3 Cheap Stocks Picks That Could Surge In A Commodity Rebound

Includes: CCJ, DNN, FCX, VALE
by: Trade In Mexico

A couple of factors have contributed to a significant price decline for many commodities. First off, there was the financial crisis that began in 2008 which knocked the price of copper, iron ore, natural gas, oil and other basic materials, to levels not seen in years. There is also an ongoing crisis and recession in Europe, and now China is tightening up on loose money policies; this appears to be creating a slowdown in that country. Most recently, the Federal Reserve's signaling of a possible tapering has created strength in the dollar and that tends to push down the price of certain commodities. However, all of this might be nothing more than a lot of short-term noise that could distract investors from the long-term and possibly even a "generational" buying opportunity in commodities.

If you want to buy assets cheap, you have to buy when few investors want them. Ten years from now, will the world have more people in it, who are using more energy, and needing more homes and cars? The most likely answer is a resounding yes. China is growing even if at a slower pace, the European debt crisis and recession will not last forever, and the U.S. is showing some signs of an improving economy. Plus, central banks around the world are printing money which could eventually lead to inflation and economic growth. When business conditions improve and the global economic cycle is back in a decisive uptrend, investors who buy commodities now could be poised for life-changing gains. Analysts at JP Morgan seem to be considering that potential now and just upgraded commodities. A recent article details the very bullish outlook, which states:

There's no way to sugarcoat it, commodities have been brutalized over the past few years given the slowdown around the world and specifically China, the lack of inflation and elevated supply. That however could change according to analysts at JPMorgan.

For the first time since September 2010, the firm is making an Overweight call on commodities.

JPMorgan analysts led by Colin Fenton say seasonal forces are reversing, supply channels are thinly stocked and sentiment is universally bearish.

Right now, investors can buy some commodity stocks at or near or even below the financial crisis lows that were reached in 2009. It is not a huge leap of faith to see that ultimately with population and economic growth in the coming years, a massive rebound could occur in many of the stocks in this sector. With that in mind, here are a few stocks that look very cheap and could be poised to benefit the most from a rebound in demand:

Denison Mines Corp. (NYSEMKT:DNN) shares appear to be a high-potential way to participate in the long-term rebound in uranium. This company owns uranium deposits in the Athabasca Basin in Canada which is one of the richest and best quality in the world. Another positive is that since it is located in Canada, it is in a politically stable part of the world, and this lowers risks for investors. This stock looks very undervalued, and it has a history of making big moves when conditions are right with uranium prices rising. The key is to buy when there is little investor interest, when the stock is cheap and uranium prices are depressed. That is the case now, so it makes sense to buy before another potentially major move. (This stock used to trade for around $15 in 2007 and even for over $4 in 2011, so major moves are possible in the future.)

There are a few factors which could lead to a rise in uranium and that could take Denison shares much higher. For example, uranium prices jumped along with other fuels when oil surged to about $150 per barrel just before the 2008 financial crisis began. In recent weeks, oil has been climbing and it now trades for close to $100 per barrel. Oil could be poised to climb well over $100 soon and continue to rise as the global economy recovers. With population growth, rising incomes and energy consumption in emerging market countries, the demand for oil and nuclear energy is bound to increase over time. Another reason why uranium prices could be poised to rise is the fact that Russia is scheduled to end a nuclear warhead recycling program which has added to uranium supplies for years. Furthermore, there are a significant amount of nuclear energy plants being built around the world and in China which will add to demand for uranium in the coming years.

Locking in bargains like Denison for the long-term will position investors to benefit for the day when oil is back at $150 per barrel and when uranium is trading at $100 per pound or more. Investors need to consider that for every dollar rise in the price per pound in uranium, this can turn into an exponential difference in the profits for Denison. If this company can turn in near break-even results on a per share basis as it has recently, just imagine what it could report if uranium rises from about $40 today, to around $85 which is where analysts at J.P. Morgan expect it to sell for in 2014.

Risk factors would include another nuclear plant incident as we saw in Japan or a global recession that pushes energy prices lower. However, many nuclear plants have increased safety policies and with supportive central banks around the world, a recession at this time seems unlikely. Some positives that mitigate risks for investors include the fact that Denison has an experienced management team, and interests in some of the highest quality regions for uranium. As one recent Seeking Alpha article points out, higher grade ore can lead to better profit margins, it states:

The grade of the ore that uranium is extracted from is important because the less uranium in the ore, the more it costs to process it.

In that regard, Denison is positioned strongly because of its exposure to Athabasca Basin, which has the richest ore deposits in the world. At this time, Canada has the best uranium ore, and the only country with a lot of ore above the 1 percent range. Approximately 20 percent of Canada's uranium deposits are in that category.

Other major uranium deposits, for example, in countries like Australia and Kazakhstan, have a poorer grade of ore, with 90 percent of the uranium grade in Australia having less than 0.6 percent, and the majority of ore in Kazakhstan less than 1 percent.

