3 Basic Material Stocks You Should Buy

By David Gould - October 3, 2012 | Tickers: ABX, FCX, GG | 0 Comments

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While gold, in particular, is well-known as an inflationary hedge, basic materials, in general, provide a way to counter the prevailing macro trends. While the sector is no stranger to supply disruptions and volatility, many companies are able to trade at very low multiples. I recommend purchasing shares across both copper and gold producers to benefit from emerging market demand, supply chain reversals, and macro uncertainty.

Freeport's Strike Says Nothing About the Fundamentals

After management caved in to labor during the Grasberg strike, Freeport McMoRan (NYSE: FCX) made top headlines in analyst reports. Many had claimed that the decision to hike worker pay and provide bonuses was a development indicating management's focus. According to some, the decision enabled Freeport to put the worst behind. My own view is that the concessions will make future business tougher given how it legitimizes the efficacy of strikes.

More generally, however, I find that the commentary on the strike has been about the strike. There is more--so much more--to Freeport that the market has failed to recognize. Now that gold is produced from Grasberg (albeit at low ore grades), Freeport can mitigate its risk of being a pure copper play. But the main upside, in my view, comes from copper. Although this basic material has been highly volatile of late, Chinese demand will keep pricing at historically high levels. As the largest public copper producer, Freeport sells around 4 billion pounds each year and thus has a strong control on pricing. This is further complemented by the company's efficient, geographically-diverse operation that would allow for an easy ramp up in copper. I believe that prices will remain north of $3 ultimately due to the rise of emerging markets.

Barrick & Goldcorp Also Look Undervalued

As attractive as Freeport is in its own right, few investments are good by themselves. Diversification is the key in mitigating risk and backing more general macro trends. Given rising concern over inflation and seemingly endless federal spending, diversification is likely to become more of a concern. At some point, even diversification becomes a non-solution. This is when gold, which performs well during economic uncertainty, becomes your best bet.

I am particularly attracted to Barrick Gold (NYSE: ABX) and Goldcorp (NYSE: GG). As the largest pure gold producer in the world, Barrick will be one of the main beneficiaries of inflationary fear. The company is likely to increase in scale, potentially buying out the one-quarter stake left in Cerro Castle and the one-half stake in Round Mountain. While mines are aging, several projects are underway to at least get the lower grade ore. The two largest consumers of gold, India and China, have meanwhile shown stronger demand that has grown faster than supply has. Accordingly, it is now a lucrative time to make an entry.

Goldcorp similarly is well positioned in these positive secular trends. After announcing poor second quarter performance, however, the market reverted to thinking myopically as the stock fell 10%. While limited access to high grade ore at Red Lake due to seismic activity was disappointing, the fact of the matter is that the company has great geographical diversity to hedge against the "hiccups" in any one region. In addition, Red Lake should not be discounted just because of one tough year. Production could be as high as 650,000 ounces and normalize around 400,000 over the next few years.

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