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Why resource stocks may not be such a bargain after all

It's easy to make the case that energy and gold stocks are bargains when compared with the underlying commodities, but investors should look deeper before trying to take advantage of the apparent disparity.

As the accompanying charts show, shares of energy and gold producers have trailed the prices for their key offerings for more than a year.

The top panel tracks a Standard & Poor's 500 index of 17 oil and natural gas producers and Brent crude, an industry benchmark.

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The bottom panel shows the NYSE Arca Gold Miners Index, consisting of 30 stocks, along with the price of gold for immediate delivery.

"The disparities mean that the cheapest resources are not found in the ground – they're listed" on stock exchanges, Frank Holmes, chief executive officer of U.S. Global Investor Inc., wrote in a recent blog post.

Proposed multibillion-dollar takeovers of Canadian energy producers by CNOOC Ltd. and Petroliam Nasional Bhd show the value available in commodity stocks, according to Mr. Holmes, who operates three commodity-related mutual funds.

CNOOC, China's largest offshore oil explorer, offered to acquire Nexen Inc. in July for 61 per cent more than the stock's market price.

The proposed deal followed an offer in June from Petronas, Malaysia's state-owned energy company, for Progress Energy Resources Corp. that was 77 per cent above the market price.

But it's not entirely clear that raw material stocks offer outstanding value.

The gap between commodity prices and share prices could be closed by commodity prices falling rather than by share prices rising.

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Peter Tasker, a Tokyo-based analyst with Arcus Research, said in a recent Financial Times commentary that gold is at its highest level in more than a century compared to U.S. house prices – a sign that prices for the precious metal are likely to tumble.

"Likewise, [gold] is at a 74-year high relative to U.S. wages, at multigeneration highs relative to wheat, coffee and cocoa and at the same price relative to the cost of a Yale education as in the first decade of the 20th century," Mr. Tasker wrote.

The relationship between oil prices and oil stocks is particularly hard to predict.

Energy forecasts are notoriously unreliable, discoveries of new reserves are impossible to forecast, and much of the world's most accessible oil is under the control of state-owned firms that don't trade publicly.

The recent spate of Asian purchases in Canada's oil patch may be a sign of the value in Canadian energy stocks.

On the other hand, it may simply be another example of foreign buyers flush with cash rushing to buy overpriced real assets.

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It's worth noting that the Japanese investors that bought prime U.S. real estate in the late 1980s and early 1990s typically lost money on the deals. An influx of Asian cash may mean something – or not.

With files from Bloomberg

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About the Author

Ian McGugan is a reporter with The Globe and Mail's Report on Business and has been writing about investing, economics and business for more than 20 years. He joined the Globe and Mail in 2010. He has been executive editor of Canadian Business magazine and founding editor of MoneySense magazine. More


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