There is a commonly believed fallacy out there that goes something like this:
China is slowing down, and it consumes most of the world's commodities right now. So if China is slowing down, it isn't consuming as many commodities, and therefore, commodity prices will head downward. I hear some version of this thought almost every day in the financial media. However, this is a flawed form of thinking.
There is no doubt China has been slowing down. But even as China's economic activity slows, commodities already hit their bottom in June. Since then, they've reversed their trend and have been heading higher even as China remains slow.
But even as commodities overall head upward, there is one metal that the markets are still bearish on. But I believe this laggard is about to join the trend higher.
Commodities Are a Global Affair
While China is definitely a big factor in commodity prices, it isn't the only one. There are several reasons commodities hit their bottom in June, despite China's continued cooling.
Annualized GDP data is delayed data. Commodities respond to global rebounds in real time, so by the time that data is official, markets have already priced it in. And while China may have slowed down, it's still growing, albeit slower than before. All around the world, other economies are doing the same. The growth may be slower, but they are growing - not contracting.
On top of that, one of the biggest factors impacting commodities right now is stimulus money from the Fed and other central banks. Whether it's money printing or other forms of stimulus, it's bullish for commodities.
All of these factors combine to keep pressure on the commodities markets and prices moving higher.
Commodities Bottomed in June
As you can see by the red and black line in the chart above, not only did commodities bottom in June, but they also collectively broke a downtrend line that lasted for over a year.
The fact that the present bottom is higher than the previous bottom, and that the downtrend line is broken, proves that there is fresh demand coming back into commodities as seen by the CRB Commodity Index chart above, which tracks a basket of 19 commodities.
But even with some people being bullish on commodities now like I am, many are still bearish on one in particular: aluminum.
This Laggard is About to Play Catch-Up
Even as copper and other metals have been rebounding, sentiment towards aluminum and aluminum companies like Alcoa (AA) remains negative. However, you can see from the black line on the chart above that Alcoa bottomed in July after the CRB Index bottomed in June. You'll also see that these two tend to track each other fairly well. It's a simple matter of the CRB Index leading the way higher this time and aluminum lagging behind for the moment … but it's about to play catch-up soon.
You see, most people viewed Alcoa's latest earnings report as a negative. But I'm seeing other things that the media didn't seem to latch onto. For instance, Alcoa still sees global aluminum demand of 6% in 2012, and they see demand doubling from its 2010 levels by 2020.
However, Alcoa is keeping its earnings guidance low right now. I would too. I'd set the bar low and then try to exceed it. From a CEO's point of view, it makes sense to underplay expectations in today's tumultuous markets. Also, an important fact the media ignored is that Alcoa reported performance improvements across all of its segments and solid revenue of $5.8 billion, despite the decline in the price of aluminum.
The Market Has Mispriced Alcoa
Investors have painted a bleak picture; we can tell that by the low price they're allowing Alcoa to trade at presently. But that's about to change. Investors have priced Alcoa very cheaply at 10.91 times forward earnings. Profit margins are still almost at 15%. Return on equity is over 22%. Earnings before interest, tax and amortization (EBITA) were $1.44 billion. So this company is far from finished. In fact, it still has $1.4 billion of cash on its books. That can help Alcoa ride through any rough patches in its industry.
Investors have mispriced what aluminum will do in the future and how Alcoa will perform, as well. I'm not saying it has to bottom at this exact second, but I am saying that just a mere six to nine months from now, I believe Alcoa will be notably higher than where it is trading at today.
You can see from the chart that I expect it to eventually regain the $14 per share level. That would be a 62% gain. Even if my timing is off and it takes two years to get there, it still makes this a great investment. Most investments aren't going to appreciate an average of over 30% over the next two years. But an asset that has been underestimated sure can - and that's exactly where Alcoa stands right now. Aluminum and Alcoa have reached the point of "maximum pessimism," and that means a bargain for us.
If you buy when no one believes in something, you'll be rewarded richly when others finally do and the news headlines have gone from gloomy to rosy. And right now, no one seems to believe in aluminum or Alcoa. Therefore, consider adding some Alcoa shares to your portfolio as aluminum finally stops lagging behind.