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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.

Jeffrey Stafford 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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