Like an enormous mortgage, eye-watering credit card bills and smashed avocado served on a hessian bag, many Australians have fallen in love with the idea of owning resource stocks.
Because our backyard is filled with red earth, coal, and gas, many investors and their advisors feel the need to fill their share portfolios with resource businesses.
But like 95% loan-to-value mortgages, it is not without risk.
Are Rio Tinto Limited and BHP Billiton Limited shares a blockbuster buy?
Rio Tinto Limited (ASX: RIO) and BHP Billiton Limited (ASX: BHP) are two of the world's largest mining companies. Despite their size, shares in the two companies rallied 42% and 54% in the last year.
However, in the five-year period prior to that they fell 55% and 68%, respectively. Talk about volatility!
That kind of price action is something you would expect to see from a penny stock. The kind of stocks that made The Wolf of Wall Street famous. Remember how that ended?
The reality is that picking normal stocks is hard enough, let alone resource stocks.
Why?
Resource businesses are an unusual beast. By that I mean, how many businesses can you think of that sell a product which is of limited supply and of which the producers have no control over the price whatsoever?
Of course, the laws of supply and demand usually kick into gear and push a commodity's price back to equilibrium, at which point only 10% of the lowest-cost producers will make money.
But it can be a nasty ride. And it usually requires tonnes of patience and a healthy spot of timing (read "luck").
Rio Tinto and BHP Billiton are some of the biggest and lowest cost producers of many commodities, which makes them relatively safer than many other resource businesses. However, following a sharp rise in the prices of coal, oil and iron ore in 2016, it would take a very shrewd investor to back these horses again in 2017, in my opinion. Take another look at the chart above.
