Why Aggressive Investors Need to Revisit Basic Materials

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We’ve now arrived at a critical juncture in the investing road. Aggressive high-yield investors must now hold their noses and take the plunge into what has been forbidden territory during the past year: The basic materials sector.

This is the deepest of cyclical sectors and is made up of the companies that have some of the ugliest charts around. But if you like a Cinderella story, then this is the place for you.

Earnings season, which is now under way, always is ushered in by Alcoa (NYSE:AA), the global aluminum maker and Dow component. It missed earnings estimates by 1 cent but beat revenues estimates handily, and money poured into companies, such as AA, that are most leveraged to a global economic rebound. That’s where some of the biggest potential gains can be captured if the economy is really turning up and not just giving us another false start.

Not to be outdone, shares of potash fertilizer maker Mosaic (NYSE:MOS) pushed higher after cruising through earnings estimates last week. Institutional investors saw these reports as investment-worthy news — subsequently buying related companies and assets that also could surprise to the upside on earnings.

Is this a trend? There’s no way to tell yet, but the early indications are quite positive. Let’s take a look …

For starters, optimism is growing that China will orchestrate a soft landing from its torrid growth rate of 10%-plus, to a more sustainable 8% GDP in 2012. Also, Chinese interest rates and incentives for lending by banks are easing, just in time for a pivotal election year for the communist party.

That tight-fisted government needs to add this splash of capitalism to remain in power while seeking the perfect balance of growth and inflationary pressures within the world’s largest emerging market.

So far, it looks like the Chinese Finance Ministry will pull it off. The government has no debt, $3.2 trillion in cash and $6 trillion of OPM (that’s “other people’s money,” as in U.S. Treasuries) to stimulate the economy and secure currency leverage at the first whiff of trouble.

The bottom line: China has the ball and can do what it wants with whomever it wants at this point.

But you’re probably wondering what China has to do with any of this. Well, I’ll tell you …

Infrastructure Is Under Way

During the past year-and-a-half, as China put the brakes on the threat of inflation, many critics said the infrastructure expansion that has defined China’s economic boom would come to a crashing halt. As such, we saw sectors like steel, concrete and building materials undergo big pullbacks. In that space of time, inventories were depleted until there was evidence the commercial building cycle was healthy again.

The latest data from China lends credence to the case that a soft landing is in the making and that a re-acceleration of large-scale infrastructure projects will be under way in 2012.

In addition, any new jobs creation bills forwarded during this election year or passed by Congress will likely involve large-scale multibillion-dollar transportation projects that consume vast amounts of steel. I like the whole trend that is setting up for iron ore demand and can see this cycle carrying well into 2014.

What we can glean from this rant is that many of the stocks listed in the iShares Dow Jones US Basic Materials (NYSE:IYM) ETF — the most widely traded exchange-traded fund in basic materials — are making key upside technical reversals on rising volume. Just as the financials are acting better on no real good news (yet), so is the tape action for the basic materials stocks. I don’t want to be in denial of what has the definite look and feel of the start of, what could be, a game-changing rally in this battered sector — which was -14% in 2011.

If you pull the charts of the top 10 holdings of the IYM fund, you’ll find one stock after another breaking out to the upside on no news. But institutional money flow has clearly sensed this is where capital is best served based on valuation, low earnings expectations and bearish sentiment voiced by the perma-bears and doomsayers who are predicting the end of America as we know it.

I don’t disagree with the bearish position on a crumbling value of the U.S. dollar. In fact, last week, our national debt reached 100% of our $15 trillion annual GDP. To put it in perspective, Greece’s debt is 140% of GDP. So, even if the dollar is headed toward further devaluation, adding hard assets and commodities to one’s portfolio may prove a viable means by which to offset any negative effects.


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In the chart to your right we can see a clearly defined reverse head-and-shoulders pattern that has formed, with a recent series of higher lows being added in with each pullback. Technical analysis is only as good as the strength of the underlying broader tape, and with the S&P now trading back above its 200-day moving average, we’re seeing new-found confidence in those sectors that are highly leveraged to the economy at a time when the Fed hasn’t declared a new round of quantitative easing.

This very salient observation is giving fund mangers the “green light” to take on risk in a sector that has about as good a chance of posting better-than-expected earnings as throwing money on either black or red in Vegas. Like I said, if this is the real deal for basic materials, then this is only the top of the first inning, and the play could easily sputter out. But my gut feeling, which has developed during the past 27 years of trading, is telling me to get involved and let the chips fall where they may in the months ahead. If I’m right, the upside will be huge. If I’m wrong, it’s OK because the downside is minimal.


Article printed from InvestorPlace Media, https://investorplace.com/2012/01/why-aggressive-investors-need-to-revisit-basic-materials-aa-mos-iym/.

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