The Basics of Profiting on Basic Materials
Today we continue our look at the sectors of the stock market with an overview of the Basic Materials sector. Feeding many industries throughout the rest of the economy, this sector centers on the extraction and processing of raw materials that aren’t included in the energy sector (oil/gas). Prominent industries categorized under Basic Materials include:
- Mining of everything from iron ore to gold. The second biggest industry in the sector by market cap.
- Metal refining, most notably steel.
- Building materials manufacturers.
- Forestry and Related Products, including paper and paper product firms.
- Chemical Production, the single largest industry in the sector by market cap.
While each of these industries has unique dynamics, we generally expect Basic Materials stocks to be starkly pro-cyclical. These firms largely produce commodities whose price depends on global demand. In a hot economy, prices on basic materials are bid up by growing firms, but supply can outpace demand when the global economy slows, leaving many materials stocks in dire straits. Expect hypersensitivity to the macroeconomic business cycle for Basic Materials stocks.
With their fortunes clearly tied to relevant commodity prices, it’s tempting to attempt straightforward analysis connecting the price of a commodity and a stock producing it. But, given the financial complexity of modern firms, these relationships can be far more tenuous than one might expect. A mine, for instance, may have already locked in its revenue a decade in advance through futures contracts. Much deeper research in necessary if attempting to trade these stocks on their fundamentals (though news-based trading offers a powerful alternative).
Because commodities are so homogenous, fierce price competition rules the day in this sector, which can cause some dramatic swings in value. Firms that can’t produce at prevailing market prices are either sold to competitors, forced to cease operations until prices rise, or declare bankruptcy. Concurrently, firms lucky enough to be able to produce at a strong cost advantage can rake in massive profits. Most industries in this sector are also highly capital intensive, so balance sheet analysis is indispensable. Debt loads accrued during commodity booms can become unsustainable when prices inevitably fall. This sector is also heavily globalized, with firms owning mineral rights, forests, and factories across the world. That means trade conflict and exchange rate risk are yet another salient factor.
Fortunately, all this volatility creates diverse and plentiful profit opportunities for news-based traders.
Mining stocks alone account for a notable portion of our top performing stocks. Just like with upstream energy stocks, a single promising report on the productivity of a mineral rights play can totally transform the value of a firm overnight. As in other sectors, mergers and acquisitions are another key driver of profitable news events. Cutthroat price competition in this sector can drive waves of mergers during downswings as firms seek to consolidate to achieve further economies of scale.
News Quantified users leverage our data analytics platform to consistently find profitable news events in every sector. If you’d like to learn more about how we’re combining quantitative insights with real-time news tracking to find market-beating profits, we recommend one of our complimentary virtual training seminars. There’s no obligation or hard sell, just an up close look at a powerful approach for letting smaller investors get in on the news-based profits hedge fund quants have been raking in for decades. You can claim a spot in our next available session using the button below: