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What are the chances of a topside break?

Lesley Beath  |  18 Dec 2012Text size  Decrease  Increase  |  

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The views expressed in this report are those of Lesley Beath and may differ from Morningstar's views.

 

Disclaimer: To the extent that any content in this report constitutes advice, it is general advice that has been prepared by Lesley Beath without taking into account the particular investment objectives, financial situation and particular needs of any individual investors. If necessary, you should consult with a licensed investment adviser or dealer in securities such as a stockbroker before making an investment decision. Opinions expressed herein are subject to change without notice and may differ or be contrary to the opinions or recommendations of Morningstar as a result of using different assumptions and criteria.


Overview

Last week was one for the resource stocks, with the ASX Materials index advancing by three per cent. The All Ords and the ASX 200 were up less than one per cent. I suggested in the last report that BHP Billiton (BHP) and Rio Tinto (RIO) were poised to break above strong resistance and they did just that. This came as the Chinese market shot ahead by four per cent, adding to similar gains the week prior.

Other resource focussed economies such as Chile, Argentina and Brazil also posted strong performances.

I have been expecting a shift in favour of the Australian resource stocks for the past few months but felt that we would not see a dramatic reversal until resistance in the ASX Materials index had been overcome. At this stage the index remains marginally below its October peak, but with BHP and Rio having broken topside, I expect a break in the index to follow. If we look at the relative-performance chart of the ASX Materials/All Ords we can see that a major low was registered in early September and that was followed by significant outperformance into the middle of the month. The ratio then pulled back sharply and has since traded in a relatively narrow range. The ratio remains below resistance at this stage but if we apply the same study to BHP and Rio, resistance has already been overcome.

I continue to believe that an overweighting in this sector is warranted. Even on an accumulation basis, the outlook is similar, but it should be noted that the Accumulation indices obviously do not reflect the benefit of franking credits.

As for the smaller resource stocks, I remain of the opinion that the ASX Small Resource index posted a significant low in late July and although the index pulled back sharply after the initial rebound from that low, there is sufficient evidence to suggest that risk over the medium term is to the upside. Some of the smaller energy stocks have posted significant gains in recent weeks and I expect that it may be time for some of the small gold stocks to follow in their footsteps. We looked at Whitehaven Coal (WHC) and Linc Energy (LNC) a couple of weeks ago and they have performed well. There is potential for more upside in Linc, but Whitehaven can pause in the near term.

In regard to the gold sector, it is interesting that gold and the US dollar have been moving in tandem for the past couple of weeks. So gold is not responding to weakness in the dollar. Gold may continue to frustrate in the near term but I remain of the view that the medium-term outlook is positive. As suggested last week, we can keep our eye on the gold/S&P 500 ratio in the near term to give some warning as to when gold may begin to accelerate to the upside.

Newcrest (NCM) was discussed last week and the support level noted; a break of that support opened risk of a test of the July lows at $20.89. The stock broke that support and risk remains to the downside. Newcrest has underperformed the ASX Gold index since early 2009 and there is nothing to suggest that a reversal is imminent. There are better opportunities elsewhere, with Regis Resources (RRL) one of the standouts in the sector. Others such as Silver Lake Resources (SLR) and Oceania Gold (OGC) are in close proximity to solid support and although they may not be ready to push strongly higher in the near term, downside risk should be limited.