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Metals And Miners Dig Up Ideal Conditions

Posted: Apr 01, 2009 11:40 AM by James Brumley

Tickers in this Article: PZG, NRP, BHP, CLF, TCK, FCX

It's not hard to find a rising stock in a bull market. Finding a winner, however, requires a combination of positive forces. Think of it as the planets aligning in just the right way at the right time, it's that rare. Well, I think the proverbial planets are lining up for some of the metal and mining stocks.

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Take the Good with the Bad
We all know that the global recession hurt demand for materials. Whether it was lumber, metal, chemicals or minerals, we just needed less in 2008. In that regard, it may have made sense for investors to shed metal and metal mining stocks like Teck Cominco Ltd. (NYSE:TCK), Freeport McMoRan (NYSE:FCX) and Cliffs Natural Resources (NYSE:CLF).

However, the 83% decline in the Dow Jones Non-Ferrous Metal Index between May of last year and November's bottom may have overstated that weakened demand. After all, consumer and capital spending were only wounded, not killed. The rationale made sense, but investors took it too far. (What people buy and where they shop can provide valuable information about the economy, see Using Consumer Spending As A Market Indicator.)

This in itself presents a buying opportunity. That opportunity is augmented, however, by the likely economic recovery.

Eventual Economic Recovery
Yes, I'm one of the minority that feels the worst is behind us. Though I still see plenty of challenges ahead, I'd rather be early to the party than late.

There have been some glimmers of hope for the economy as of late. Durable goods orders were up 3.4% last month, and new home sales increased from 322,000 in January to 337,000 in February. Both were better than expected, as economists were looking for a 2% decline in durable goods orders and new homes sales were forecasted to total 300,000. (Learn more in Economic Indicators: Durable Goods Report.)

Though neither the economy nor the market is going to turn around instantaneously, as we phase into a recovery, stocks will respond accordingly. It just so happens that metal and miners are expected to be some of the early beneficiaries of a recovery.

Hints of such rejuvenation come in the form of China's record-level importation of copper in February (at 329 thousand tons), and a handful of companies that managed to raise funds recently. Paramount Gold & Silver (AMEX:PZG) raised $9 million in an equity financing, while Natural Resource Partners LP (NYSE:NRP) raised $200 million through what was mostly debt financing.

Not that these higher level - probably institutional - investors aren't capable of throwing away good money. But, in this environment, to raise that kind of money is likely to be an indication of a well-calculated risk from the investors' perspective. That's not the only reason I really like metal and mining stocks as long-term ideas right now. There's an even bigger, better reason.

Inflation Not Necessarily an Enemy
You probably know as well as I do that the U.S. government is between a rock and a hard place. Interest rates are at rock-bottom levels right now - the effective fe d funds rate is hovering just under 0.2%. Yet, to raise rates at this fragile time would probably doom what little economic stability we're trying to build upon. At the same time, the Fed is injecting up to $1 trillion worth of cash into the economy, and more may be on the way. One of these conditions alone can lead to inflation, but with each of them fueling the other, inflation could surge more than any of us might imagine. Will inflation reach crippling levels? Probably not, but it will be more than a minor nuisance.

There is, however, one industry that will benefit from inflation, and that's basic materials and commodity companies, and the corporations that mine them. It widens their margins, which is why I think we're on the verge of an explosive, multi-year increase in commodity prices on top of the impending economic recovery.

Bottom line
Though the economy isn't going to turn around immediately, the possibility of inflation and the previous overreaction of investors has made things look pretty promising for metal and mining companies. It looks like the beginning of the perfect storm for the likes of Freeport McMoRan, Cliffs Natural Resources, BHP Billiton Ltd. (NYSE:BHP), and most other metal mining stocks. (For more read Sector Rotation: The Essentials.)

By James Brumley

James Brumley is a freelance writer and registered investment advisor. He began his career as a broker with a major Wall Street firm, where fundamentals and long-term holding periods were core strategies. After that, he switched gears completely, becoming an analyst at a short-term trading newsletter that focused on technical analysis. He now manages client money using the best of both philosophies. His company, Bluegrass Portfolio Management, offers investors an opportunity to reap superior returns with minimized risk.

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