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Resource giants could stumble

Just over two years ago Rio’s share price hit a low at $36.53. This week, it’s trading close to $82. BHP’s low in January 2016 was $14.06. Today, it’s closer to $32. Capital gains of better than 120% PLUS dividends. Who said blue chips are boring?

Traders say “Harry Hindsight is a great trader”, and it’s true. It’s easy to look back and say “coulda, shoulda, woulda”. But how do investors know at the time that a stock is offering an opportunity to either buy or sell? One approach is to throw off the blinkers and consider all the important factors that can drive a stock price.

Fundamental analysis of companies is a powerful tool in attempting to understand whether a stock is cheap or expensive. However all company valuations are estimates. They require analysts to make guesses about future earnings and costs, and external factors like interest rates and commodity prices. The often wide range of valuations of a single company shows that valuations are opinions, not fact.

Luckily investors can draw on additional sources of information in deciding entry and exit points. A simple one is a measure of sentiment. If there is almost universal consensus on a stock, it is often at a turning point. If everyone believes Wesfarmers is a buy, bearish analysts are capitulating and contrarian opinions are hard to find, it’s probably close to time to sell.

Further, if these extremes of sentiment coincide with important chart levels the signal is reinforced. And if the most important stocks in a sector are displaying these characteristics simultaneously investors should take note.

This brings us to BHP and Rio. Remember how oil prices hit a low below $30 a barrel and some were calling for $10? Iron ore touched $42 a tonne? All industrial commodities were under pressure, and the almost universal consensus was that they would fall further. That was the turning point.

Right now the commodity bears are capitulating. Analysts are reluctantly increasing commodity price forecasts. Share valuations are going up. And major mining stocks that ran hard against consensus are now the subject of buy recommendations from the same analysts that were bearish 50% ago.

This extreme in sentiment occurs as the share prices of both BHP and Rio are sitting near key resistance. At the moment both are making new highs. For BHP that is above the 3 year high at $32.16 in January this year. For Rio it is above the high at $82.73 from February.  The direction for both will likely by set by the movement from here. A sustained break through should bring new highs. However failure at these levels could see a very different outlook.

None of us know the future, but in my view there is a short term flush due in the global mining stocks. I’m looking for a 10% - 15% pull back in share prices.

This may not matter to long term holders. However active investment is a strategic response to a market with a modestly positive outlook and sideways tendencies. Decreasing the overall cost of my portfolio by locking in gains with a view to buying back at lower share prices can be an important tactical response to spectacular gains in blue chips.

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