Basic Materials Selloff Offers Opportunities

NEW YORK ( TheStreet) -- Basic materials stocks have taken a beating on China's lower growth forecast, selling off sharply this week.

The dive was exacerbated by Tuesday's news that Europe may be in a recession and Greece could miss a debt deadline.

It's a mistake to lump all of the stocks in the basic materials sector together, though, and while copper stocks like Freeport McMoRan ( FCX) are beholden to Chinese demand, the broader basic materials sector is less reliant on the appetite of the Chinese economy and the general global GDP trade.

The Materials Select Sector SPDR ( XLB) is down close to 5% in the past five days, reaching its lowest price since early January, at under $36 on Tuesday. Freeport McMoRan is down 11% during the same five days, and that makes perfect sense, according to Morningstar materials analyst Min Tang-Varner.

"China has been the key driving force for higher metal prices in the past five years. When we first went into recession the reason the copper price dropped off only for a month or two was because China was backing up the truck and buying," the Morningstar analyst said. "Look for the extended weakness in names not linked to metals," the analyst added.

A chemicals company like DuPont ( DD) is also exposed to the U.S. and Latin American seed market, though Brazil, the biggest Latin American market, has been among the recent concerns of an emerging economy slowdown. A seed company like Monsanto ( MON) specifically, an industrial gas supplier like Praxair ( PX), or a chemicals market player like Ecolab ( ECL) -- all of which join No. 1 holding Du Pont among the top 10 holdings in the Materials Select Sector SPDR -- are very different growth stories than a metals company, and extended weakness could present buying opportunities.

The opportunity hasn't arisen yet, but it should be on the radar of investors if the selloff is extended.

"This global demand news is tangential for a chemicals company like DuPont," Tang-Varner said.

The Morningstar analyst said there are chemicals companies that are tied to the auto paint market and the housing market through paint and coating divisions and those are GDP trades, but Praxair, for example, as an industrial gas supplier, doesn't fit the bill of a "materials" stock that should suffer extended weakness on a slower global growth picture.

This valuation divide is reflected in the differing fortunes of these stocks, even if this week all the materials companies are down. Praxair and Ecolab are both trading near 52-week highs, while Freeport McMoRan shares have retraced most of the gains made since the beginning of 2012.

"Right now might not be the time to enter but as we compile more negative news, it's important for investors to recognize that some of these 'basic materials' companies are more immune to a slowdown. They follow more than just GDP growth," Tang-Varner said.

Many of the materials companies continue to be cash machines and if dividends come back into favor as a way to play stocks -- as they were in the first half of 2011 -- materials stocks have the cash hoards to offer reliable dividend streams.

"These companies have amassed quite a large cash pile during the past few years and have been very conservative so and even if we are heading into recession, I don't see them reducing dividends any time soon," Tang-Varner said.

Wells Fargo Advisors chief macro strategist Gary Thayer offers the macro equities case that supports the Morningstar' analyst's "buy materials stocks on weakness" argument. Thayer wrote in a research piece this week that market volatility was likely to increase since investors had become complacent, problems like Europe have not gone away, and stocks have run up in the first two months of 2012 at a pace that represents the largest two-month gain for the markets since 1991. The Wells Fargo strategist wrote that as a result buying on strength is not advisable, but stock market weakness remains a buying opportunity.

-- Written by Eric Rosenbaum from New York.

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