Investments that defy logic are more common than you’d think. Even during periods of modest growth of gross domestic product, indices and investment strategies based on basic materials would seem to benefit from improving economic conditions. The two one-year charts below display a disparity of this premise. The first chart is the one-year US GDP, and the other is a one-year chart of the iShares Dow Jones US Basic Materials ETF.
The simple line chart of GDP growth does indicate expansion in the US economy. However, the bar chart of the iShares Dow Jones US Basic Materials ETF indicates choppiness throughout the year with a minimal year-to-year change.
Looking further, the one-year posted return is -0.79%, the three-year return is 4.18%, and the five-year return is -1.04%. It seems that this sector has been in the doldrums, and most likely such a pattern will continue. It just baffles logic how such a non-performer can hold close to $0.5 billion dollars in assets to manage. More clues to this may be found in the top holdings. See the industry allocation chart below.
The largest position of iShares Dow Jones US Basic Materials Sector Index Fund is E I Du Pont De Nemours And Co (NYSE:DD). As of April 30, there is approximately 10.8% of this stock held in the iShares Dow Jones US Basic Materials ETF. Du Pont does exert a strong influence on this strategy.
According to a press release issued at the end of 2012, E I Du Pont De Nemours And Co (NYSE:DD)’s management sees increased operating expenses and a continued challenge in segments of its business because of ongoing weakness in the world economy. I am not too excited about this company as an investment opportunity. This is a case in point of the philosophy that a good company and a good stock are not always the same thing. Take a look at the price chart below. Even with the recent uptrend it remains to be seen if this indicates a change in trend that leads to an increased demand for shares of E I Du Pont De Nemours And Co (NYSE:DD).
Next in line is another large chemical company stock, The Dow Chemical Company (NYSE:DOW). The weighting to The Dow Chemical Company (NYSE:DOW) is approximately 8.6% of the iShares Dow Jones US Basic Materials ETF. See the chart below.
This is another example of a disconnection between stock price performance and good earnings and related developments. The first quarter of 2013 was filled with positive comments, such as increased earnings per share, from period-to-period, of $0.46 per share versus $0.35 per share. Cash flow from operations increased by nearly $500 million, and debt-reduction programs have removed $901 million from the books. Yet these factors have yet to stimulate the investing public to buy the shares.
Dropping to the third stock in the iShares Dow Jones US Basic Materials ETF highlights a position of approximately 7.2% in Praxair, Inc. (NYSE:PX), another chemical company. The 10-Q released on April 26 shows some more unimpressive results that seem to be consistent with this sector. Gross sales from period-to-period were basically flat, net income dropped, the number of shares outstanding decreased, and basic earnings per share declined. The price chart below shows another stock that is just moving sideways. I do not see any prospects for better-than-market-rate returns here, either.
The fourth stock held in the iShares Dow Jones US Basic Materials ETF is Freeport-McMoRan Copper & Gold Inc. (NYSE:FCX). The current allocation to this stock is 6.0%. This is a mining company, and the three main materials it brings to market are gold, copper, and molybdenum.
The first quarter of 2013 earnings announcement showed that earnings per share were $0.68 versus $0.80 for the first quarter of 2012. What is more significant is that the net results were achieved by the sale of more copper and molybdenum, and less gold.
Another highlighted item was the completion $10.5 billion in debt to be used for the pending acquisition of Plains Exploration and Production. This acquisition is on hold because the price Freeport-McMoRan Copper & Gold Inc. (NYSE:FCX) offered is considered too low.
These factors, in my opinion, make this stock unattractive. Adding to this is the recent and volatile drop in the price of gold, a key component of the business strategy. It appears in the price chart below that these negative factors are reflected accordingly.
In my analysis of this sector it appears that this is not the place to invest. Perhaps the only viable strategy for this group is to write options against it and collect ongoing premiums until such a time when a new trend develops and is confirmed. Even this concept is for the sophisticated investor that understands and accepts the risks of options.
The article A Flatlining ETF That Should Perform Better originally appeared on Fool.com and is written by Jeff Stouffer.
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