If you’re investing in resource stocks, the best time to buy is usually not when commodity prices are at their strongest and everyone is excited about mining. The better opportunity tends to show up when a commodity has gone through a significant downturn, the market has turned pessimistic, but the underlying companies remain financially strong and the commodity is starting to stabilise.

That’s because resource stocks are cyclical by nature. Profits can rise enormously when commodity prices rise, and fall just as dramatically when prices fall.

The cycle works like this: a commodity boom pushes mining profits up, which pushes share prices up, which makes investors optimistic. Companies respond by investing more, supply increases, and eventually the commodity price falls. That drags profits down, share prices down, and investor sentiment turns pessimistic. Supply gets cut, the commodity stabilises, a recovery begins, and eventually a new boom takes shape.

The ideal situation is a good company in a bad commodity environment

This is probably the most important principle. Picture a mining company with a strong balance sheet, relatively low production costs, high-quality assets, a commodity with reasonable long-term demand, solid cash generation, manageable debt, and experienced management. Now imagine the commodity price falls 30%. Profits fall, the share price falls 40%, and the headlines turn negative. Investors start saying mining stocks are finished.

That’s often exactly when things get interesting — because the company may still be fundamentally sound underneath all that pessimism. If the commodity eventually stabilises, profits can recover considerably, and the share price often recovers well before earnings actually climb back to their previous highs.

The most attractive stage is usually early recovery

You can roughly split the resource cycle into three stages. In the downturn stage, commodity prices are falling, companies are cutting costs, analysts are slashing earnings forecasts, and investors are pessimistic — share prices fall and risk is very high, but that’s also when genuinely attractive valuations can appear.

Then comes stabilisation and early recovery: prices stop falling, supply starts tightening, demand improves, and the company stays profitable with costs under control. Analysts begin nudging forecasts back up, even though investor sentiment is still fairly negative. This stage is often the sweet spot — the fundamentals are turning before the crowd notices. This is where believe we are right now in the cycle.

Finally there’s the boom stage, where commodity prices are high, companies are reporting record profits, investors are enthusiastic, share prices have already risen substantially, and the media won’t stop talking about it. Companies start announcing expansions and acquisitions. Returns can still be good here, but the risk of buying near the top is much higher.

Look at production costs

This is one of the most important things to understand about miners. Imagine two gold companies: Company A produces gold at $1,500 an ounce, while Company B’s cost is $2,200 an ounce. With gold at $2,500, Company A is sitting on a comfortable $1,000 margin, while Company B only has $300 to work with. Now if gold falls to $2,000, Company A still holds onto roughly a $500 margin, while Company B is suddenly in serious trouble. This is exactly why low-cost producers tend to hold up so much better during downturns — and the same logic applies just as much to iron ore, copper, lithium, and coal as it does to gold.

Look at the balance sheet

A company can own a fantastic mine and still turn out to be a terrible investment, simply because mining is so capital intensive. Building mines, maintaining equipment, expanding production, funding exploration, developing infrastructure, repaying debt, and handling unexpected problems all cost real money. If commodity prices collapse while a company is carrying heavy debt, it may be forced to raise capital at a rock-bottom share price — and that can badly dilute existing shareholders. So before buying in, it’s worth asking how much cash and debt the company actually has, whether it generates free cash flow, how much capital expenditure lies ahead, whether it’s likely to need to issue new shares, and whether it could realistically survive several years of low commodity prices.

Watch the commodity, not just the company

You shouldn’t assume a stock is a bargain just because it’s fallen 30% — you need to understand why it fell. If iron ore is weak because Chinese steel demand has softened temporarily while supply is actually tightening, that could turn into a real opportunity. But if it’s falling because of a structural surge in supply alongside permanently deteriorating demand, that’s a far tougher investment case.

Look at supply and demand

Prices are ultimately driven by the balance between the two. If copper demand is growing 5% a year while mine supply only grows 2%, the market tightens over time and that tends to support higher prices. But if companies are rushing to build new mines and supply is set to grow 8% against demand growth of just 3%, that points toward oversupply and downward pressure on prices. So the real question worth asking before buying a resource stock isn’t what the commodity did last week — it’s what the supply and demand picture looks like over the next three to five years.

Lauren Hua is a private client adviser at Fairmont Equities.

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