10 Undervalued Commodity Producers to Consider

Commodities tend to exhibit boom bust cycles more than almost any other asset class known to man. Moving higher in long, unending waves and lower in steep cliffs of panic and sorrow (for speculators, that is), commodities tend to bottom in V shaped reversals and tend to top out in blow off top type pyramid price patterns. Looking at the mess that is today’s commodity correction, conclusions can be made that the complex as a whole is rather weak and that the strong upward momentum in commodities has come to a swift end. The “deflationists” will argue that commodities will tank due to the ending of quantitative easing and that more rounds of QE are warranted given the route in the “stuff” market over the past week.

Likewise, the tried and true bulls will point to several short term factors that are crushing the complex such as five straight back to back margin requirement hikes on silver, the killing of bin Laden, the rebound in the U.S. dollar, the pricing in of the ending of QE2, selling by trend following hedge funds, the release of the strategic oil reserves, and finally the idea many have that the bull market is over. Margin calls are surely being hit as we speak in these riskier assets, but has the bull case been completely refuted for the longer term?

Here is why I believe commodities are still attractive over the longer term:

1. The tremendous increase in the federal budget deficit and national debt
2. The tremendous increase in the money supply from QE and the bailouts
3. Banks may actually start lending new reserves at some point, creating inflation
4. The economy is improving at a mild pace
5. Global demand for resources will grow with a rising world population

Here are 10 stocks which appear to be good value plays in the space:

VALE: This iron ore and metals mining stock has not moved for months now and the stock looks too cheap at less than 6X forward earnings. Many are predicting a major slowdown in China and a sell off in China but I just don’t see it happening anytime soon. I like the stock here and think it’s one of the cheapest names in the mining space, as does Jim Cramer.

FCX: Freeport has not moved for months either and the stock is downright cheap on forward earnings at around 8X estimates. I also like the fact that these miners have significant undervalued in the ground assets that investors can backstop their holding with from a margin of safety perspective.

COP: ConocoPhillips shares are cheap here and at a forward PE of around 8X I think long term investors should sell the January 2012 put options on this stock as a way to get involved without putting up too much capital. If oil sells off even more than it has already, investors will be able to play defense and will not own the stock until around $65 or so per share.

CVX: Like ConocoPhillips, Chevron is undervalued and under-loved at current prices. We think investors are too gloomy on oil and that the sell off was driven by margined speculators leaving the market. The increase in the money supply is the main reason to stay bullish on commodities and on oil in general. With continued high oil prices, expect CVX to grow earnings in the years ahead.

PBR: Petrobras has been crushed since its deal with Brazil to expand reserves. I like the stock here as this company is replacing reserves while many of the majors are facing declining production due to the fact that some of them are running out of oil at any price. Petrobras is the best play on deep sea oil here and I think the stock is a bargain at 7X earnings. Look to sell the January 2012 $31 puts for a way to scale into the name.

JASO: Chinese Solar stocks are the redheaded stepchild of the value investment space right now, but I think the fears are overblown in the sector. China has a huge problem given its massive population and need for electricity. Coal can only go so far as pollution is already unmanageable. Tailwinds are driving strong growth here, not European subsidies.

STO: Statoil is a bargain at a 2.4X EV/EBITDA ratio – investors are completely writing off the company. I like this stock and think the recent pullback is a buying opportunity in the name. Covered calls seem like a good way to play this stock.

SDRL: SeaDrill is cheap on cash flows and management has shown that it can execute. While many of the other drillers have lost money over the past year, SDRL has delivered ROI to shareholders. I like this company given its newer fleet and deep sea focus.

NEM: Newmont is the cheapest pure play gold miner in the world. I like this stock and think investors should sell the January 2012 $55 puts here. Newmont at 11X free cash flows is far too cheap because the assets in the ground are worth several times the entire market cap of the common stock.

DUK: Duke Energy could revolutionize the pipeline and fracking businesses. Natural gas is going to be a huge driver of the economy in the years to come and I think the benefits from a carbon perspective outweigh the risks that come from fracking. Eventually, I think the Pickens Plan will be supported by Congress and that Duke is well positioned to drive shareholder value in the years ahead.

Disclosure: I am long NEM, SDRL, DUK, PBR, JASO.