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Basic Materials: Recent Commodity Rallies Leave Few Opportunities

The market overestimates the sustainability of recent commodity rallies, leaving the basic materials sector severely overvalued.

Kristoffer Inton
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  • Optimism continues to reign in the basic materials sector year to date, but investors are overestimating the sustainability of recent commodity price rallies. The basic materials sector remains severely overvalued, with a market-cap weighted price/fair value estimate of 1.26 as of May 31.
  • The reasons for rallies in steel, iron ore, and gold differ, but we don't expect any of the price gains to hold. Limited impact from steel trade cases and significant oversupply will bring pain to steelmakers and iron ore miners, respectively, in the second half of 2016. The recent Brexit vote helped extend the 2016 gold rally as interest rate hikes are potentially delayed through the second half of the year. However, pending rate hikes--though now further out--still weaken the outlook for gold miners into 2017.
  • While multifamily starts and permits have slowed down amid tighter lending standards, strengthening housing formation still bodes well for housing starts in the long term.
  • A bumper crop of seed and crop chemical mergers is reshaping the industry as competitors try to jumpstart their businesses amid a stagnant operating environment. However, consolidation is unlikely to generate significant synergies or improved competitive positioning.

 

Kristoffer Inton does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.

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