Don’t Abandon the Resource Stock Ship Just Yet

If you’re a commodity investor, I’m sure your favorite asset class’s recent performance has given you a run for your money. Judging by what my colleagues in retail brokerages are saying, phones are ringing off the hook and the broker who ends up picking up the line is not having a pleasant chat about the weather and profits.

Yet I, along with the other editors at Lombardi Financial, am no longer alone in my contrarian voice advising investors not to abandon mining and energy stocks just yet. Apparently, we are not the only ones reasoning that China, India, and other emerging markets are not yet done pushing the demand for commodity asset classes through the roof.

If only the correlation coefficient, that pesky statistical tool explaining the relationship between the demand/supply imbalance and stocks’ fundamentals, made more sense. The discord in rationality is precisely what is driving commodity investors crazy. Thankfully, when it is difficult to be rational, it pays to be a contrarian. One of the techniques often successfully employed in disputing the efficient market theory is to do exactly the opposite from money managers.

So, what are money managers doing as of late? Well, because the Street appears worried about China’s economy and sustainability of the demand for resources and energy from the emerging economies, most have been reallocating their money under management into safer asset classes, such as financial or Big Pharma stocks. And what are contrarians supposed to do if that is the case? Exactly the opposite!

There is one more factor adversely impacting the demand for raw materials — the fiasco of subprime lenders in the U.S.

With troubles on the mortgage front, rumors traveled fast to construction sites. As rumors turned to reality on construction sites, trouble traveled even faster to manufacturers and raw material suppliers. And here we go again; industrial mining and energy stocks have taken a beating — although there is hardly any evidence that either domestic or global economic growth is “curbing their enthusiasm.”

In our experience, these irrationalities have a way of sorting themselves out on their own. Here are a few facts that might help speed things along: Global economic growth is forecasted at 4.5% for 2007. The supply imbalances are still very much a reality, particularly when it comes to raw materials and energy. Aside from a few short squeezes in the spot market, which generated short-lived buying pressures, the U.S. dollar is mostly painting a depressing picture. Add to the mess geopolitical uncertainties, base and precious metals, as well as energy stocks, should start recovering sooner rather than later.

So, if you’re thinking of abandoning ship — don’t! If your risk tolerance is being tested, place a hedge to offset any potential downside. Finally, if there is really a risk of you losing your beauty sleep, diversify outside of Canada and the U.S.