One high profile fund manager has suggested that now's the time for investors to plunge into the oil and iron ore sectors, following the massive selloff in both sectors.
Simon Mawhinney, joint portfolio manager of the Allan Gray Equity Fund, takes a contrarian approach to investing, meaning he likes to buy shares of companies that are unloved by the market. He has told the Australian Financial Review (AFR) that now is one of the best times in many years to buy good quality energy companies. Mr Mawhinney noted that the fund was buying stakes in Origin Energy Limited (ASX: ORG) and Woodside Petroleum Limited (ASX: WPL) in December 2014.
"We are just coming out of the bull market and we are now a couple of years, at best, into the weakness", he says, adding, "cycles run for a lot longer than people expect. If oil prices remain at these levels, bankruptcies will certainly follow. The same is true for iron ore producers. Arrium Ltd (ASX: ARI) announced the first major iron ore mine closure in Australia on Friday. Others will follow if prices remain at or below current levels."
I can understand investors taking a contrarian approach, but no one has any idea where oil or iron ore prices will be next year, let alone in five or ten years. For all we know, they could remain at or below these levels for many, many years.
If you look at the following chart, you can clearly see that iron ore prices could fall even further, as could oil.
Source: Indexmundi
Entering a sector where companies have no control over the price they receive for their products, like iron ore miners or oil producers, is fraught with danger.
Those resources and energy stocks that have high production costs could easily shut up shop or go bust before the commodity price has a chance to recover. And the low-cost producers, such as BHP Billiton Limited (ASX: BHP) and Rio Tinto Limited (ASX: RIO) will see their profits and margins squeezed in the meantime, with likely commensurate cuts in earnings and dividends. That may well see their share prices fall too.
Allan Gray is sitting on massive losses, after taking a 13.5% stake in Arrium from November to mid-January. The fund manager invested more than $113 million buying up 395 million shares, at an average price of 28.6 cents. Those shares are now worth around $73 million – a $40 million paper loss to Allan Gray.
We wrote 2 years ago why investors should avoid Arrium – and many of those issues still remain.
Invest in iron ore and oil stocks at your peril.
