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Stock Strategist

Basic Materials: The Recent Commodity Rally Shouldn't Give Investors Hope

As China's investment-fueled boom falters, investors must look elsewhere. Hello U.S. housing.

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  • In aggregate, basic materials stocks look somewhat overvalued, with the average company under our coverage trading at a 12% premium to our fair value estimate. That's not to say that we don't see pockets of significantly undervalued companies in the sector.
  • Despite the recent rally in some commodity prices, our outlook for commodities related to Chinese fixed-asset investment remains negative. In particular, we see significant downside in iron ore, where we expect prices to fall by half as Chinese steel demand wanes and scrap supplies surge.
  • Price outlooks are relatively better for commodities related to the Chinese consumer. Gold is one such commodity. However, we would preach caution on the recent safe-haven gold rally. In our view, resurgent investor demand rests on shaky footing.
  • With faltering Chinese growth likely to wreak havoc on investment-oriented commodities, we look to U.S. housing as a pocket of opportunity. We believe housing starts will be driven higher during 2016, underpinned by our demographic forecast, wage growth, and higher loan volumes. Our long-term housing starts forecast remains considerably bullish versus consensus.

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Jeffrey Stafford does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.