The next part of my search for cheap is flipping through commodity price charts to see which of these markets has collapsed and declined over the past year. As a younger man I was fascinated by the idea of trading commodity futures, but the markets quickly proved to me that a value bias in futures is not really healthy -- unless you approached it with a much larger bankroll than I had at the time.
Still, paying attention to commodity prices makes sense for a fundamental investor. They are the raw ingredient for the products made by many companies, and they're a huge input into margins and profits. Cheaper steel could mean more profitable cars for Ford (F), and cheaper coffee prices could boost Starbucks (SBUX). I do not trade commodities anymore, but I do check the prices from time to time to see whether anything unusual or potentially profitable is occurring.
One commodity that leaps off the chart for me is cotton. Cotton prices on the Nymex have plummeted by more than 40% over the past year. Slowing demand, the end of China's purchasing program and an export ban in India have helped the fluffy stuff decline over the past several months. Many analysts expect demand to remain weak, which could keep prices fairly low thought the summer. This scenario could be a boost to the margins of apparel manufacturers like Oxford Industries (OXM) or PVH Corp. (PVH) for whom cotton ins an important raw material.
Coffee and cocoa have both declined over the past 52 weeks, and that is welcome news around Chez Melvin. I drink coffee like water all day, and the wife and daughters are fond of cocoa's end products as well. These declines are helpful to consumers, but a company like Starbucks that uses a fair amount of both could benefit as well. Most coffee firms lock in prices well ahead of time, so the boost in profits for these companies may not come until the end of 2012 or early 2013. Even if delayed, though, a decline of more than 30% in a raw material that is around one-sixth of your cost of goods has to help the profit margins eventually. I am not a fan of the coffee stocks like Starbucks or Dunkin Brands (DNKN), but momentum investors will be pleased for the potential of positive earnings surprises the next few quarters.
Lower wheat and corn prices could be great news for consumers as well. Wheat is down more than 20% over the past year, and it looks like a surplus could put additional pressure on prices. Corn is down a little less than 20%, but any decline in these key grain markets will help shoppers feeling the pinch of food inflation over the past year. The declines in many food commodities could also provide a small boost to margins for some of the beleaguered grocery chains such as SuperValu (SVU)
One of the more interesting commodity developments is in the energy sector. Natural gas has been talked almost to the point of exhaustion. We all know that slowing demand and an enormous amount of new supply has driven the price of NG to decade lows. At the same time, increasing regulations and slow demand has pushed the price of domestic thermal coal to low prices as well. Coal is not quite back to the lows of 2002, but it's not far off. Digging a little deeper, I see uranium oxide is selling near five-year lows as well.
These are the three major fuel sources for electricity generation in the U.S., and the prices have been falling for some time. One would think that this would be a boon for electric utility companies. When I look at the profits for the domestic regulated utility companies, though, I see this is far from the case. Most are struggling to get back to the profit levels of several years ago, and the return on equity and capital for much of the industry is still well below pre-recession levels.
None of the electric utility stocks are cheap, despite the obstacles and weak-profit environment. Yield-chasing has pushed them well above tangible book value. I have never lost money buying a regulated utility below tangible book value, and I have never seen much money made purchasing these stocks above that level, either. If the costs of fuels such as natural gas, coal and uranium begin to rebound over the next year or so, profits for these companies could plunge even further. Commodity charts make at least one thing very clear to me: Electric utility stocks as a group are a sell and avoid.
I am not a macro, chart or commodity guy, as you well know by now. But spending a little time with charts of various assets and markets around the globe can provide valuable information -- even for a value guy like me.
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