Financial commentators are agreed that one of the most important factors underpinning the bull market has been the persistently good news on inflation. After many years of economic growth in the US inflation was expected to rear its ugly head. It hasn't happened and as a consequence interest rates and bond yields have continued to decline. This has encouraged investors throughout the world to seek out more attractive investment opportunities in equity markets.
Whilst most sectors of the equity market have benefited from the boom in share prices there is one notable exception. Companies involved in resource-based businesses such as oil companies and mineral extraction companies have seen sharp falls in their shares prices. In the Irish market the high risk oil exploration companies such as Tullow and Dana have seen modest share price declines. The two Irish companies involved in zinc production Arcon and Ivernia West have seen very sharp falls in their share prices so far this year, reflecting weakness in the zinc price.
Of course, this underperformance from resource stocks is the flipside of the good news on inflation. An important factor in the disinflationary environment is weakness in commodity prices, including the all important oil price. In general, the supply of most commodities has remained plentiful throughout the economic upswing, thus keeping a lid on any price rises. However, the Asian crisis of the past year has sharply reduced the demand for many commodities. With the Asian crisis likely to get worse before it gets better an early bounce in commodity prices is very unlikely. However, once the situation eventually stabilises there could well be bargains available in resource-based stocks.
Resource-based stocks quoted on the Irish stock exchange tend to be relatively small and narrowly focused. Although some Irish companies have broadened their base of activities they are still only suitable for the more speculative portfolios.
However, the British market contains some quite large companies involved in extractive industries. Although investment in these companies would involve relatively high risk they offer a potentially attractive route of gaining exposure to the resource-based sector.
The table, above, provides some information on three of these companies Rio-Tinto, Billiton and English China Clays. Rio Tinto is the largest by far of these companies and is capitalised at more than £7.5 billion sterling. The smallest English China Clays has a respectable market capitalisation of more than £700 million.
A striking feature of these shares is the fact that all are offering very high dividend yields. In an environment when the historically high yielding financial shares are now offering dividend yields only in the 2-3 per cent range, the 5.7 per cent yield offered by English China Clays is certainly very tempting.
Of course a high dividend yield is only attractive if the company can generate sufficient earnings to pay and grow it. In the case of all three companies the dividend is comfortably covered by earnings. In the case of Billiton earnings are over twice the amount paid in dividends. Dividend cover is somewhat less in the case of Rio Tinto and English China Clays with dividend cover at a ratio of 1.6.
The activities of these companies cover a wide range of mineral extraction and refining activity. The largest of the three companies Rio Tinto is involved in the mining and production of a range of commodities including copper, gold and aluminium.
These companies' balance sheets are in good shape with debt as a proportion of equity being under 50 per cent in all three cases.
Investment in resource-based companies is not for the faint-hearted but can offer the more adventurous investor potentially attractive returns. Compared to their Irish counterparts, the quoted British stocks offer exposure to the commodity cycle whilst at the same time providing the cushion of relatively high dividend yields.
