Stocks for a Commodity Boom

05/28/2004 12:00 am EST

Focus:

Elliott Gue

Editor and Publisher, Energy and Income Advisor and Capitalist Times

"Commodities are in a long-term secular cycle that should be with us for a decade or more," says Elliott Gue, editor of Wall Street Winners and Trading Floor Pro. Here, he explains the role of Asia in this commodity boom, and his favorite stocks to play this trend.

"Few remember that while stocks roughly marched in place for most of the late 60's and all of the 70's, commodities boomed. Conversely, from 1982 until 2000 stocks boomed and commodities slipped. That cycle is changing again and commodities will be the big beneficiary in the decade ahead. Furthermore, since the global economy is still trying to get its bearings in a post-bubble era, real assets should perform extremely well. There's no doubt that Asia is the region with the greatest long-term growth potential, with China and India being the two main drivers. And many of their smaller neighbors are set to follow. What's more, these economies are far from their saturation points, so commodity consumption will stay strong for years to come. China and India are both large countries with enormous populations. Short-term profit taking and volatility notwithstanding, commodities should reward the patient investor handsomely.

"As these countries become wealthier, there will be important changes to the world economy. Basic infrastructure like roads, housing, telecom, and electric networks need to be built. After all, manufacturing activity simply stops if there aren't roads and a reliable electric supply to service the factories and transport the workers. On the consumption side, per capita income in urban households is already up about 55 percent since mid-99; an increasingly wealthy middle class in China will demand more consumer goods, and access to modern electric networks, housing, and waterworks. And the size and population of China and India suggest that this consumer boom will be the largest and longest lasting the world has ever seen. This all spells a boom in demand for basic commodity products. Already China and India are hungrily importing the world's excess supplies of most commodity products. Supplies are already thin for basic materials like copper, iron ore and even food products-prices are rapidly rising.

"China simply doesn't have a large enough domestic supply of aluminum, copper, or iron to satisfy booming demand. To keep the economy humming, these goods have to be imported from abroad. Take copper as an example, which has uses in construction, telecom networks, and even pipes to carry water. The offshoot of all of this is higher copper prices. Copper prices were up on the order of 40% in 2003 alone. And it's not just copper prices that are moving rapidly higher. China's huge population needs to eat and as the population gets richer they'll be needing more and more basic foodstuffs. Imports of food products like soybeans and corn are rapidly rising as are prices for these basic commodities. The growing demand coupled with low supply has resulted in prices skyrocketing to levels unseen for about a decade. With imports rising quickly over the past couple of years to China and exports from major agricultural producers like Brazil getting stretched, commodity prices have only one way to go.

"With mining operations covering every imaginable base, and with reserves spread across the globe, London-based Rio Tinto (RTP NYSE) is a mining powerhouse. Rio's operations are divided into six major segments: iron ore, copper, aluminum, energy, industrial minerals, and precious metals. Iron ore and copper are the two largest segments, accounting for more than 40 percent of total revenues. The company owns five of Australia's largest iron ore mines and holds minority interests in several more. In copper, Rio holds large mining and copper smelting operations in the US, Europe, South America, and Africa. Clearly copper is one of the commodities in tightest supply worldwide and prices have been steadily rising for months. Rio Tinto's reserves of copper and copper processing plants are looking more valuable by the day. Rio's diversification among different commodities is a real boon; the company isn't totally leveraged to continue price gains in any single commodity. And with particularly strong operations in Australia, Rio is strategically located near its largest growth markets across Asia. With a dividend of over 2.4%, RTP is a buy under 110.

"And while most investors fret over missing out on all the upside in the Nasdaq, the powerful bull market in Phelps Dodge (PD NYSE), one of America's oldest companies, has been largely ignored. The stock was up close to 100% in 2003. Phelps is currently the world's second-largest copper producer (over 65% of its annual sales), much more if you count Phelps' sales of copper wire. The company fell on hard times in the '90s as copper prices fell. But steps were made to reduce costs and reduce debt by laying off workers and cutting production. This restructuring makes Phelps a stronger competitor today and positions the company well to enjoy a more benign period of rising copper prices. Phelps looks like a solid buy at current levels but be prepared to weather the inevitable dip-large companies like Phelps rarely rally 100% without at least a brief correction. Buy Phelps under 72 and use dips to add to your position.

"Aluminum is often an overlooked commodity. But it's at the heart of a variety of industrial and consumer products. Specifically, aluminum is lightweight and strong so it's used in airplane and building construction. And on the more mundane side aluminum cans used to package beverages are an obvious growth market in China where sales of consumer products like Coca-Cola are rapidly on the rise. Aluminum Corporation of China (ACH NYSE) is a great play on Chinese demand for the metal. After recently reporting 11% growth in aluminum sales for the third quarter, the company raised its guidance on prices for the rest of the year. The stock has already run up a good deal in anticipation of higher aluminum prices but there's more room to go. Don't be surprised to see the stock pull back on the order of 15% in the context of its long-term uptrend. The best strategy is to accumulate the stock using several purchases over time and using 5 to 10 percent corrections as an opportunity to buy more. For now, buy China Aluminum under 75, using dips to get more aggressive.

"China will also have to continue buying agricultural products from the US and South America. Bunge (BG NYSE) the world's largest processor of soybeans stands to benefit. Already, the company's exports of soybean products to China are booming, totalling around 4 million metric tons in 2003 alone. Of course, rising commodity prices coupled with rising shipping costs (freight costs more than doubled in 2003) have increased the company's costs but to date much of that increase has been passed on to the customers. Buy Bunge under 33.

"Finally, Argentina-based Cresud (CRESY NASDAQ) has also seen a pick-up in demand. Cresud is Argentina's largest producer of all types of agricultural products from grains to meats. All of these products are in high demand and have seen rapidly rising prices since late 2002. That makes the company's 80,000 head of cattle and 440,000 acres of arable land an increasingly valuable commodity. Meat, in particular, is in short supply. As Asians become richer they're to follow the same path of consumption as other industrialized nations, switching consumption of vegetables and grains for meat. Add to that the latest fad for high protein, low carbohydrate diets in the US and you have a recipe for rapidly rising demand for meat products. Also in Cresud's favor is the improving economic situation in Argentina. After the country defaulted on its massive foreign debts and devalued the peso, property values collapsed. That made the value of Cresud's primary asset, land, fall off a cliff. But more recently, the company reports a firming up of land prices making it's real estate assets more valuable again. Buy Cresud under 15."

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