As noted above, JP Morgan analysts are now bullish on commodities and also expect the price of uranium to double in 2014, but other analysts have also turned bullish recently as well. On June 3, 2013, analysts at Cantor Fitzgerald initiated coverage on Denison and set a buy rating. Earlier this year analysts at Raymond James upgraded Denison to an outperform rating based on the "world class" uranium deposits and the potential for a takeover of Denison. Raymond James stated these bullish remarks: (Wheeler is a Denison project and "DML" is the Canadian ticker symbol for Denison.)

We believe corroboration of a high-grade 60 Mlbs resource confirms Wheeler as a world-class deposit at, or very near, the size to justify an economic mine. Accordingly, we view takeout potential - already high, given DML's 22.5% interest in the McClean Lake mill - as bolstered by the news."

There have been takeovers in the uranium sector in recent months: One article, that said 2013 is the year to buy uranium stocks, details recent buyout offers in this sector. Uranium One (OTC:SXRZF) announced it would be bought by ARMZ, for $1.3 billion, and Rio Tinto (NYSE:RIO) made an offer for Hathor. Since industry leader Cameco (NYSE:CCJ) has been acquisitive in the past and because it has neighboring properties in the Athabasca Basin, it could be a possible suitor for Denison. With Denison shares looking very undervalued, the significant upside from a potential rebound in uranium prices and the takeover potential make this stock worth buying now.

Vale S.A. (NYSE:VALE) shares might not be ready to move higher yet, but it does look like the stock might be bottoming out now. In this case, it is worth watching it for signs of strength that could come later this year.

This company is one of the world's largest producers of iron ore, but this industry has had plenty of bad news in recent months. As most investors know, the Chinese economy has been slowing down. Since that country is a large consumer of commodities, this factor has negatively impacted iron ore prices. However, this is probably already more than priced into Vale shares as the stock looks cheap for investors with a long-term horizon.

First off, Vale shares look undervalued based on earnings. Analysts expect the company to earn $2.24 in 2013 and $2.08 for 2014. That puts the price to earnings ratio at just around 5.5 times earnings. This is a fraction of the average for the S&P 500 Index (NYSEARCA:SPY) which is trading at about 15 times earnings now. The dividend of 75 cents provides a yield of nearly 6%, which also beats many other income investments.

The demand from China might be better than the market realizes, since Vale recently said it expects no slackening of demand from that country and that it expects iron ore prices to improve in late 2013. Some analysts have also been turning bullish. Goldman Sachs believes that iron ore prices will rise and that Vale shares are heading higher. It has set a price target of $29.30 for Vale.

Investors should consider downside risks that are prevalent in the mining sector, like strikes and weather issues. But, if China sees a potential economic bubble burst, then all bets are off as demand for iron ore is likely to go down much further. However, when the cycle turns, the upside for Vale appears to be significant as it traded for over $40 in 2008, and over $37 in 2011. At just $12.80 per share, it makes sense to consider buying even a small position and holding it for the dividend income and the longer-term upside.

Freeport-McMoRan Copper and Gold (NYSE:FCX) shares have been punished from the big drop in gold prices and the weakness in copper. However, the company also has exposure to oil which has been strong and that diversifies the revenue stream. While there is not much the company can do about weakness in gold and copper prices, investors should remain focused on the fact that Freeport is one of the largest natural resource companies in the world, and that is has a strong balance sheet. It also has a few more positives that were recently noted in a Forbes article which stated:

FCX has one of the lowest costs of copper in the world in Indonesia because the deposits are relatively heavy in gold as well. Of course, in the last year, gold has swooned as well and has dropped about a third in value. Even if demand for copper diminishes in China, India is in the wings waiting to take up the slack along with other developing countries. Major resource discoveries are rare and unusual. Controlling the world's second largest copper mine is a considerable resource.

Unlike many natural resource companies, Freeport actually has a strong balance sheet which includes about $9.6 billion in cash and $10.09 billion in debt. This financial strength gives the company flexibility, it lowers risks for investors and it makes the dividend more secure.

Analysts expect the company to earn $3.04 in 2013 and $3.66 in 2014. That gives this stock a below market price to earnings ratio of just 9 times. If the company can post those kinds of number when copper and gold prices are depressed, just imagine what it could earn if commodities rebound. When business conditions are ideal, this company could be making significant profits as it has in the past. The shares have traded around $60 in 2008 and 2010, which gives a sense of the future and long-term upside potential. On June 3, 2013, analysts at Barclays gave the stock an overweight rating and set a $40 price target. While investors are waiting for a higher share price, the company rewards shareholders with a dividend of $1.25, which yields 4.5%. Of course, investors should consider that if the Chinese economy continues to slow, copper prices might suffer. If gold keeps dropping, that will also create additional downside.

Data is sourced from Yahoo Finance. No guarantees or representations are made. Please consult a financial advisor before making investments.

Disclosure: I am long DNN. I may buy VALE shares soon. 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.