Why Small-Cap Resource Stocks Beat Blue Chips Hands Down

Don’t look now…but resource stocks are going up!

It’s been quite a week in fact.

The Metals and Mining Index (XMM) has had its longest winning streak in six months: over five straight sessions of gains, it’s up 9%.

And this makes it the biggest weekly gain for eighteen months.

After a twenty-five month long slide in resource stocks, is this the start of the rally we have been waiting for…?

It could be. And if it is, what is the best way for investors to profit most from it?

The US markets are setting all-time highs…

The Australian market is at a five-year high…

But the Australian resource sector…missed the memo completely.

The Australian Metals and Mining index (XMM) is the lowest it has been in four years.

It is back to levels not seen since the GFC!

While the rest of the world has been cracking the bubbly, resource investors have had less to smile about. It’s been a long hard slog in the trenches for the last 25 months.

But it has also been the genesis of the most outstanding investment opportunity the market has offered up in a long time.

After going vertical for months, most Australian bank stocks are now the most overbought in thirty years. To me they look like a great opportunity to buy high and sell low.

But…if you’re the type of investor that likes to buy low and then sell high…the deeply oversold Australian resource sector looks like a much better prospect for getting the equation the right way round.


Source: Bigcharts

It may not be tomorrow, next week, or next month…but we’re getting close to a major money making opportunity in Australia’s most unloved sector: resources. On Wednesday I wrote to you about why we should expect a recovery; and why we could well be on the cusp of another sixteen years of commodity price rallies.

So…

How Should You Play it?

‘How about BHP?’

[Alex: Yawn]

Sorry, you lost me there. Something about BHP? BHP isn’t my idea of an exciting stock market investment.

Why?

For a start, a mega-cap miner like that covers so many commodities you don’t get to focus on a specific commodity that you may like.

But the MAIN reason I leave BHP to the automaton fund managers is this: it’s much easier to get a 100% gain on a stock with a $100 million market cap, than it is to get a 100% gain on a stock with a $1 billion market cap.

Here’s an example of what I mean…

Take Panaust (ASX: PNA). It’s one of Australia’s biggest copper stocks.

In July 2010, it had a market cap of $7.5 billion.

Between July 2010 and April 2012, the copper price gained 25%.

But multibillion dollar copper producer Panaust managed to climb just 2.3%.

In comparison, Discovery Metals (ASX: DML) had a market cap of $200 million back in July 2010. And over the same period, Discovery climbed 108%.

The point is this: For nimble investors, it’s easier to leverage commodity price moves with smaller stocks.

Those were happier days for Discovery’s shareholders. I advised Diggers and Drillers readers to take profits at that point, to lock in a 108% gain. It paid to be disciplined, as the share price has come crashing down since then.

Take another example.

Gold gained 20% between April 2011, and May 2012.

crash by 38%, even while gold rose 20%.

Meanwhile, smaller gold stocks were locking in the gains.

Mid-cap gold producer, Regis Resources (ASX: RRL) gained 40% in this time.

Small-cap gold explorer, Azimuth (ASX: AZH), gained 60% in the same period.

It’s pretty clear that if you do your homework, and filter out the contenders from the pretenders, small-cap resources are capable of far more rewarding moves than the bungling big-caps.

The conditions have to be right though.

Today, the conditions are right. We are the end of a bear market for resources, or very close to the end of it.

Winter is turning to spring in the resource sector. So it’s time to stop being bearish, and start thinking about the massive opportunity ahead. I’ll have more for you on this theme in the days and weeks ahead.

Dr Alex Cowie
Editor, Diggers & Drillers

PS. The S&P/ASX 200 continues to trade near the top of its three-month range. But it’s struggling to move much higher. Even bumper bank profits and an interest rate cut couldn’t give the market the boost investors wanted. In today’s Money Morning Premium, Kris asks financial planning veteran Vern Gowdie what investors should do as income stocks trade at sky-high prices. Click here to upgrade now.

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