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Quarter-End Insights

Our Outlook for Basic Materials Stocks

We see fewer investing opportunities in basic materials today because of strong stock market performance without a commensurate improvement in forecasts relative to our previous expectations.

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  • Our basic materials coverage universe has approached fair value compared with three and six months ago, when we saw many more undervalued names in the sector.
  • Coal stocks have been hard-pressed by weakening metallurgical coal prices and low natural gas prices.
  • Policy statements from Beijing and monthly data from the National Bureau of Statistics on fixed-asset investment, industrial production, retail sales, and real estate spending will be required reading for investors in the second quarter.

Basic materials stocks as a whole have performed well in recent months. However, we have not seen any fundamental improvement in outlook compared with our expectations in late 2011, so we've had little cause to raise many of our fair value estimates. As a result, the price/fair value ratio for the basic materials sector is currently 0.87, compared with 0.77 three months ago. The biggest changes in sentiment for basic materials companies within the past year or so has been for coal miners and fertilizer producers. It wasn't too long ago that investing in metallurgical coal exposure was all the rage, but the fundamentals are no longer supporting that trade given a pullback in metallurgical coal prices. We think the market's dimmer view of miners with metallurgical coal exposure is largely warranted. In contrast, we'd argue that caution in the fertilizer industry is less warranted. Crop fundamentals and farmer economics remain strong.

Elizabeth Collins has a position in the following securities mentioned above: WY, MT. Find out about Morningstar’s editorial policies.

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