Much like analysts at Citi, I'm quite bearish on the resources sector and BHP Billiton Limited (ASX: BHP) and Rio Tinto Limited (ASX: RIO) in particular.
The prospect of increasing iron ore supply from both Brazil and Australia, together with slowing demand from China leads me to believe that iron ore prices are inevitably going to drift lower over the next 18 months.
And with OPEC looking as though it is struggling to come to an agreement regarding a production freeze, I wouldn't be surprised to see oil prices drop back down to around US$45 a barrel in the next few months.
If this were to happen I feel it is quite likely that BHP Billiton and Rio Tinto would see margins squeezed and earnings growth halted. This would cause their respective share prices to tumble.
But not everybody sees it this way. A report in the Australian Financial Review reveals that Australian fund manager Maple-Brown Abbott is bullish on the resources sector and still thinks shares such as Rio Tinto can climb higher.
In fact, its managing director Garth Rossler believes some companies in the resources sector could see their share prices double if commodity prices hold at their current levels.
I completely agree with Mr Rossler on this. If commodity prices were to hold at their current levels then a good number of shares such as BHP Billiton, Rio Tinto, and Fortescue Metals Group Limited (ASX: FMG) could charge higher.
These companies are running very profitable operations with prices as they are and are likely to produce bumper profits if they hold.
But unfortunately I just don't expect prices to hold firm. So for this reason I will personally avoid the sector. I'm happy to be wrong and miss out on gains, rather than be wrong and see my investment cut in half.
