As I wrote yesterday, virtually every sector of the market is trending higher right now.
All but one.
Of the 11 core sectors that make up the S&P 500 Index, only the materials sector was down significantly last week.
And given that the materials stocks down the most rate as “Bearish” on my Green Zone Power Ratings system, I recommended against aggressively buying the dip.
We have a disconnect. Normally, inflation and dollar depreciation are good for commodities. Yet even while the Iran war and the closure of Hormuz have reignited inflation, most of the stocks in the sector aren’t benefiting.
So, how can we explain the bearishness in the sector? And more importantly, can we turn this apparent anomaly into a profitable trade?
I’ve been successfully trading select materials stocks for the past year, as I’ll explain in a moment. So, I can tell you with 100% certainty that there are gems to be found.
But how do we find them?
Let’s see what my system has to say.
A Peek Under the Hood
Looking at the sector as a whole, materials look awful.
At 13 out of 26, half of the stocks in the sector rate as “Bearish” and another seven rate as “Neutral.”
Only six in the entire sector rate as “Bullish,” meaning they have a score of 60 or higher.
(For those new to my Green Zone Power Ratings system, “Bullish” rated stocks outperform the S&P 500 by double on average over the following year.)
My system indicates that the recent poor performance of the sector is justified. The vast majority of materials stocks are poised to underperform.
But what sets those select six that rate as “Bullish” apart?
I pay close attention to this space because over the past year, materials stocks — especially miners — have been a major source of gains for me in Infinite Momentum Alert.
Earlier this year, I closed out a 131% gain in Barrick Mining Corp (B), which I had held for a little over a year.
And that followed recent gains of 65% in Kinross Gold (KGC), 42% in Fortuna Mining (FSM) and 33% in Eldorado Gold (EGO).
I’m also sitting on gains in five materials stocks in Green Zone Fortunes, my longer-term buy-and-hold service.
So, it’s clearly possible to make money in materials…
“Materials” are not a uniform block of stocks, even though all deal with basic commodities in one way or another.
Some companies are well positioned to benefit from inflation because they can raise their prices as quickly as — or faster than — their costs rise.
For others, it’s the exact opposite. Inflation in their costs is outstripping any benefits they get from higher sales prices.
Let’s keep digging into the details!
Where Do Materials Stocks Pick Up Points?
The Green Zone Power Rating is a composite score based on six primary factors: momentum, size, volatility, value, quality and growth, each of which is composed of several sub-factors. (As we are looking at large-cap constituents of the S&P 500, I don’t consider size when doing the sector X-ray.)
Let’s take a look at where materials stocks are putting points on the board.
A surprisingly high number rate as “Bullish” on their quality factor. Fully 16 out of 26 have a quality factor of 60 or higher.
My quality factor is a composite of various measures of profitability, balance sheet strength and capital efficiency. I wouldn’t consider the high number of “Bullish” rated materials stocks a “normal” phenomenon.
Raw materials companies aren’t generally going to rate highly on most of the quality subfactors. Profit margins for commodity businesses tend to be pretty low.
Iron ore is iron ore… soybeans are soybeans. There really isn’t much room for premium pricing in a world of standardized commodities.
Likewise, these are capital-intensive businesses. Unlike a software business, which you can run from a patio table at Starbucks, a materials business requires a massive investment to operate.
But remember, these aren’t “normal” times.
As I mentioned earlier, some materials companies really benefit from inflation, as the increase in the sales price of their products outstrips the increase in the cost of their inputs.
This boosts their profit margins… and thus their quality scores.
The materials stocks doing well today are the ones benefiting the most from inflation.
So, let’s give those six “Bullish” rated stocks a look.
“Bullish” Materials
There are some familiar names here.
CF Industries (CF) is one of the world’s largest makers of nitrogen-based fertilizer. I recommended it in Green Zone Fortunes back in late February as a backdoor play on the AI boom.
I knew that rising living standards due to the tech revolution would come with higher-protein diets.
That’s still true, of course. But it’s not why we’re up almost 30%. No, the sudden spike in prices was due to Iran’s closure of the Strait of Hormuz, which is the gateway to the world for about half of all nitrogen-based fertilizer.
The longer the Strait stays closed, the more CF stands to make out like a bandit.
Gold miner Newmont Corp (NEM) is another fine example. I added Newmont to the Green Zone Fortunes portfolio back in November, and we’re already up about 25%.
In large part due to fears over inflation and the stability of the dollar, the price of gold has roughly doubled over the past two years.
But the cost to mine an ounce of gold out of the ground hasn’t really changed all that much. So, profit margins for gold miners have absolutely exploded higher.
A similar dynamic is at play in copper.
Unprecedented demand for data centers to power the AI boom has caused copper prices to explode higher, while the cost of mining it hasn’t really changed all that much.
That’s been a boon to Freeport-McMoRan (FCX), so it should come as no surprise that the company rates as “Strong Bullish” on both its quality and growth factors.
To good profits,
Adam O’Dell
Editor, What My System Says Today
