The basic difference between exposure to a commodity or to a commodity stock is simple. Buying into an LME or MCX contract entitles you to a tonne or a certain amount of the commodity at a pre-determined price. Factors that influence the price include shocks on the demand-supply front and cost of production.
Buying one share of Hindustan Zinc, NMDC or any other commodity firm entitles you to the profits that company earns from selling ore. In addition, you get a share of the company's reserves, cash, machinery and other assets.
The variables that affect a stock price include the price of the commodity the company sells (this impacts earnings), demand outlook, volumes (and expansion plans), regulatory environment and competition.
What works for investors is simple: Several Indian miners are among the lowest-cost producers of their commodity. Being in this group leaves them with ample breathing space when the going gets tough in the commodity space. Not to mention they are immensely profitable and generate large amounts of free cash-flow.
Buying during corrections
They also have substantial reserves and cater to growing domestic markets. A correction which hammers the price could serve as a great opportunity to buy into such players for cheap.
In the Indian scenario, investors who picked up NALCO, Hindustan Zinc, Sesa Goa or NMDC in 2005 and did nothing for the next six years fared far better then those who held the underlying metals.
However the two steel producers have not fared quite as well under-performing steel billet prices over that duration.
While it can be difficult for resource firms to shield against a correction in realisations or higher cost of doing business, there are traits which make certain players relatively better bets than others. Miners with low debt and low operating costs make for especially compelling investment bets. NMDC and Hindustan Zinc are two such players.
They have high-quality assets and industry-high operating margins. Their strong balance-sheets reflect oodles of cash and they continue to accumulate more (though the government has tied their hands on using it). Over the next two-three years, the demand-supply equation for both iron ore and zinc look relatively rosy.
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