Investing in Basic Materials: Is There Still Room to Grow?

The basic materials sector, encompassing miners, metal refiners, and chemical producers, has experienced a rollercoaster ride in recent years. After surging in 2021 and early 2022 due to a recovering global economy driving demand, the sector faced a downturn as economic growth slowed. However, despite recent dips, industry experts like Randy Watts, Chief Investment Officer at O’Neill Global Advisors, believe there’s still significant growth potential in basic materials. Let’s delve into the factors shaping this sector and explore promising investment opportunities.

Economic Indicators: A Mixed Bag for Basic Materials

The outlook for basic materials is intricately linked to global economic health. While recent data from China, a major materials importer, revealed a contraction in factory activity, other regions offer a more optimistic picture. Europe’s growth, although moderating, remains robust, and the United States is poised to benefit from President Biden’s trillion-dollar infrastructure bill. This massive investment in highways, bridges, and other construction projects is expected to significantly boost demand for steel and other materials.

Steelmakers: Riding the Infrastructure Wave

Randy Watts highlights the steel industry as particularly well-positioned for growth. With increasing U.S. auto demand and the anticipated infrastructure boom, steelmakers like Cleveland-Cliffs and Steel Dynamics are attracting investor attention. These companies are experiencing strong earnings and generating substantial free cash flow.

Adding to their appeal, China, a major steel exporter, has imposed tariffs, creating a more favorable environment for U.S. and EU producers.

Electric Vehicle Revolution: A Boon for Battery Materials

The rapid rise of electric vehicles (EVs) presents another significant growth driver for the basic materials sector. Lithium batteries power most EVs, and demand for this key material is skyrocketing. Albemarle and Livent, major players in the lithium market, are ramping up production capacity to capitalize on this trend.

Watts emphasizes the long-term potential of this sector, predicting that the shift towards electric mobility will continue to drive demand for battery materials for years to come.

Valuation and Outlook: Finding Value in Basic Materials

Despite the positive long-term outlook, some analysts express concerns about overvaluation in the basic materials sector. However, Watts argues that many stocks in this sector, particularly in the steel and battery materials industries, remain attractively priced relative to their earnings potential.

Companies like Cleveland-Cliffs and Steel Dynamics are trading at price-to-earnings ratios below five, suggesting undervaluation. This discrepancy between current valuations and future growth prospects makes basic materials an intriguing sector for investors seeking value.

Navigating the Volatility: A Long-Term Perspective

The basic materials sector is inherently cyclical, influenced by global economic fluctuations and commodity price swings. While short-term volatility is expected, a long-term perspective is crucial when investing in this sector.

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By focusing on companies with strong fundamentals, sound management teams, and a clear strategic vision, investors can navigate the ups and downs of the market cycle and capitalize on the long-term growth potential of the basic materials sector.