This Long-Dead Sector is Staging a Huge Turnaround

Natural resource stocks were the worst-performing group in 2015, with the sector plummeting nearly 27%. But since its January lows, this group has been on a tear, more than doubling the return of the benchmark S&P 500. 

That’s right, the long-dormant sector finally looks like it’s back from the dead. 

Up until a few weeks ago, natural resource stocks had been mauled by a multiyear bear market. At its 2016 low, the sector was down nearly 50% from its June 2014 high. Adding insult to injury, the decline lasted twice as long as the 2008 bear market. 

The sector’s poor performance was due to a trifecta of bearish factors that slammed precious metals and industrial commodities.

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For starters, both rising interest rates and a rally in the U.S. dollar weighed heavily on precious metals, resulting in a four-year secular bear market in gold.

The dollar has been rising on improving U.S. economic conditions and declining prospects in Europe. Economic weakness in Europe has the European Central Bank working to weaken the value of the euro, which makes the greenback stronger by comparison.

Since gold is priced in U.S. dollars, when the value of the dollar goes up, the value of gold decreases. All else being equal, this is a simple mathematical relationship. So, when the dollar strengthens, it lowers the value of gold producers’ inventories — a major component of the natural resources sector.

Second, industrial commodity producers have been hurt by slowing growth in China. 

While still the world’s largest consumer of industrial commodities, China overbuilt its infrastructure using very lax credit standards and has been in its own financial meltdown over the past year. The net effects of China’s credit crisis are similar to what the United States experienced back in 2008. Thus, China’s economic slowdown has led to slackening demand for industrial commodities.

Lower demand plus large supply equals lower prices. Just take a look at this chart of BLS Spot, which tracks 22 economically sensitive commodities:

  

The final piece of the bearish trifecta was the crash in oil prices that began in the summer of 2015 and accelerated as production remained at record levels and the supply glut worsened.

The Light at the End of a Long, Dark Tunnel

However, things now appear to be stabilizing. Since January, bullish factors have staunched the bleeding and led to an impressive surge. 

The Federal Reserve has been less hawkish on interest rates, with traders scaling back the number of rate increases they expect this year, which is bullish for gold and oil. Additionally, the European Central Bank has upgraded its quantitative easing program, and China’s stock market has started to rebound.

In short, it looks like the worst may be behind us.

If this is indeed the case, there are opportunities for huge gains in this severely beaten-down sector. But you must have a way to separate the wheat from the chaff. 

How I Plan to Uncover the Sector’s Biggest Winners

To weed out all but the companies with the greatest potential to soar, I look at two important factors: relative strength (RS) and cash flow relative strength (CFRS).

High RS helps me find stocks that are already outperforming, which studies have shown is one of the main factors in their ability to continue to outperform. And high CFRS helps me avoid potential disasters by excluding companies with poor fundamentals.

When these two factors are combined, they give us a stock’s Alpha Score, which can range from 0 to 200. The higher the number, the more breakout potential the stock has, and I only consider purchasing stocks with Alpha Scores above 140.

To illustrate the power of this indicator, let me show you what happened with a little-known stock in the natural resources sector, Westmoreland Coal (NASDAQ: WLB).

On Dec. 18, 2013, the Alpha Score triggered a buy for WLB with a score of 158. 

Less than 10% of stocks have a score that high at any given time, and within two weeks, WLB had bounced 33%. 

Within six months, shares doubled. And when the Alpha Score finally triggered a sell, we closed the position for a 134% gain in 10 months.

The Alpha Score not only uncovers winners like WLB, but it also helps keep us out of lagging stocks and sectors. For instance, the Alpha Score did not signal a buy in the natural resources for the past six months. (Mind you, while the Alpha Score remained dormant in this particular sector, it led us to plenty of winners in other sectors of the market.)

That is until now.

The Alpha Score just signaled buys for two companies with huge potential to soar. 

Now, it won’t all be smooth sailing (it rarely is), but these new buys with their Alpha Scores of 154 and 170 show the most promise I’ve seen in years in this beleaguered sector. 

If you’d like to learn more about the Alpha Score and how you can put this powerful indicator to work in your own portfolio, follow this link.