Major Stock Markets & Commodities Can't Agree

Major markets are deceiving. Although it appears that the averages are "holding up" relatively well, with the Dow Industrials and S&P 500 only trading about 10% off of their recent highs, things are collapsing elsewhere.

Commodities have been whacked pretty hard.

And some individual stocks -- specifically those in the technology and materials sector -- have lost as much as 50% of their value.

Market technicians would call this a market "divergence," in which there is conflicting information. While some blue-chip stocks have held up well, economically sensitive stocks such as cyclical and materials stocks have sold off violently and are reflecting a global slowdown led by the developing world.

I have an explanation for all of this. With treasury bonds paying just 2% interest, their "safe haven" status is limited to protecting investor capital. Investors may be hiding in the "safe haven" of dividends of blue chips such as AT&T Inc. (NYSE: T) and Abbott Laboratories (NYSE: ABT), which have performed well. With rates so low, there are plenty of people who believe it may be just as safe to stash your money in a pharmaceutical or telecom company paying you a 4% dividend.

With the European debt crisis bubbling up and China weakening, the commodities markets have priced in a pretty vicious slowdown in the global economy. But remember -- markets think ahead. By the time you read headlines confirming "recession," the markets will have already priced it in. There is no doubt that the commodities sector is pricing in a significant global slowdown. The question is whether you think it will be worse than what the market is saying.

Looking at the valuations of some stocks in the materials sector, some have gotten cheap enough that they may be worth nibbling at. Commodities and materials stocks are about as cheap as they have been in a couple years. But I would step gingerly, because as we said there is no way of knowing how bad this is going to get.

If you are looking at places to shop, start with the mining sector, which has many profitable, stable companies trading at less than eight-times forward earnings and go from there. A couple of weeks back I mentioned Barrick Gold (NYSE: ABX), which has traded up from the levels where we bought it (near $45). I bought Barrick when it traded at a P/E of 5, which seemed irrationally cheap to me. I will be looking for it to get back up above $50 to have more confidence and may even add to the position.

If we expand the metals horizon to the industrial area, including iron ore and copper, there are more opportunities. Stocks such as Rio Tinto (NYSE: RIO) and Freeport-McMoran (NYSE: FCX) have been absolutely crushed, down as much as 50% from their peaks last year, on fears about the slowdown in China. Unless China is entering a full-blown depression, these stocks have already priced in a significant slowdown in the developing markets.

RIO pays a 4% dividend and trades at a trailing price/earnings (P/E) ratio of 15. However, this year's analyst estimates are for $7.40 a share, yielding a P/E of only 6. These estimates may be too optimistic, but even with earnings of $6 per shares, RIO is a bargain. FCX is now paying a 4% dividend. It has a trailing P/E of 8 and a forward P/E of 6.35. Analysts expect about $4 a share in earnings this year and $5 in 2013. If FCX can deliver just holding the line on $4, it is very cheap at $34.

Another cheap stock in this area: Cliffs Natural Resources Inc. (NYSE: CLF), the US-based producer of iron ore. Its high was $100 per share as recently as last August, believe it or not. It now trades at $50. That's a 50% decline while the broad indices have moved higher. But another interesting thing is that analysts still believe it can earn $8 or more in 2012. That puts its P/E based on this year's estimates at less than 5.

What I find most intriguing about Cliffs is that the stock price is exactly where it was two years ago, when it was earning half as much money. I think you can safely take a shot with a stop near $47, limited the risk for a few dollars. If the economy is going to enter full-blown meltdown stage, we'll know pretty soon.

The oil and gas patch is another place to look. Many energy-related names have also gotten very cheap. Apache Corp. (NYSE: APA), which has been hurt by cheap natural gas prices, is trading almost 40% off its high as recently as last year. With the company expected to earn $12 per share in 2012 and the stock trading at $84, its got a P/E of about 7. It pays a small .80% dividend.

Finally, the last area of interest in commodities and materials is the agricultural sector. One stock that caught my eye on a few cheap-stock screens is CF Industries (NYSE: CF), a fertilizer maker. CF trades at a P/E of about $8. It was recently named one of the top five of Forbes best companies. It pays a 1% dividend.

It's clear at this point that the commodities markets have priced in a pretty serious slowdown. If you think things will be only that bad, or a little better, it's time to start putting some money to work. Of course I am not 100% certain that the commodities correction is over, but it seems at least ripe for a decent bounce. As I said, wading into this sector warrants caution, as we could still be in for a steeper decline, so patience will be required.

(Disclosure: The author owned Barrick Gold and Cliffs Natural Resources at the time of this writing. Positions can change at any time.)