Digging Around Commodities After the Tumble

 | Apr 16, 2013 | 2:00 PM EDT
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As we examine the fallout of Monday's commodities slide, the question of maximum pessimism in material stocks begins to rear its head. The action in gold and silver appeared to constitute margin-related liquidation, and that is often one of the first signs of maximum pessimism in a sector or asset class. If you become the buyer of last resort in an unloved asset, it's usually a path to extraordinary profits -- so I am always on the alert for signs of maximum pessimism and the extreme buying opportunities it creates.

I am of the opinion that the metals have to be getting close to that point. Silver has sunk 21% so far this year, while gold has lost 16%. Copper is often considered the most economically sensitive commodity, and it is off 10% so far for 2013. Coal prices have once again begun to retreat from the highs of December, and they appear to be headed back towards the $50-per-ton level. Iron ore prices have recovered a little, but are still well below the levels reached in 2010. Industrial metals like steel and aluminum are declining, as well, as demand falls off around the globe.

All of this has not gone unnoticed by stock traders. Coal stocks have pulled back 25% already this year, steel stocks have fallen by 17% and gold miners are down more than 20%. Aluminum stocks are the star performer of the sector, falling just about 3.5% so far in 2013. When we look at charts of individual names such as Cliffs Natural Resources (CLF), U.S. Steel (X) and my favorite, ArcelorMittal (MT), they look like water slides rather than rollercoaster. These stocks have pointed straight down, with just a few minor bumps and twists to keep it interesting. The selling in both the commodities and the stocks has been heavy and pretty much continuous so far this year. Nobody want to own them, and that is catching my attention.

When it comes to gold itself, I have no opinion, nor do I wish to form one. The metal as an investment holds no interest for me. But gold mining is a business like any other, and some of these stocks are approaching levels at which where they are cheap enough to consider. I also find it of interest that some of the really smart investors on Wall Street were long some gold stocks – such investors as Seth Klarman, Donald Smith & Co. and Arbiter Partners. 13F filings are due in about a month, and it will be interesting to see if they've held or added to their positions. It does seem that, for now, declining gold prices could actually be a long-term positive for the miners as a lot of marginal production permanently goes offline.

As ugly as Monday was for commodities, I do not think the gold miners have reached the maximum pessimism just yet. They are getting close, but the larger miners still trade above book value, and I would expect them to trade at a discount to tangible book before they'll bottom out and they become attractive investments. Barrick Gold (ABX) fetches 1.6x book value and Newmont (NEM) is at 1.2x its tangible asset value. Of the gold miners I quickly scanned this morning, only AuRico Gold (AUQ) looks cheap enough to buy at 70% of tangible book value.

The silver miners appear to be much closer to the point of maximum pessimism. I have to put my research hat on this afternoon and get a better grip on the silver business, but the stocks are currently cheap relative to their asset values. Coeur d' Alene Mines (CDE) is the largest U.S. silver miner, and it currently trades at just 60% of tangible book value. Hecla Mining (HL) is currently fetching only 80% of its tangible book value. Of the two largest Canadian miners, Silver Wheaton (SLW) remains at a premium to book, but Pan American Silver (PAAS) is trading at a 20% discount to its asset value. These stocks are nearing five-year lows, and they appear to be bargain issues worth serious consideration by long-term asset-based value investors.

I have stock my toe into the materials stocks, and have positions in Cliffs, Arch Coal (ACI) and Arcelor Mittal (MT) so far. Both have gone down since I made my originally purchases, and I expect they will move further against me before materials and miners will reach the point of maximum pessimism.

I also expect that, before that point is reached, I will own more of the basic-materials stocks as the selling pressure creates more bargains. The key to buying in search of maximum pessimism is to move very slowly and to buy on a scale as the decline progresses. Stay small, move slowly and be patient. It has always worked in the past, and I see no reason it will not work here in the materials space.

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