Quarter-End Insights

Basic Materials: Overpriced, With Significant Downside Ahead for Commodities

Andrew Lane
  • On a market-capitalization-weighted basis, our basic materials coverage trades at a 25% premium to our estimate of intrinsic value, remaining the most overvalued sector. Our bearish perspectives on most mining and metals companies are the primary drivers of this.
  • Miners and industrial metals companies we cover remain substantially overvalued, reflecting our expectation of a structural change in demand growth from China as its economy matures and makes the transition toward less commodity-intensive and more consumption-driven growth.
  • Gold is among the few mined commodities that isn't directly tied to the fortunes of Chinese fixed-asset investment, but as the U.S. Federal Reserve continues to pursue rate increases, prices look primed to fall. Higher inflation has buoyed gold prices but should only strengthen the central bank's resolve.
  • Unfavorable weather conditions weighed on first-quarter results for many of the agriculture companies we cover, as a delayed start to the U.S. planting season reduced sales across every crop input category. While seed sales should bounce back in the second quarter, we expect planters to use less total nitrogen and crop chemicals in 2018 as the late start reduces midseason application volumes. However, stronger potash demand outside of North America should more than offset stagnant or slightly reduced demand in North America.
  • The  Bayer (BAYRY) acquisition of Monsanto closed in June after receiving all regulatory approvals. All major agriculture deals from companies under our coverage have now closed.
  • U.S. construction activity has continued to gain momentum during the first quarter, with housing starts following builder confidence higher. However, lumber companies look expensive following short-term supply disruptions. We remain optimistic on long-term infrastructure spending, leading to positive outlooks for aggregate and cement companies.

Andrew Lane has a position in the following securities mentioned above: CCJ. Find out about Morningstar's editorial policies.