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Make a Move Into Materials Stocks

The materials sector has been volatile and seen glimmers of hope, but the stocks haven’t held on to gains as the economy continues to struggle at home and as industrial demand from China remains relatively weak.

Commodity prices from aluminum to copper remain under pressure, squeezing margins at major materials players from Dow bellwether Alcoa (NYSE:AA) to Southern Copper (NYSE:SCCO) to global mining powerhouse BHP Billiton (NYSE:BHP). Business spending has been soft and thus industrial chemicals from Dupont (NYSE:DD) and Dow Chemical (NYSE:DOW) to Germany’s BASF (PINK:BASFY) haven’t been as in demand.

But that all could be changing in the next year or two, presuming the European economy figures things out and the American recovery continues to take shape.

I know those are big-time “ifs.” Part of the reason metals and chemicals stocks have been held back is because the economic uncertainty remains high and there are no clear signs in the data yet that those conditions are substantively changing.

But if you’re looking for value, perhaps the only part of the market that isn’t fairly valued (or overbought) is the materials sector.

Many base metal players including Alcoa and U.S. Steel (NYSE:X) trade at single-digit forward P/Es. Yes, margins are thin thanks to weak pricing, but operations are very profitable once more after big-time cutbacks during the downturn. Elsewhere chemical stocks like 3M (NYSE:MMM) and Dow Chemical are at 52-week highs but remain fairly valued at worst, with P/E’s around 13 or so.

The opportunity cost is real, of course. If you get a modest gain in materials stocks that track the market, you’re really no better off than just buying an indexed fund. And unlike buying an indexed fund, the risk of lagging the market remains persistent.

But if you truly believe the American economy is turning around and that demand for building materials and industrial chemicals will pick up, you could do worse than taking a stake in a broad-based materials ETF.

The iShares Global Materials ETF (NYSE:MXI) appeals to me because it has a good breadth geographically and across different sectors. BHP is the top holding, with other big stakes in industrial chemicals stocks like Dow and BASF. But there’s also exposure to miner Rio Tinto (NYSE:RIO) and agricultural chemicals giant Monsanto (NYSE:MON). The 30-day yield is also over 2%, which is right on par with the broader S&P 500.

There is risk here since materials are a very cyclical play. But if you’re a long-term investor who believes things are slowly getting better, this materials investment could pay off big-time over the long haul.

Presuming the up-and-down nature of these stocks ceases and the profits start to stick going forward, of course.

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Jeff Reeves is the editor of InvestorPlace.com and the author of “The Frugal Investor’s Guide to Finding Great Stocks.” Write him at editor@investorplace.com or follow him on Twitter via @JeffReevesIP. As of this writing he did not own a position in any of the stocks named here.

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