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Have Commodities Become the New Tech Stocks?


Published: February 5, 2006

RETURNING to basics has been a major theme in the markets. If investors in the late 1990's took a bold leap into the future with technology stocks — off a high ledge, as it turned out — they are now embracing age-old economic mainstays like copper, lumber, oil and gold.

Prices for metals such as aluminum, above, are recovering from a slide in the 1990's, which had led companies like Alcoa and Reynolds to merge to improve their finances.

A widely followed benchmark of commodity prices, the Commodity Research Bureau index, reached a record high recently after nearly doubling since late 2001. Shares of companies that supply these materials — gas pipeline operators, miners of industrial and precious metals, forest products concerns — have followed a similar trajectory, but some analysts contend that prices have risen too far, too fast.

"There are probably some areas that offer better prospects" for investors "because commodity price expectations are very high," said Stuart Schweitzer, global markets strategist at J. P. Morgan Asset Management. "I would be surprised if the commodity-type stocks are a top-performing group in 2006."

Commodities, especially industrial ones like copper and lumber, are a bet on economic growth. Mr. Schweitzer expects continued strength in Asian and other emerging markets — a trend that has underpinned commodity prices — but he expects growth elsewhere, especially in the United States, to be more subdued than it was in the last couple of years. "I suspect the U.S. economy will slow down somewhat this year," mired by softness in housing, he said. "If that's right, commodity demand will ease back along with it."

Some fund managers with portfolios that specialize in commodity producers are also beginning to show concern about rapid price gains. While they maintain optimistic long-range outlooks, they express reservations about the near future.

"We're going through a long-term recovery from stupid oversold levels," said Fred Sturm, who manages the Ivy Global Natural Resources fund. "Prices of many of these commodities were unsustainably low." In the late 1990's and early 2000's, he pointed out, gold and oil traded at nearly 20-year lows after having fallen by more than two-thirds.

The depressed prices helped to force commodity producers to merge — Alcoa and Reynolds in aluminum, for example, and Exxon and Mobil in energy — and to take other steps to improve their finances. That drove the first move in what he expects to be a three-stage rally in commodity markets.The last stage, he predicted, will be "a true scarcity phase when Mother Nature slaps us in the face and grabs our attention and tells us we're running out of commodities like oil when people keep wanting more."

But that's well in the future, Mr. Sturm said. Right now, "we're in a big fat middle phase where commodity prices are expected to remain above their average ranges but will not continue to trend higher," he said. "We expect them to modify from recent levels in energy and in some of the metals, including copper."

He described his view of commodity stocks during this stable period as "persistent but moderated bullishness" and said valuations "are still very attractive, even if earnings don't continue to grow at the same supercharged pace" as in recent months.A bit more than half of Mr. Sturm's fund is invested in energy suppliers, including ChevronTexaco, Thai Oil and Massey Energy, an American coal mining company. For the last six months, he said, he has been allocating more of the fund's $2.5 billion in assets to producers of precious metals as a play on growth in developing markets.

"Gold remains a form of money, and in much of the emerging world where they don't trust what comes out of the A.T.M. machine, people may buy an extra gold bangle and store it as money," Mr. Sturm said. He said, too, that energy producers in the Middle East and elsewhere were prone to buying gold with surplus cash, of which they have plenty these days.His bet on precious metals is also a hedge against unforeseen negative events. "Gold is the best form of insurance when you're not sure what you're insuring against," he explained. Among the miners of precious metals in his portfolios are Buenaventura in Peru and Impala Platinum in South Africa.

John Hill, an analyst at Citigroup, says he also thinks that the rally in gold has further to go. He has told clients that prices have continued to climb against an economic backdrop often associated with weakness for the metal, including rising interest rates, controlled inflation and a stronger dollar. 

"We continue to be positive on gold," he wrote, citing "healthy underlying supply-demand fundamentals in the form of Indian fabrication, Chinese retail investment and recycled Middle Eastern petrodollar flows."

Citigroup's analysts have buy ratings on Newmont Mining and Barrick Gold and they are neutral on another large North American producer, Placer Dome. They also recommend buying Alcoa, United States Steel and the specialty steel maker Nucor. Other prominent components of Mr. Sturm's portfolio are Aracruz Celulose and Suzano, the Brazilian pulp and paper companies; Nalco, an American water treatment company; and Companhia Vale do Rio Doce, or CVRD, a Brazilian miner of base metals.

Mr. Sturm highlighted one segment — chemical making — that benefits when prices of other commodities fall. Energy is a major cost in chemical production, and with energy prices due to moderate, in his opinion, the chemical makers could thrive.

He is especially optimistic about suppliers of industrial gases. "Companies may enjoy stronger profitability and an ability to pay down debt" for the next two years as prices increase for the gases they manufacture, he said. Shares of companies like Praxair, Air Liquide and Air Products and Chemicals "are more attractive than they may appear." The outlook for Praxair appears so bright that one investor who seldom buys commodity producers, Rick Drake, co-manager of the ABN Amro Growth fund, keeps it in his portfolio.

Mr. Drake shuns commodity stocks. "They tend to be cyclical companies," he said, "and our focus is on consistent, sustainable growth through all parts of the cycle."

"They do well when prices skyrocket," he added, "then eventually someone comes along and builds up supply, the price comes down and companies get hurt."

Praxair's performance is not nearly as volatile, he said. It is a basic materials company producing hydrogen, and Mr. Drake expects its use to expand. "The hydrogen business has been real strong because of oil," he said, "not because oil prices are higher, but because environmental laws are such that when you get low-grade crude oil, you need more hydrogen to refine it."

Hydrogen also produces efficiencies in steel making, Mr. Drake noted, and is used in clean rooms for, among other things, semiconductor production. "It is more of a play on industrial production" than commodity price inflation, he said, describing Praxair as "a very steady, consistent growth company."

STEADY growth is desirable, but investors are often willing to take a chance on companies with more volatile earnings streams if they believe they can catch the upswing. Gil Knight, a senior portfolio manager at Gartmore, contends that the rally in commodity prices is robust enough to warrant significant exposure to the sector, although he also worries that prices may have moved ahead too fast.

Mr. Knight has long held shares of oil drilling and exploration companies, such as Halliburton, Ensco International, Southwestern Energy and Range Resources, but he warned against following his lead.

"I wouldn't buy any of these stocks up here," he said. "They're in nosebleed territory." Still, he said, "in terms of percentage gains versus other industries, I don't think they're going to do as badly as people think."

He finds greater opportunity in other industries. He said he added to his position in Freeport-McMoRan Copper and Gold in January, when the stock dipped slightly amid allegations that the company had inappropriate ties to the Indonesian military. Its shares have risen about 50 percent in the last six months.His other favorites include Joy Global, a manufacturer of mining equipment that he called "a fantastic little company," and two suppliers of cement and other basics, Florida Rock and Vulcan Materials.

He agreed that commodity prices would be supported by strength in emerging economies. "If you pay attention to growth," Mr. Knight said, "you have to stick with energy stocks and probably some commodity stocks this year."


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