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Quarter-End Insights

Basic Materials: China-Dependent Producers Largely Overvalued

This year's credit-fueled increase in Chinese fixed-asset investment will prove unsustainable.

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  • We continue to regard the basic materials sector as overvalued. We expect this year's credit-fueled increase in Chinese fixed-asset investment to prove unsustainable, ultimately giving way to weaker demand and prices for China-leveraged commodity producers. Our coverage universe traded at a market-capitalization-weighted price/fair value of 1.28 as of Aug. 31.
  • Our bearish China outlook informs an especially negative outlook on industrial commodities, with below-consensus price forecasts for aluminum, copper, iron ore, and steel. Although we're relatively more positive on gold, we expect eventual rate hikes to trigger a reversal in recently strong investor inflows. Whereas we had viewed gold miners as attractive less than a year ago, the space looks largely overvalued today.
  • Among the major macroeconomic drivers for materials stocks, we're most positive on U.S. housing. Household formation among millennials, while delayed, is likely to drive meaningfully stronger new construction through the end of the decade. We prefer lumber producers for housing exposure.
  • The overhaul of the seeds and crop chemicals industries through mergers and acquisitions continued in the third quarter, with seeds giant Monsanto (MON) accepting Bayer's (BAYRY) purchase offer in September. Although we're generally positive on agriculture names because of the long-term tailwind afforded by emerging-markets food consumption, we question the strategic rationale of recent dealmaking and doubt that the integrated seed-chemical model will strengthen competitive advantages.

 

Daniel Rohr 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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