One of the oldest market adages regarding the start of a new bull market is that the old leadership is rarely, if ever, the new leadership. Meaning the sectors that led the last bull run aren't likely to be atop the leaderboard in the new bull market. Well if the current market rally is really the start of a new bull market then it might be time to dispense with old market adages because there are some familiar faces leading the market's move higher: materials stocks. Commodities stocks or cyclicals, call them whatever you want, but the fact is this old guard is looking mighty bullish lately.
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Stunning was the rise to prominence for cyclicals and commodities stocks through the latter half of 2007 and into early 2008, but nearly as startling were the ferocious declines that these stocks endured when the commodities bubble popped and the market went south in the second half of 2008. So scorned were a large amount of investors that many may have a hard time believing that cyclical stocks are back in play, and perhaps back in a big way.
By their very definition, cyclical stocks are risky bets. They perform well when the economy is humming along and demand is robust for their products. The other side of the coin is that when the economy tumbles, so do these stocks, and in a big way.
Let's take a look at a few former materials darlings to see if they will rise to prominence once again.
Is Copper King Again?
Copper prices, which are intimately tied to emerging market demand, particularly from China, and from home builders and electrical component manufacturers, have been on a tear for while now. They started to rebound in January and copper futures are up more than 50% this year. Copper for September delivery closed at $2.47 a pound on July 20, a nine-month high.
That could mean a blowout quarter is in store for Freeport McMoRan, the world's largest copper producer, when it reports second-quarter earnings on July 21. The tale of Freeport's stock is like a tale of three cities. The first being the run up to $125 in mid-2008, then the precipitous plunge to $15.70 in December, but had you bought the stock then, you would've given yourself quite a Christmas present. Freeport shares now go for $57 and have traded as high as $61.55 this year.
While an uptick in demand from China should buoy Freeport's shares, the stock is still hampered by weak demand from the housing sector. That said, Freeport is still one of the best ways to play a commodities rebound.
More Fertilizer Drama
The fertilizer sector has certainly provided investors with some compelling mergers and acquisitions drama this year and Mosaic, the second largest maker of potash fertilizer, is the latest name to be mentioned in takeover talks. Brazilian iron ore giant Vale (NYSE: VALE) is rumored to be interested in acquiring Mosaic for $25 billion, but Vale has denied those rumors.
Mosaic's shares have had even more dizzying run than Freeport's as the bursting of the commodities bubble was big trouble for potash prices. After touching $162.54 in mid-2008, Mosaic plunged all the way to $21.94, but the stock has more than doubled since then.
Trading at about 12 times forward earnings, Mosaic is still reasonably priced and if the takeover scuttlebutt persists, that should lead the shares even higher.
Strong As Steel?
Steel is yet another raw material that saw its fortunes get tossed around during the market collapse of 2008, and, like copper, steel's demand story is intimately tied to China. If China's buildup of commodities is coming to end as some market observers are speculating, that could hurt steel exporters like Companhia Siderurgica of Brazil.
Siderurgica shares have nearly quadrupled since December, as Brazilian shares have again gained the market's attention. That's a nice run, but it can't hide the fact that as of the end of 2008, Siderurgica had $6.23 billion and negative free cash flow. With a balance sheet like that, Siderurgica falls into the speculative category at this point, but it is not an expensive stock, trading at just 13 times forward earnings. (Learn about the components of the statement of financial position and how they relate to each other in our article Reading The Balance Sheet.)
Bottom Line: Cyclicals Are Back ... Maybe
The recent market rally aside, the economy still has a long way to go to be considered out of the woods. Likewise, the stocks mentioned here have a long way to go see their previous lofty levels. Keep in mind that Freeport would have to more than double to see its 2008 high and Mosaic would have to more than triple from here to do the same. It's hard to see that happening in the short-term, but Freeport appears to be the best of the stocks we highlighted here. (For a related reading on commodities, check out Commodity Funds 101.)
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