Materials have outperformed every other sector on a global basis over the past five years. As a result, the brutal market selloff of late left investors asking, “Is this the end of the bull market in resources?” Coupled with the visible–albeit expected–global economic slowdown and lower oil prices, investor anxiety is rational.

We can’t rule out more weakness, so we still need to exercise caution going forward. (See VRI, 3 July 2008, The First Half.) No sound investor could have claimed that materials were selling at bargain prices. But these retracements should be viewed as buying opportunities as investors prepare for the next leg up.

The main difference between the current selloff and last year’s selloffs is that this slowdown has spread globally.

The sector bounced back after the last downturn as long-term investors took advantage of strong growth at discounted prices and supply constraint. These two factors remain present today.  

We’ve discussed the supply constraint investment theme here many times. (See VRI, 10 July 2008, Focus on Supply, for our most recently commentary on the subject.)

And we continue to focus on the topic as power problems, nationalization issues, labor disputes as well as simple scarcity of resources and insufficient infrastructure affect the supply process. In many situations, these disruptions reach levels equivalent to 6 percent of total consumption. Further studies have shown that to be the case with copper.

We expect scarcity to remain a major challenge for the resources sector for years to come, as the industry plays catch up with strong emerging market growth and increasing demand.

The current economic slowdown has market participants questioning the validity of those claiming emerging market growth remains strong. And, yet, nothing has changed materially: China will still grow by 8 percent no matter which direction the rest of the world moves. The Chinese aren’t considering the possibility of a deep, prolonged global recession.

We’re mentioning China separately because its economic development is the dominant factor for projecting any kind of growth for the resource industry. In the past 10 years, China has gradually gained a big share in resource consumption. It now consumes 40 percent of global steel production, 32 percent of aluminum, 25 percent of copper, 20 percent of paper and 10 percent of oil.

Interestingly enough, the Chinese leadership has repeatedly noted that the domestic economic growth of the country will continue as it fits with its strategy to create a vibrant, domestic-oriented economy.

It seems that most investors aren’t paying attention to these developments in China, thereby underestimating the country’s huge potential. China has the size, the money and–above all–the determination to move in this direction.

And China isn’t alone; India, the Middle East and Russia are also contributing to consumption. For India, its size and steady economic growth will continue to pull weight, while Russia and the Middle East–both petroleum producing behemoths–have the cash to improve their domestic infrastructure, ensuring strong demand for materials.

This is an extremely powerful trend, and it’s happening more often in developing countries because a large chunk of oil-generated revenues can be used to dramatically improve their domestic economies. 

The recent selloff has created quite a number of opportunities. Investors have offloaded former solid performers either to take profits off the table, for fears of political uncertainty or because of lower earnings growth expectations.

In VRI’s portfolio, Mechel (NYSE: MTL), Freeport McMoRan Copper & Gold (NYSE: FCX), and Norilsk Nickel (OTC: NILSY) are selling on the cheap.

We still favor all three plays, particularly Mechel. Despite its latest challenges, we stick by our recent analysis. (See VRI, 24 July 2008, The Trade, Mechel and More.)

Although the aforementioned scarcity issues do allow for higher prices, it also adds to cost, hurting margins in the short term.

We’ve covered rising costs facing all companies in recent issues. The recent earnings announcements of some of the bigger names in the industry–including our own favorite, Freeport–emphasize the trend.

That’s why we’ve been advocating exposure to larger diversified mining companies as your first step into the resource arena. These companies have the financial muscle and the know-how to respond to rising costs. See VRI, 12 June 2008, In Size, Sureness.

VRI’s portfolio holdings Xstrata (OTC: XSRAF), Anglo American (LN: AAL, NADQ: AAUK) and Rio Tinto (NYSE: RTP) are strong anchors for any portfolio.

We also strongly recommend our food and water play, China Green Holdings (Hong Kong: 904, OTC: CIGEF), Hyflux (Singapore: HYF, OTC: HYFXF), and Suez Environnement (Paris: SVE). See VRI, 31 July 2008, The Next Leg Up.

Agricultural chemicals are still high-quality plays. Our favorites–in descending order–are Monsanto (NYSE: MON), The Andersons (NSDQ: ANDE), and Du Pont (NYSE: DD).

We also favor uranium as prices continue to drift downward. We view this as a buying opportunity and expect the yellow cake’s demand to continue for years to come. Our favorite company is Paladin Energy (Australia: PDN, OTC: PALAF) because it offers strong leverage and strong valuations. See VRI, 29 May 2008, Faraway Places.

Finally, we still like gold. It remains a great defensive play that’s still experiencing a solid, multiyear bull market.

We prefer bullion or its exchange traded fund (ETF) proxy streetTRACKS Gold Trust (NYSE: GLD). Our favorite yellow metal company is Goldcorp (NYSE: GG). Lihir Gold (Australia: LGL, NSDQ: LIHR) is our leveraged gold play. It’s a turnaround story that we’re constantly reviewing as we follow management’s efforts to improve performance and growth.  

Speaking Engagements

You’re invited to tune in as KCI’s LIVE Webcast events air from the 30th annual Money Show San Francisco. The editors will be presenting their latest insights and recommendations surrounding this year’s central theme “Tech and Biotech Investing.”

Registration is FREE and can be completed at MoneyShow.com. So please check out the KCI events, and tune in Aug. 7-10, 2008.

The Best Stocks Money Can Buy
Friday, Aug. 8
6 pm – 6:45 pm PDT

I also have a special invitation for readers to join me and my colleagues Elliott Gue, Gregg Early and Neil George aboard an exciting 11-day investment cruise Dec. 1-12 through the Caribbean and Panama Canal.

This will be a unique opportunity to step away from your daily routines, relax in one of the most beautiful parts of the world and share analysts’ knowledge and passion for the markets. During the sail, you’ll not only explore the cerulean splendor of the Caribbean, but you’ll also delve deep into current markets in search of the most profitable opportunities for your portfolios. You’ll also have the rare chance to sail through one of the world’s engineering marvels, the Panama Canal.

It’s always a special treat to meet and talk with subscribers in person, and we couldn’t have picked a better setting than aboard the six-star Crystal Serenity. This is sure to be an especially memorable experience. We hope you’ll join us.

For more information, please click here or call 877-238-1270.