With the exception of gold, all groups in the basic materials sector fell hard last week on fears of a global recession and its impact on the global demand and prices of raw materials, and the resulting impact on the profits and earnings of the companies in the basic materials sector. Overall, the basic materials sector SPDR Fund (NYSEARCA:XLB) ended down 7.1% for the week, most of it on Thursday and Friday, in concert with the steep drop in the market indexes in the latter part of the week.
This article covers our analysis of the big news and price moves in the basic materials sector last week, evaluating them for buy and sell ideas.
Yamana Gold Inc. (NYSE:AUY), Kinross Gold Corp. (NYSE:KGC), Newmont Mining Corp. (NYSE:NEM), New Gold Inc. (NYSEMKT:NGD) and Great Basin Gold (NYSEMKT:GBG): All five are Canadian gold mining companies, and all were up 5% or more last week on no company-specific news, but on general strength in gold as a defensive asset. The markets have been exceptionally volatile over the last four weeks based on a variety of global macro-economic factors, including concerns over U.S. debt, congressional negotiations over the debt limit and its impact on the U.S. and global economic output going forward, concerns over Europe’s debt problems, and concerns about rising inflationary pressures in China.
The Gold Miners ETF (NYSEARCA:GDX) went up 3.4%, and the price of gold rocketed up 6.2% last week. Of these, NGD engaged in the exploration of gold, silver and copper in Brazil, Australia, Mexico, Canada and Chile, and KGC, engaged in mining and processing gold, silver, and copper in the U.S., Brazil, Ecuador, Chile and Russia, were up the strongest at 9.0% and 7.6% respectively. The other Canadian gold miners up strongly last week included AUY, engaged in the exploration and development of gold properties in South America and Mexico; NEM, a producer of gold in the U.S., Australia, Peru, Indonesia, Canada, New Zealand, Ghana and Mexico; and GBG, engaged in the exploration and development of gold properties in South Africa and the U.S.
Of these, AUY, KGC and GBG trade the cheapest based on a forward P/E and growth basis. AUY trades at forward 13 P/E while earnings are projected to increase at over 40% compounded growth from 59c in 2010 to $1.16 in 2012; KGC trades at a forward 15-16 P/E while earnings are projected to increase at almost 40% compounded growth from 58c in 2010 to $1.08 in 2012; and GBG trades at forward 8 P/E while earnings are projected to stage a swift surge from an 8c loss in 2010 to a 13c profit in 2011, to a 25c profit in 2012. Furthermore, based on our review of the holdings of over 60 high alpha hedge and mutual funds (from managers such as Soros, Icahn, and Mario Gabelli), we determined that of these five, they are most bullish about NGD and GBG. Taken together, these high alpha or guru funds hold an out-sized $384 million or 10.6% of the shares outstanding of NGD, including adding $1 million to it during the June quarter; and they also hold an outsized $42 million or 5.0% of GBG, including cutting a minor $2 million during the June quarter. Of the other three funds, gurus are most bearish about NEM, cutting $184 million from their $928 million prior quarter position in the company.
Gold stocks are roughly flat over the last four weeks of market turmoil while the price of gold has gone up over 15% from $1600 to just shy of $1850 at Friday’s close. The consensus is that we could see gold over $2000 soon, and certainly the macro-economic case seems to support that. In that case, gold stocks as a group have a lot of catching up to do and are an attractive trade at these levels. We believe that AUY, KGC and GBG are the most attractive buys in the group based on their valuation and growth characteristics, as outlined above.
Patriot Coal (PCX), Teck Resources (TCK), Peabody Energy (BTU), Arch Coal Inc. (ACI) and Alpha Natural Resources (ANR): All five are North America based coal companies, among the largest in the world, and they plunged down 10%-15% last week on no company-specific news, but on general market weakness and fears of a global recession and its impact on energy demand. The Coal ETF (NYSEARCA:KOL) was down 5.6% last week. Of these five, PCX with 14 active mining operations in Appalachia and the Illinois Basin, and ACI with 23 active mining operations in WV, WY, IL, KY, ME, NM and CO, were down the most last week, at 14.1% and 14.3% respectively. The other major coal producers down steeply last week included TCK, a Canadian miner of coal, copper, zinc, molybdenum, gold and lead, mainly in Canada, the U.S., Chile and Peru; BTU, the largest private-sector coal company that provides 2% of the worldwide and 10% of U.S. electricity and is engaged in coal production and sale through 28 operations in the U.S. and Australia; and ANR, engaged in the production, sale, and processing of coal from mines and preparation plants in VA, WV, KY and PA.
Of these, ACI is the cheapest, trading at less than forward 5 P/E, while earnings are projected to increase at 80% compound growth from $1.14 in 2010 to $3.71 in 2012. Furthermore, TCK is at attractive valuation levels, at a forward 7 P/E while earnings are projected to double from $2.65 in 2010 to $5.70 in 2011. Based on our review of the holdings of high alpha or guru funds, we determined that they are under-weight in all five coal stocks, and except for TCK, they cut their holdings in each of the stocks in the June quarter; SAC Capital was the sole buyer of $49 million in TCK stock in the June quarter, and no other guru funds traded this stock last quarter.
Thus, on a relative basis, it seems that ACI and TCK are more attractive compared to their peers in the coal mining group. Besides ACI and TCK, we wrote earlier about buying PCX and ACI as they approached long-term support levels in the $10-$12 range and in the $16-$18 range respectively. We continue to stand behind that based on our belief that we are at the beginning of a long-term super-cycle in coal, driven by economic growth in China and India. This is likely to lead to a tight market, and higher prices and profits for coal companies that also operate in the metallurgical coal business, such as all five discussed here.
Molycorp Inc. (MCP), Rare Element Resources (NYSEMKT:REE) and Avalon Rare Metals (NYSEMKT:AVL): All three are North America based miners of rare earth metals. Of these, MCP, a U.S. based commercial stage miner and processor of rare earth ores at the mountain pass facility near the CA/NV border, fell 17.4% last week; and AVL and REE, Canadian development-stage miners of rare earth metals and minerals, fell 13.9% and 14.7% respectively last week. We have written earlier about our buy thesis on MCP based on its cheap valuation and projected explosive growth in revenues and earnings, and would view the current pullback as a buying opportunity. We are less enthusiastic about AVL and REE as they are still in the development stage and with no revenue and earnings projected in the short-term, they are more vulnerable to a pullback if the markets go through a continued volatile period ahead.
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Please note that the cumulative price change referred to in the last column of the Table above is used here as a measure of volatility to determine big movers in the group. It equals the sum of the absolute value of the change in daily prices. So, for example, if a security had price moves of 2%, -3%, 4%, -6% and 1% during the five days of the week, the cumulative price change during the week would be the sum of the absolute values of the daily price changes, which in this case would be 16%.
Credit: Historical fundamentals including operating metrics and stock ownership information were derived using SEC filings data, I-Metrix® by Edgar Online®, Zacks Investment Research, Thomson Reuters and Briefing.com. The information and data is believed to be accurate, but no guarantees or representations are made.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Disclaimer: Material presented here is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock you should do your own research and reach your own conclusion. Further, these are our ‘opinions’ and we may be wrong. We may have positions in securities mentioned in this article. You should take this into consideration before acting on any advice given in this article. If this makes you uncomfortable, then do not listen to our thoughts and opinions. The contents of this article do not take into consideration your individual investment objectives so consult with your own financial adviser before making an investment decision. Investing includes certain risks including loss of principal.