Penn Wealth Publishing

2019.09.15 Penn Wealth Report Vol 7 Issue 04

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15 Sep 2019 penn wealth Report volume 7 iSSue 04 9 Copyright 2019. All Rights Reserved. inveStment Intelligence Obviously, silver is also considered a precious metal, despite its wide array of industrial applications. Base metals, how- ever, are the blue-collar cousins to gold and silver. If a country's industrial base is humming, massive amounts of iron, cop- per, nickel, zinc, and other base metals are being put to work. And if that's the case, demand overtakes supply and the prices of these metals rise. Just the opposite has been happening. For years, China's growth spurt and building spree (even if nobody was living in the cities they built) helped sustain the price momentum of base metals. Now, however, as Chinese growth slows to its weakest level in nearly three decades, these prices have been falling back to earth at an alarming rate. Even without the trade war, this emerging economy would not have been able to keep up its pace of growth—despite the sophomoric graphs created by the media showing the exact date at which the Chinese economy would surpass that of America's. It is the simple law of large numbers—an equa- tion the press couldn't wrap its tainted head around. en there is the fourth-largest econ- omy in the world, Germany, which is dancing around a new recession. ink of the massive amounts of base metals used to build German automobiles. Now con- sider the horrendous state the German automakers find themselves in right now, due in good measure to the slowdown within the largest importer of German autos—China. Certainly, slumping base metal prices might be one leading indicator pointing to a global recession. But just because China won't regain the growth trajectory it held for the past two decades (remem- ber Japan in the 1980s?), aren't there other regions waiting to fill the void? e most promising emerging market in the world right now is probably India, a nation with roughly the same popu- lation as China, but with an ace up its sleeve—it is a democracy. Unfortunately, India also has a byzantine business system which has been nearly impossible for most US companies to navigate. Conducting "business as usual" in India often carries the risk of running afoul of US regula- tors. Nonetheless, Prime Minister Modi is the leader who can bring India into the 21st century. Also worth noting are countries which are welcoming the businesses fleeing from China to reduce the threat known as country risk. China has already lost the trade war in that respect: companies that are leaving will be in no hurry to go back. ese countries include: Vietnam, Indonesia, Malaysia, Portugal, and a host of Eastern European nations. Latin American nations such as Brazil and Argentina should certainly be on that list, but geopolitical troubles in that region has stifled growth. In short, we believe the press has exag- gerated the importance of China's economic growth as a component of global growth. And this false narrative ("if China's growth rate slows the world is in a recession") has helped pummel down the price of base metals. If this is a buying opportunity, where should we look? When a narrative—false or otherwise— drives a sector or an industry down, glittering jewels can always be found by sifting through the debris. We believe that is the case with basic materials, which includes base metals, right now. Let's con- sider a few options which may be ripe for the picking. e Invesco DWA Basic Materials Momentum ETF (PYZ $50-$56-$71) is based on the Dorsey Wright® Basic Materials Technical Leaders Index. is index is designed to filter through com- panies which are showing strong relative strength (momentum) as compared to all companies within the universe. Currently, PYZ holds 49 companies operating in the basic materials sector, to include: FMC Corp (FMC), Ecolab (ECL), Air Products & Chemicals (APD), Celanese (CE), and PPG Industries (PPG). e fund's hold- ings carry an average P/E ratio of 17 and an average market cap of $13 billion. We consider both of those metrics in the sweet spot. e VanEck Vectors Steel ETF (SLX $31-$31-$47) has been crushed (no pun intended) over the past year. Sitting at its one-year low share price, SLX seeks to replicate the performance of the NYSE Arca Steel Index. ere are cur- rently 25 mining and manufacturing companies held in this ETF, with such well-known names as Rio Tinto (RIO), Vale SA (VALE), Nucor (NUE), and Steel Dynamics (STLD) all in the top ten. Any comeback in steel prices would be nicely reflected by a move higher in this fund. Anyone following Penn Wealth's global strategy reports is familiar with the ongoing threat of China trying to corner the rare earth minerals market to its own geopolitical ends. Incredibly, the last US-based rare earth miner, Molycorp, owner and operator of the Mountain Pass rare earth mine, filed for bankruptcy in 2015. e strategic importance of rare earth metals for this nation's defense and industrial base cannot be overstated. e VanEck Vectors Rare Earth/Strategic Metals ETF (REMX $12-$12-$21) tracks an index of global companies that mine, refine, or recycle rare earth and strate- gic metals. Compared to base metals, these substances have more specialized uses in high-tech components, and are often more difficult to extract. Examples include cerium, manganese, titanium, and tungsten. If the supply of these met- als were disrupted, it could wreak havoc on a country's high-tech industrial base. REMX holds 21 of the world's top rare earth miners, and yes, over half are based in Asia. While these three ETFs can mitigate the risks associated with any one par- ticular company, we do like shares of Southern Copper Corp (SCCO $29-$31- $45) sitting near their 52-week low. With a P/E of 16, SCCO is one of the world's largest copper producers, with 155 billion pounds of the metal (more than any other company) sitting in reserves. Based on its free cash flow and earnings projections, we would place a $38/share fair value on the company. In fact, Southern Copper may well be one of the best ways to play a base materials comeback.

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