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Why I'm recommending ‘Losers' right now

by , 22 September 2014

Over the past few months I've been recommending investors buy these ‘Losers' because I believe some of them could be the best performing stocks of the next three years.

I know this sounds odd. But let me explain…

Losers are shares that have fallen dramatically. Shares in a market that have underperformed or lost you money for a multiyear period.

And the market I see the best value in today has been a ‘Loser' since 2009…

I’m talking about resources shares. Metals, mining, platinum, gold, coal, copper, and potash. You name it and you can be sure the sector’s had a horrible run of late.

To get an idea of how out of favour resource stocks are, we can look at the JSEs resources index. The index tells you how well the share prices of the top 10 resource shares on the JSE have done. You can see in the chart below this sector has literally gone nowhere in the past five years. In sharp contrast you’ll see how the All-Share Index has DOUBLED in exactly the same time.

Why I’m positive on this losing sector right now

You see, I believe maximum pessimism makes for extraordinary profits.

And boy, are investors pessimistic on resource stocks at the moment:
  • We’ve just seen a five-month strike in the platinum sector, followed by a one-month strike in the metalworkers sector.
  • Investors are selling many resource stocks hand over fist. Clueless bankers are calling ‘sell’ signals on resource stocks because they’re in the ‘wrong’ sector instead of looking at the individual businesses and their merits. Why, in the past year I’ve seen some of these smart analysts call ‘sell’ signals on a stock that has subsequently DOUBLED in value.
  • Mining companies are ‘de-merging’ assets, selling ‘non-performing’ mines, or just outright closing their doors. The Toronto Stock exchange, the world’s largest market for resource shares have seen a total of 134 resource companies disappear from the market this year.
In other words, blood is running in the streets in the resource sector. Investors have labelled these stocks as ‘Losers’ for good.

Why stocks from the worst sector could be next year’s best performers

The fact is, deep bear markets like this create opportunity.

Just think back to 2007/2008 and the massive market crash we saw back then.

By early 2009, most investors had given up on stocks. They’d given up on investing in general. The world was too scary to consider the idea. Buying any stock made people sick to their stomachs. What money they hadn’t lost in the fall, they had pulled from the market and left it sitting in cash. The resource market had a cloud of black pessimism over it.

But that was exactly when I went to work...

Buying Pan African Resources at that stage was a no brainer. I picked up the share at 68c – and sold this year at 268c, including dividends I made more than 310%.

Same goes for Wescoal, I bought the small stock at 68c back then and within months I sold it again at 130c.

I don’t bring up this story to boast. I bring it up because it’s extremely important to realize that to make extraordinary gains; you have to buy near points of maximum pessimism.

In other words, to succeed in beaten-down resource markets, do the same thing you need to do in any other market:
  • Buy what's hated yet still valuable – right now coal miners and especially small cap coal miners are truly hated and being sold down across the board. But there are opportunities to buy some of these shares on P/E ratios below 10 – yet these companies still have mines in development that could DOUBLE revenues and profit within the next year or two.
  • Invest in companies with great management and solid track records – Now while there are companies with loads of potential and enough mineral resources to last 100 years that doesn’t mean they’re worth your money. Wesizwe and Jubilee Platinum immediately spring to mind here. Both these companies have incredible potential, lots of platinum reserves that can be mined profitably. But neither company has a track record of any kind. In fact, all that management at these firms have shown over the past five years is that it knows how to issue more shares.
  • Don’t be blinded by the ‘macro’ picture, dig deeper to find true value – Think of an ant nest – you only see a little bit of it above ground. And a wave of rainwater over it would destroy what you saw above ground. Yet underground it is still full of healthy ants, working away and increasing the size of the colony. How does this relate to investing? Well – if you simply look at the obvious picture you can see you might think the sector has been destroyed by the wave of bad news – just like rainwater destroyed what you could have seen of the ant nest, including perhaps the unprepared and unlucky ants. But just like there were ant survivors thriving after the rainstorm – similarly there are great companies thriving amidst the bad news. You just need to dig deeper for the truly great companies!
 
When will things turn around for small-cap resource stocks? I'm not sure... No one is. But as a value investor, I'm not interested in timing the market. I'm interested in buying quality assets that are trading at a discount to their true value... and waiting for the market to realize this value.

Right now, the majority of stocks on the JSE are trading at all-time highs. It’s difficult to find the ones that still show value. But they exist in the small-cap resource sector...

And that's exactly why I'm focused on finding 'Loser' shares for my Resource and Scarcity Report readers right now (if you're interested, you can find out more about this group here.

Here’s to unearthing resource profits

Francois Joubert

Editor, Resource and Scarcity Report


Why I'm recommending ‘Losers' right now
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