As Inflation Looms, These Commodity Stocks Could Shine

Stock performance with laptop and calculator

Inflation has been low for decades and commodity prices have lacked the luster they enjoyed from the late 1990s through the financial crisis, when most experienced double-digit annual (inflation-adjusted) price growth. According to a 2013 paper published by Pimco, this period--known as the commodity "supercycle"-saw price growth in oil, copper and corn to the tune of 1,062%, 487% and 240%, respectfully.

But the outlook for this asset class could be shifting. The Fed has upgraded its growth and inflation forecasts--along with its announcement of a rate increase (and three more to come in 2017)--as summarized in its latest summary of economic projections:

Some potential contributors to the expected increase are:

  • A tighter labor market: As unemployment falls, rising demand for goods and services is addressed by increased prices (as reflected in the Phillips Curve);
  • Stabilizing oil prices are typically accompanied by higher inflation expectations;
  • Slowing appreciation in the U.S. dollar: While the dollar remains at records highs, it has leveled somewhat.
  • This month's issue of the AAII Journal offers data that point to a strong outlook for this asset class:

    An S&P Dow Jones Indices report from 2012 states, "While equity and fixed income returns are negatively correlated with inflation, commodity returns have a significant positive correlation with both expected and unexpected inflation. Commodities tend to thrive in a rising inflation environment while equities and fixed income assets generally generate poor returns."

    Ternium SA ( TX ) is a producer of finished and semi-finished steel products and iron ore which are sold either directly to steel manufacturers, steel processors or end users. It is favored by our Kenneth Fisher-based stock screen due to its price-sales ratio of .69 (based on trailing 12-month sales), comfortably within the preferred range of 0.4 and 0.8. Debt-equity of 32.46% is considered acceptable by this model, and average long-term growth in earnings-per-share of 115.13% is nearly eight times the required level. Free cash-per-share of $3.46 is sufficient to sustain three years of losses, a requirement under this strategy.

    Terra Nitrogen Company, L.P. ( TNH ) produces nitrogen fertilizer products, principally ammonia and urea ammonium nitrate solutions. It is favored by our Benjamin Graham-based investment strategy given its revenue base (12-month trailing) of $476.2 million (versus the minimum requirement of $340 million) and the current ratio of 2.23 compared to the minimum requirement of 2.0. TNH has no long-term debt, a plus according to this screen, and earnings-per-share have more than doubled over the past ten years (growth of at least 30% required) and has not been negative over any of the last five years. The price-earnings ratio of 12.59 is within the allowed ceiling of 15.

    Rio Tinto Plc ( RIO ) is a mining company that focuses on aluminum, copper and coal, diamonds and minerals and iron ore. The company earns a perfect score under our James O'Shaughnessy investment strategy based on its size (market capitalization of $71.40 billion) and cash flow-per-share of $2.09, which exceeds the market mean of $1.45, as required to pass this model. This screen likes companies with outstanding shares in excess of the market average (627 million shares), and RIO passes this test with flying colors with 1.8 billion shares outstanding. Trailing 12-month sales of $32.34 billion are more than 1.5 times the market mean, a requirement under this model, and dividend yield of 3.91% adds appeal.

    Cameco Corp. ( USA ) ( CCJ ) is a Canada-based uranium producer that scores well under our Joseph Piotroski investment strategy, which looks for stocks in the top 20% of the market based on book-market ratio (the inverse of price-book ratio). With a book-market ratio of 0.98, CCJ meets this criterion. The company's return-on-assets (0.74%) is considered favorable by this model and represents an increase over the prior year, a plus. Operating cash flow for the current year ($342.81) exceeds net income ($51.45 million), as required, and the number of shares outstanding has remained stable, indicating that the company is able to generate sufficient operating cash to fund its business.

    Dow Chemical Co. (DOW) is a manufacturer and supplier of chemical products for the agricultural, consumer and automotive markets as well as a provider of infrastructure solutions and delivery systems for coatings, adhesives and other products. The company earns a perfect score under our O'Shaughnessy-inspired investment strategy based on its size (market capitalization of $66.25 billion) and number of shares outstanding (1.12 billion) which is well in excess of the market average (627 million). Under this model, both cash flow-per-share and trailing 12-month sales are required to exceed the market mean level by 1.5 times. With cash flow-per-share of $9.16 and sales of $46.6 billion, DOW handily meets these requirements.

    At the time of publication, John Reese and his clients were long TX, TNH, RIO, CCJ and DOW

    The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

    The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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