Large Gains Ahead In Cyclical Commodity Stocks, Depending On China Bounce

by: ChartProphet

Commodities and China Signal a Positive Bounce

Even with the huge risks, government shutdown, debt ceiling debate, and economic uncertainty, there are a number of very good stocks to buy right now.

While the stock market has risen too sharply to simply "jump in," a few signs point to a continuation of the uptrend. There exist a few very profitable opportunities in stocks that have seen sharp drops as a result of the big declines in China and commodity prices.

Predicting Gold's Bottom (For Now)

In my TV appearances (CNBC, Yahoo Finance, BNN) at the end of June, I predicted the EXACT bottom in gold prices. I was expecting strong support at $1200, and prices bottomed on the exact day I was on TV. Look at what happened on June 27, as I appeared on CNBC:

As CNBC had me on at 1-1:30pm, gold prices plummeted from $1225 to $1200 in less than an hour. Even better, I predicted that day that gold would bounce for "weeks or months" - and that exactly happened as gold bounced from $1200 that day to over $1400 by the end of August. Call it good research, excellent timing, and definitely some luck.

What the Gold Bounce Signaled

But gold's short- to medium-term bottom signaled an even more important outcome: a major bounce in commodity prices and emerging market stocks like China, Brazil, and India. Because of this potential bounce (or recovery), I knew that the U.S. stock market had more room to continue rising. Even with all of the bad news, the commodity-related stocks were revealing what was really happening. In an economic recovery and periods of growth, commodities like copper, steel, iron, and oil see rising prices. So long as these commodities and cyclical companies continue to rise, so will the stock markets around the world.

[Cyclical companies are companies which are strongly tied to economic conditions, doing well when the economy is growing and poorly in times of slow growth or recession. The result can be a very up and down nature to the stock prices.]

What makes this even more promising is that most of these commodities and cyclical companies have much more upside left! While the market has continued to rise, these companies are actually still near the bottom and present some of the best entry-points to invest.

For the next 6 months, we are looking for many of these commodity and cyclical stocks to rise significantly. Even some large, well-known companies like Alcoa (NYSE:AA) and US Steel (NYSE:X) could gain 30-50% over the next year. We don't fully trust the economic recovery yet, but there are a number of high-potential stocks at least in the near term.

Why Materials and Commodity Cyclical Stocks are BUYS

Right now, the best place to invest is the materials (NYSEARCA:XLB) sector. That is not necessarily a recommendation for the entire sector, but rather specifically those companies within the sector whose stocks have seen massive drops since 2011. Many of these stocks have lost over 50% of their value due to the earthquake/nuclear reactor debacle in Japan (NYSEARCA:EWJ), as well as the slowdown in emerging markets such as China (NYSEARCA:FXI), Brazil (NYSEARCA:EWZ), and India (NYSEARCA:INP) - and the resulting sharp slowdown in demand.

The troubles in emerging markets (NYSEARCA:EEM) and the overall global economy are not over, but commodity-related stocks should outperform over the next months for a number of reasons:

1. Huge Price Drops and Depressed Valuations - Many of our favorite commodity stocks have already dropped over 50% since early 2011, with some losses even closer to 80%. After such massive declines, a bounce or recovery is likely.

Examples of some of our favorite stocks in this investment theme are Alcoa , Cliffs Natural Resources (NYSE:CLF), US Steel , Peabody Energy (BTU), EXCO Resources (NYSE:XCO), Encana (NYSE:ECA), Devon Energy (NYSE:DVN), and LDK Solar (NYSE:LDK).

Notice how all of them have seen major declines since early 2011:

2. China and Emerging Markets Bounce or Recovery - China and other emerging markets bottomed in late June 2013, after losing more than 20% since January 2013. Materials and commodity stocks, which are heavily dependent on global demand, dropped sharply as a result of the slowdown - many even losing over 50%. However, the bottoming of emerging markets and the resulting re-acceleration in demand signals at least a rebound in the beaten-up commodity stocks. If the bounce or recovery continues in global markets, the corresponding bounce or recovery in commodity and materials stocks will be even greater.

Notice how China bottomed on June 24, 3 days before gold (NYSEARCA:GLD) and on the same day as the U.S. markets (NYSEARCA:SPY):

3. Alternative to High-Flying Stocks and Overall Market - Instead of chasing stocks like Netflix (NASDAQ:NFLX), Tesla (NASDAQ:TSLA), and LinkedIn (NYSE:LNKD), which are already up HUNDREDS of percent since their lows, buying depressed commodity stocks at cheap valuations is a much better option. It is extremely unlikely that most of the high-flying stocks can double or triple from here and are not worth the risk; on the other hand, the materials and commodity stocks have much more room to rise. Moreover, why should you chase the overall U.S. stock market, which is up 150%? If the stock market continues to rise, the commodity stocks will likely see much better performance than most other sectors; and if the stock market falls, at least you would be buying commodity stocks, which have already fallen significantly and will likely outperform as other stocks have more room to fall.

Netflix , Tesla , and LinkedIn performance, Jan. 1 2012 - Sept. 30, 2013:

Commodity and materials stocks performance, Feb. 1 2011 - Sept. 30, 2013:

4. Near Recent Multi-Year Lows - Most of the depressed commodity stocks are still very close to multi-year lows and strong underlying support levels, providing very attractive entry points with defined minimal risk. If the stock drops below recent lows or support, you can simply sell out at a small loss.

Why buy stocks with the overall market at all-time highs?

Instead, buy stocks like Encana and those mentioned above, at very good prices with underlying support:

5. Building Momentum - Aside from the steep drops, cheap valuations, and underlying support levels, many commodity and materials stocks are good investments because they are just beginning to gain momentum. The first step for these stocks was to stabilize and form a base following the steep drops; now comes the "follow-through" phase as investors become aware of the opportunities and pile in as buying volume picks up. Many technical and momentum indicators have been pointing to the growing strength of the trend.

To use just one example (perhaps the most known and historically-significant) from among the group of commodity and materials stocks we like, we'll point out Alcoa.

Before Alcoa reported earnings on October 8, I expressed my thoughts:

Alcoa beat earnings estimates, and the stock shot up 3% on high volume. In fact, volume had been increasing over the previous 3 months and had actually been foretelling of a positive outcome. The bottom had been formed for now, or maybe even for years to come.

Notice the rising volume and underlying support, which was pointing to a bottom:

Even more significant, perhaps, is the fact that Alcoa is now breaking out of a triangle, which has taken 2 years to complete! With the positive earnings report, and supported by high buying volume, Alcoa has broken out to the upside and could see $9, $12 or more.

The same is the case with many of the other companies mentioned above. Momentum is building up, and now is the time to buy at the lows.

The market looks dangerous, but what if the following rule is true:

"Massive" moves usually can't take hold if too many people expect them. Big market shocks can only happen when people are least prepared.

What if all the negativity and "anticipation" of a renewed recession actually signals a continued rise?

PORTFOLIO STRATEGY for October-December 2013

Technology, retail, and banks are not so appealing; for now, we are mostly interested in the producers and refiners of steel, iron-ore, aluminum and natural gas, as well as international shipping companies, bargain solar stocks, technology/chip stocks, and select biotech.

Disclosure: I am long AA, ECA, XCO, CLF, X, AKS, LDK. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am short: NFLX and F through put optionsI may initiate long or short positions in: DVN, GLD