market shut down for 10 years”.
And the second is this: “A bank is no different than any other business. It’s how much cash you’re going to get between now and Judgement Day, discount it and compare it to other investments”.
A mining company’s largest variable is the price of the commodity it mines. No matter how good a company’s management is, or its branding, or its operations, it still has no say in how much it can sell its product for. And that makes it unpredictable. If the market indeed closed for 10 years, would you be willing to bet that the price of iron ore, oil, copper or gold would be higher in 10 years’ time? Not to mention until Judgement Day? These are cyclical products, which obey very rigid laws of supply and demand.
And yet, the market never seems to price these companies in that light. The current BHP share price, for example, is built on top of an iron ore price at record highs. If iron ore prices were to fall 20% over the next month, it’s likely that the share prices of BHP, Fortescue and Rio would take a hit. That’s a scenario all investors might want to keep in mind with this sector right now.
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Motley Fool contributor Sebastian Bowen has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.
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