Why Bank Stocks have Outperformed Resource Stocks…

It’s not often we agree with US Federal Reserve chairman, Dr Ben S Bernanke.

But over the weekend, Dr Bernanke claimed, ‘Both humanity’s capacity to innovate and the incentives to innovate are greater today than at any other time in history.

We couldn’t agree more. It’s why we’ve hired a specialist analyst – Sam Volkering – to help us launch a new technology investment service. While others preach doom and gloom, and fear modern technology, we look forward to it. Why? Because we believe technology improves the quality of life.

We’ll reveal more on this new service in the coming weeks.

Of course, we’re not about to give Dr Bernanke a free kick on his running of US (and indirectly, global) monetary policy. It has been a total disaster. Despite that, it has opened up a lot of opportunities for investors to make money, and that’s set to continue…

The idea that a central bank can artificially stimulate an economy without side effects is naive. The 1920’s and 1930’s saw huge leaps in industrial innovation, but it didn’t stop the Great Depression and more than a decade of misery.

One problem with central bank meddling is that it creates an uneven economy.

For instance, although the banking sector has reaped the benefit of cheap money (Commonwealth Bank of Australia [ASX: CBA] and Wells Fargo & Co [NYSE: WFC] are up 48.2% and 28.9% respectively over the past 12 months), the arguably more productive resource sector hasn’t done so well.

Mining giant BHP Billiton [ASX: BHP] has gained just 7.6% in 12 months, and Freeport-McMoRan [NYSE: FCX] has gained just 2%.

Sadly, those are some of the better performers in the resource sector. Many resource stocks have slumped in recent months as investors shun risky stocks in favour of ‘safe’ income stocks.

Banks Creating Assets from Thin Air

But the resource stock collapse has puzzled many people. How can bank stocks rise when all they own are pieces of paper called mortgages, while mining stocks digging iron ore, copper and gold from the ground own real hard-as-rock assets?

Well, that’s where you can thank Dr Bernanke and the banking system. For start, banks can do something mining companies can’t – banks can create money from thin air in order to create an asset.

Mining companies however, have to beg for money from banks, other financial institutions and investors. And rather than just stamping ‘approved’ on a loan form to create an asset, resource stocks have to spend millions to obtain their assets.

Financial Services Index – blue line; Metals & Mining Index – red line
Source: Google Finance

The thing is, at some point investors will surely look at the above chart and think, ‘I’m gonna buy the cheap stocks and sell the expensive stocks.’

If they do that, resource stocks should be near the top of the list.

Of course, it’s not as simple as buying cheap and selling dear. If it was that simple you’d just buy every beaten down stock and wait for other investors to pile in and drive the price higher.

You have to be more selective than that. You have to work out what investors want.

A Surprising Place to Find Income

As we explained in our latest issue of Australian Small-Cap Investigator, most of the commentary suggests investors want income. That’s not true. What investors actually want is growth and income.

But rather than getting growth from growth stocks, over the past 12 months they’ve gotten that growth and income from blue-chip income stocks. With those stocks now trading at a premium, investors know they need to look outside the top 50 stocks if they want income and growth, or even just plain old growth.

It may surprise you to know that we’re looking at the income and growth angle in Australian Small-Cap Investigator. Far more small-cap stocks pay a dividend than you may think.

But Doc Cowie has taken a slightly different approach in Diggers & Drillers. Saying that, our strategies have one thing in common – cash.

The Doc has recently put into play a strategy he used to good effect from 2009 to 2010…the last time resource stocks went bonkers, and the Metals & Mining Index more than doubled (many small-cap resource stocks did even better). The strategy is simple to explain, but requires a lot of analysis to put into practice.

Simply put, it’s about ripping apart resource companies‘ balance sheets and production schedules, and working out which stocks have the cash flow to succeed.

After all, mining is an expensive game. Just because a company has found a resource doesn’t mean they’ll ever dig the stuff from the ground. It can cost millions, sometimes tens or hundreds of millions to get a project through to production.

That’s why it’s important that mining companies have enough working capital to move from exploration to production. And that’s where the Doc’s analysis makes the difference.

Lower Aussie a Boon for Resource Stocks

You’ve seen the Doc’s writings in Money Morning over the past few weeks. We don’t think we’ve ever seen him so excited about the opportunities in the resource sector.

In fact, he was almost delirious when he showed us this quote from the Australian on Friday:

An analysis by RBC Capital Markets found that a further pull-back in the value of the dollar against the US dollar to US89c could see net profit at some Australian mining companies soar by more than 36 per cent.

Most analysts have given up on resource stocks. But not the Doc. And right now it’s the perfect time to do the analysis the Doc excels at. Hundreds of small mining companies have recently released their quarterly cash flow reports.

This reveals how much cash these small miners and producers have on the books. It means the Doc can crunch the numbers to find which stocks have the best cash flows to progress their projects.

If the Doc is right, it’s a great time to look at a select few beaten down resource stocks. And with the speed at which the market gobbles up value, these stocks may not stay beaten down for long.


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From the Port Phillip Publishing Library

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Money Morning: Cash is King in this Market

Pursuit of Happiness: What Drives Entrepreneur’s and Inventors

Australian Small-Cap Investigator:
How to Make Money From Small-Cap Stocks

Money Morning is Australia’s most outspoken financial news service. Your Money Morning editorial team are not afraid to tell it like it is. From calling out politicians to taking on the housing industry, our aim is to cut through the hype and BS to help you make sense of the stories that make a difference to your wealth. Whether you agree with us or not, you’ll find our common-sense, thought provoking arguments well worth a read.

Money Morning Australia is published by Port Phillip Publishing, an independent financial publisher based in Melbourne, Australia. As an Australian financial services license holder we are subject to the regulations and laws of Corporations Act and Financial Services Act.

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