Time to Unload Commodities?

Days like Tuesday don’t feel too great when you have bets in the energy and industrial metals sectors. Many stocks were down as much as 6 percent yesterday alone. Despite the huge moves we’ve seen dating back to last year, the combination of strong fundamentals and low valuations continue to explain my bullishness.

Commodities are cyclical, and one day the party will certainly end, however I think the bull market in energy and materials still has ways to go. Really, it’s simple supply and demand. Even at today’s elevated prices, demand worldwide should remain strong. On the supply front, there is no reason to believe the world is going to all-of-the-sudden find lots more oil. Metals such as copper and gold take years to be mined, and unmined supply is fairly limited as well.

The stocks will always be very volatile, as a one-year chart of any company in the sector will show, but I can’t help but think sell-offs like the one we saw Tuesday are opportunities for those who have yet to jump in.

Take Anadarko Petroleum (APC) as an example. Late Monday, the company reported earnings of $3.88 per share on sales of $2.25 billion, easily surpassing estimates of $3.35 and $2.09 billion. In fact, actual results even beat the highest printed estimate on the Street ($3.77/$2.23B). However, the stock fell more than $3 to $102 per share as crude oil prices dropped by a decent amount.

APC also announced a 2006 capital expenditure budget of $4 billion versus $3.4 billion in 2005. Production growth is expected to be in the 4-8 percent range this year. It’s not just an oil price story, but production is growing too.

After seeing last quarter’s results, I have no reason to think the highest 2006 estimate coming into that report, earnings of $15.73 per share, is unattainable. That would put the stock’s forward P/E at 6.5x. Most investors will tell you such a multiple signifies peak earnings, and they’d be right. Price-earnings ratios are always lowest at cyclical tops and highest at cyclical bottoms. The bullish case for Anadarko centers around the idea that 2006 might not be the top.

If China and India continue to grow as a percentage of the world economy, and other nations follow their lead, oil could reach at least $100 per barrel by the end of the decade. That might not happen, but I think it very well could, and the odds of $30 oil anytime soon are very, very low. Energy and materials represent 10% and 3% of the S&P 500, respectively. I think investors should be overweight these areas for the next several years.

Enjoy this post? Subscribe and never miss another one: RSS | Email | Twitter

2 Thoughts on “Time to Unload Commodities?

  1. SiamTwin on February 8, 2006 at 11:18 AM said:

    agree 100%. the theme of rising demand meets supply inelasticity has yet to be fully played out.

  2. David Hopkins on February 8, 2006 at 1:38 PM said:

    I second that agreement. The ideal situation is to find a poorly managed oil or natural gas firm with great assets that is not a market darling and jump on for the ride early on. I was able to do this with XEC (not mismanaged, just undervalued), and to a lesser extant, COP – the most undervalued major integrated, in my opinion. I do think we have a much better chance of seeing $80 than $30 for oil. Rising demand from India, China and the developing world (Latin America, for example) combined with lower supplies and higher and higher extraction costs add up to an upward ascendency in prices.

Post Navigation