McElroy’s Certainty Principle

  • You’ll never get rich from quantum
    physics
  • My principle lets you hold on to your
    money
  • An iron-clad certainty

Whereas the
scientist Dr. Werner Heisenberg is famous for his Uncertainty Principle of
quantum physics, I’m somewhat less notorious for my Certainty Principle of
investing. But I have one thing going for me: my principle is a lot more
likely to help you and me make some money. I won’t win any Nobel Prizes, but
I might be able to retire a decade earlier.

I bring up quantum physics, because much of that field is
based on the idea that you can’t know everything all at once. Making
meaningful observations about a given particle entails giving up knowledge of
either its position or its velocity/direction – both of which are important
for any physics problem.

In the investment world – unlike quantum physics, we can
know with a great deal of certainty the position and direction of a
company.

Because investing is different than quantum physics,
thankfully.

We can know the direction and position of a publicly traded
company because these companies are required to accurately report these facts
in quarterly and annual reports.

And whereas your guess is as good as mine about where all
the photons are in a hurry to, it’s much, much easier to see that some
companies just aren’t going anywhere.

For the bulk of your portfolio, you should
be seeking these types of companies. Sure, you’re not likely to double your
money very quickly with my “Certainty Principle” companies, but in a volatile
bear market, having your money stay put is a true triumph.

I was reminded of my certainty principle while reading a
recent
Wall Street Journal
article about “uncertainties” related to Australian
mining giant Rio Tinto (NYSE: RTP).

This $23 billion market cap company mines just about
everything you can think of: aluminum; copper, gold, molybdenum, silver, and
nickel; diamonds; industrial minerals, such as borates, titanium dioxide
feedstocks, talc, salt, metal powders, zircon, and rutile; thermal and coking
coal, and uranium; and iron ore.

I’m probably missing a few – but you get the idea.

Right now this company is in the midst of a nasty new
potential 40% Australian mining tax, which could certainly hurt their bottom
line.

The stock is down on this news, as well as news that their
iron ore production fell 2% year over year.

But Rio Tinto is one of the world’s largest iron ore
producers. Much of that iron ore is shipped to China – in addition to the
necessary coal and coking coal needed to make steel. So a bet on Rio Tinto is
a bet that China will continue to build skyscrapers to match their ~8% annual
growth projections.

The world uses
between 950 and 1300 billion metric tons of iron every year – it’s the most
commonly used industrial metal – but it’s also the cheapest.

That means that only huge international mining corporations
have the scale to make a profitable go of iron ore production. They squeeze
everyone else out of the marketplace by their sheer volume. If the Australian
40% tax on mining does manage to stick, it will certainly hurt Rio Tinto’s
share price in the short term – but for the long term it will just act as
another barrier to entry for smaller companies in the field. They’ll still
continue to get iron ore out of the ground and sell it to the Chinese for a
~12% profit margin.

And right now Rio Tinto is extraordinarily cheap. The stock
sells for less than five times trailing earnings and at $47.50 per share, it
hasn’t been cheaper all year.

If you like the “certainty” that the world will continue to
use billions of metric tons of iron, and that China will continue its growth,
and that Rio Tinto will continue to be one of the sole providers of iron
ore…then you should own this stock.

I’d suggest buying it under its 200 day simple moving
average of about $51, collect the 1.8% dividend and hold until the
certainties change.

Good investing,

Kevin McElroy

Editor

Resource Prospector

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