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The misery in the resource sector is creating a buying opportunity for patient investors.

Shares of oil producers and miners are now at some of their cheapest levels in history compared with the rest of the market. They are priced for despair.

Canadian energy stalwarts such as Canadian Natural Resources Ltd. and Cenovus Energy Inc. trade for roughly half their prices at the beginning of the year. Global mining titans such as BHP Group Ltd. and Rio Tinto Ltd. also change hands for substantial discounts to their prices of a few months ago. At least for now, they offer dividend yields north of 6 per cent.

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If the coming years turn out to be just a little bit better than miserable, downtrodden resource shares like these could produce surprisingly strong results, according to Lucas White and Jeremy Grantham of GMO LLC, a money manager in Boston.

RESOURCE COMPANIES CAN WIN

WITHOUT RISING COMMODITY PRICES

Returns (real terms, log scale), 1926-2009

3.1% per year

1,000%

500

Energy/metals

companies

vs. S&P 500

-0.1% per year

0

Commodities*

-50

As of Dec. 31, 2009

*Represented by GMO Commodity Index, an index of 34 commodities

JOHN SOPINSKI/THE GLOBE AND MAIL, SOURCE: gmo

RESOURCE COMPANIES CAN WIN WITHOUT

RISING COMMODITY PRICES

Returns (real terms, log scale), 1926-2009

3.1% per year

1,000%

500

Energy/metals companies

vs. S&P 500

-0.1% per year

0

Commodities*

-50

As of Dec. 31, 2009

*Represented by GMO Commodity Index, an index of 34 commodities

JOHN SOPINSKI/THE GLOBE AND MAIL, SOURCE: gmo

RESOURCE COMPANIES CAN WIN WITHOUT

RISING COMMODITY PRICES

3.1% per year

Returns (real terms, log scale), 1926-2009

1,000%

500

Energy/metals companies

vs. S&P 500

-0.1% per year

0

Commodities*

-50

*Represented by GMO Commodity Index, an index of 34 commodities

JOHN SOPINSKI/THE GLOBE AND MAIL, SOURCE: gmo

As of Dec. 31, 2009

“Resource equities have gone from cheap to cheaper and now register at the cheapest levels ever recorded on some measures,” they write in a recent report entitled An Investment Only a Mother Could Love.

Mr. White and Mr. Grantham say right now is prime time for investing in despised miners and energy producers. Their case rests, in part, on the strongly cyclical nature of most resource industries, an up-and-down pattern that has played out with vicious intensity over the past 20 years.

Beginning around 2000, commodity producers enjoyed a burst of prosperity as China’s rapid industrialization sent prices for most raw materials soaring. Then came the payback: High prices inspired a massive wave of investment in new production and the increased output swamped the market after 2010. Commodity prices tumbled and resource stocks swooned.

These already cheap stocks have slid even lower in recent weeks because of pandemic-induced pessimism about global growth and fierce political battles over production cuts by major oil producing nations. Share prices have rebounded modestly in recent days, but they are still well below January levels.

The GMO authors gauge the resource sector’s fall from favour by using a valuation metric that combines price-to-earnings and price-to-book ratios as well as dividend yield. According to this all-in-one yardstick, energy and metals companies entered 2010 trading at about a 28 per cent valuation discount to the S&P 500, “not far from where they trade on average,” according to Mr. White and Mr. Grantham. Ten years later, at the end of 2019, the discount had jumped to 66 per cent. By the end of March, the discount had swelled even further, to nearly 80 per cent.

valuations are at historic lows

Valuation of metals/energy companies relative

to S&P 500, as of March 31

1.4

1.2

1.0

Avg.

0.8

0.6

0.4

0.2

0.0

1926

1944

1962

1980

1998

2016

Valuation metric is a combination of P/E (normalized historical

earnings), price-to-book value, and dividend yield.

JOHN SOPINSKI/THE GLOBE AND MAIL, SOURCE: gmo

valuations are at historic lows

Valuation of metals/energy companies relative

to S&P 500, as of March 31

1.4

1.2

1.0

Avg.

0.8

0.6

0.4

0.2

0.0

1926

1944

1962

1980

1998

2016

Valuation metric is a combination of P/E (normalized historical earnings),

price-to-book value, and dividend yield.

JOHN SOPINSKI/THE GLOBE AND MAIL, SOURCE: gmo

valuations are at historic lows

Valuation of metals/energy companies relative to S&P 500, as of March 31

1.4

1.2

1.0

Avg.

0.8

0.6

0.4

0.2

0.0

1926

1935

1944

1953

1962

1971

1980

1989

1998

2007

2016

Valuation metric is a combination of P/E (normalized historical earnings),

price-to-book value, and dividend yield.

JOHN SOPINSKI/THE GLOBE AND MAIL, SOURCE: gmo

This is stunningly cheap, according to the GMO duo. “Over the last 100 years, we have never seen resource companies trading at anything close to these levels relative to the broad market,” they write.

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The bargain-basement prices reflect many factors, including entirely reasonable doubts about the declining outlook for fossil fuels in a world challenged by global warming. However, the market has gone too far in marking down resource producers, according to the GMO duo.

Most traditional oil and gas producers have “significantly less than 15 years of reserves and no matter how quickly the world transitions to clean energy, we will need oil and natural gas for the foreseeable future,” they write. Investors will still have to be cautious, especially when it comes to investing in coal and oil sands producers, but they should not shun the sector entirely.

This is a striking declaration from Mr. Grantham – the “G” in GMO. He is a prominent advocate for strong action on climate change. But even he sees good reasons for investing in mining and energy stocks at today’s levels.

One reason is that resource companies don’t need rising prices to prosper. From 1926 to 2009, resource stocks delivered better returns than the S&P 500 despite commodity prices that declined in real terms, according to GMO.

Another reason is the sector’s growing emphasis on rewarding shareholders. In recent years, miners and energy producers have steadily boosted dividends.

To be sure, those payouts are vulnerable in the short term. Cenovus, Suncor Energy Inc. and Royal Dutch Shell PLC are among the energy producers that have cut or suspended dividends in recent days. But investors who hold diversified portfolios of resource shares should still do well, according to the GMO analysts. They figure commodity producers will deliver yields two to three times higher than the S&P 500.

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“While the short-term prospects are uncertain, we believe this will likely wind up being an excellent entry point for long-term investors,” they write.

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