Masters Series: How to Master the Booms and Busts of the Resource Sector

Editor's note: Natural resources can be one of the most lucrative areas of the market.

 

That might sound crazy right now. Commodity prices have been falling for weeks. But as you'll learn in Stansberry Research's new book Secrets of the Natural Resource Market, this sector is highly cyclical.

 

As S&A Resource Report editor Matt Badiali shows in today's edition of our weekend Masters Series – excerpted from Secrets – the sector goes through big booms and busts.

 

When it booms, you can make triple-digit gains. (Five out of 10 of Stansberry Research's "Hall of Fame" recommendations have come from the natural resource sector.)

 

When these stocks turn up again, you'll want to be ready to collect huge returns in mining, energy, and agriculture.

 

If you understand these investments – and several other useful concepts contained in this guide – you can profitably trade the natural resource sector for the rest of your life. Read on to learn how to master this volatile sector…

 

How to Master the Booms and Busts of the Resource Sector

By Matt Badiali, editor, S&A Resource Report

 

One aspect of the resource business is so important that if you don't thoroughly understand it, nothing else you do right can possibly help you.

 

You will lose every cent you put here.

 

Insiders call this aspect "cyclicality." Cyclicality might sound like industry-speak, but it's actually a simple concept... A cyclical asset is one that booms and busts like crazy.

 

One year, it will skyrocket 200%... The next year, it will plunge 50%. After plunging, it might drift sideways for a year, and then rise 300%.

 

Contrast this to a "noncyclical" asset, like shares of Johnson & Johnson (JNJ)...

 

JNJ is the world's largest health care and consumer-products company. It sells everyday items like Listerine, Tylenol, and Band-Aids. Demand for these products is relatively constant. Even recessions do little to dent mouthwash sales. This makes JNJ shares relatively noncyclical. They don't go through wild booms and busts.

 

Natural resources, however, do go through wild booms and busts. Consider the case of uranium from 2000 to 2008...

 

Uranium is a natural resource whose chief use is fueling nuclear-power reactors. For much of the 1990s, uranium prices were mired in a bear market. Excess supplies from the previous years had depressed prices.

 

Low prices meant no one was investing in new uranium deposits. There simply wasn't any money in it.

 

In 2003, for example, it cost miners $20 per pound to mine uranium, but they were selling it for $15 per pound. Miners were losing about $5 on every pound of uranium they produced. Mines closed, and no new ones opened.

 

It was grim – a classic "bust."

 

Then... after years of bust... we started seeing increased demand for the cheap fuel. But the lack of investment in new uranium projects meant supply was limited. Increased demand and low supply pushed uranium prices higher and higher.

 

As you can see from the chart below, prices quadrupled in about three years...

 

 

In response to this new uranium boom, exploration companies went wild. The table below shows uranium exploration spending in Canada (a major uranium-producing country). You can see how fast the industry increased spending...

 

 

That's an incredible 5,484% increase in uranium-exploration investment in just four years. This shows you that when a commodity goes into a "boom" cycle, it attracts huge amounts of money. Uranium climbed from $10 per pound in 2002 to nearly $140 per pound five years later.

 

You can imagine what that kind of rise does to the share price of companies in the sector...

 

Consider junior uranium explorer Mega Uranium (MGA). Its ride from 2003 to 2007 was spectacular. Shares went from $0.04 each in September 2003 to $7.41 in April 2007. That's an amazing 18,425% return...

 

 

Now remember... every "boom" eventually turns into a "bust."

 

In any given resource sector, the cure for high prices is high prices.

 

When huge amounts of money flow into a sector, it creates tons of new companies, bloated values, increased supplies, and eventually, plunging prices.

 

Hundreds of new uranium-exploration companies were created from 2004 to 2007 to capitalize on the new uranium boom... many with no real assets or even a hope of becoming a real company.

 

As you can see from the updated chart of uranium, the boom turned into a bust. Uranium prices collapsed from nearly $140 per pound to $40 per pound...

 

 

Most uranium stocks lost more than 90% of their value. Shares of Mega Uranium peaked at $7.41 in April 2007 and had fallen to $0.37 by June 2010. That's a 95% decline in three years...

 

 

Investors lost $0.95 of every $1 they invested if they followed the crowd, bought at the top, and didn't cut their losses.

 

It's not just uranium. These cycles happen all the time in natural resources. Oil, natural gas, nickel, copper, platinum... you name it. Commodities boom and bust like crazy.

 

When "bust" periods of excess supply depress prices, people find new uses for the cheap resource. At the same time, producers of that resource can't make much money, so they stop investing in new projects to bring on supplies.

 

This "increased demand, decreased supply" situation creates a crunch that drives prices up by hundreds of percent... and causes incredible stock gains in the companies that focus on that resource.

 

Then, after prices rise, increased supplies come online... Producers of that resource invest heavily in new projects to cash in on the "boom" times.

 

Meanwhile, users of the now-expensive resource look for alternatives. This decreases demand.

 

The "decreased demand, increased supply" situation can crush the price of the commodity... and send the share prices of stocks that focus on that resource down more than 90%.

 

All commodities are highly cyclical. And while these big cycles chew up most crowd-following investors, you can use them to make incredible profits in mining, agriculture, and energy stocks.

 

You simply get into booms early and avoid the big busts.

 

My friend Rick Rule is one of the greatest resource investors in the world. He has made himself and his clients hundreds of millions of dollars with his ability to spot great values, get into big resource trends early, and avoid big resource busts.

 

He coined the phrase, "You're either a contrarian or a victim."

 

Rick's phrase captures everything you need to know about resource trends. To make huge gains, you have to buy assets when nobody wants them – like uranium stocks in the late 1990s. This is when assets get very cheap.

 

Going against the crowd in these situations will give you a sick feeling in your gut.

 

But that's a sign that you're probably doing the right thing.

 

When the crowd wakes up to the boom times that follow the bust, they'll bid up your shares to incredible heights. That's when you – the contrarian – sell out to the unfortunate victim.

 

That's the way to make big money in resources. It has been the case for hundreds of years... and it will be the case for hundreds more.

 

 

Editor's note: Secrets of the Natural Resource Market is one of the most comprehensive guides to resource investing Stansberry Research has ever published. In it, resource-investing experts like Matt Badiali, Rick Rule, and Brian Hunt teach you the essential toolkit you'll need to make big, safe returns for decades… how to make commodity investing nearly risk-free… and much more.

 

Whether you're just starting out in resources or looking for ways to reduce your risk while increasing your profits... this is a must-have guide. Click here for details on how to claim your copy today.