Commodities: How To Find What Still Shines

Some metals have bucked the commodities slide, but choose carefully

The great bull market in commodities that started in 2002 is taking a breather. Metals, agricultural products, and other raw materials climbed sharply in the past few months, with the Goldman Sachs Commodity Index rising 22% from January through the end of March. But many are leveling off or turning south. "I would expect some consolidation, some choppy markets, and some sideways-type price action," says John Brynjolfsson, who manages a commodity fund for Pacific Investment Management Co.

As bearish as the current outlook is, several trends bode well for commodity-related investments longer-term. Continuing growth around the world -- especially the industrialization of China, India, and other Third World countries -- has led to raw-materials shortages and should keep demand brisk. Since major reinvestment in production isn't on the horizon, supplies of everything from copper to gold will likely stay tight, and prices should stay high. "We still remain upbeat on commodity-price outlook" over the next 1 1/2 to two years, says Douglas Porter, deputy chief economist at BMO Nesbitt Burns, the brokerage arm of the Bank of Montreal (BMO ).

Bulls argue that bigger gains are on the way for commodity-related stocks, if not right away. "Personally I'm inclined to look for opportunities," says John B. Helmers, principal at Swiftwater Capital Management LP, a Greenville (S.C.) fund that oversees $140 million.


Where will those opportunities be? Alcan Inc. (AL ), the giant Montreal aluminum company, has seen its stock cascade from about $52 a share last fall to under $30. But deals with big customers such as European planemaker Airbus should help drive sales. Likewise, nickel producer Inco Ltd. (N ) has seesawed from above $43 a share in early March to under $39. With a huge new mine at Voisey's Bay on Canada's east coast expected to come on line next year, Inco is positioned to rebound and goose its share of the market whether nickel prices resume their climb soon or not.

Pick your plays carefully. Steel prices peaked in September and may stay low amid weakness in the U.S. auto market and growing production capacity in China. While producers will be under pressure, Nucor Corp. (NUE ), the acquisitive U.S. steelmaker, can turn cost advantages its way. And after topping $456 an ounce in December in New York, gold has slipped to about $427 and could fall further as central banks try to rein in inflation. Even a company such as Barrick Gold (ABX ), whose mining costs are nearly $200 an ounce lower than the prices gold now fetches, could still be a winner.

Eventually, commodities should turn around. Until then, wary investors are giving many stocks linked to them oh-so-small price-earnings multiples -- a ringing buy signal for someone able to wait out the lean stretch.

By Joseph Weber

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