Three ways to play materials
There are still a number of ways to make money in the materials sector. It comes down to finding stocks with stability, good management and a strategy to leverage the long-term trends, MacDonald said, but you also have to know exactly where to look.
1. Agriculture. One of the most promising parts of the market is seeds and fertilizers, such as nitrogen, phosphate and potash, said Jeff Nelson, an equity analyst with Edward Jones. While it is a highly cyclical area—weather can wreak havoc on this subsector—he thinks it's one of the best long-term plays.
It's projected that the world's population will grow by another 2 billion people between now and 2050, and emerging markets diets are becoming increasingly sophisticated as more people move into the middle class.
This is good news for the sector, because demand for food is only going to grow from here, he said. "The agriculture market is blessed with one of the most stable drivers," Nelson said.
Making it even more attractive is that supply could have trouble keeping up, said Tobias Welo, the lead manager on Fidelity Investments' Select Materials Portfolio. Most of the world's land is already being farmed, he said, which means the only way to grow production is by increasing yield on existing crops. How do you expand yields? By improving seed and fertilizer application, Welo said.
While much of the demand for food will come form emerging markets, fertilizer companies, such as CF Industries, a Deerfield, Ill.-based nitrogen and phosphate manufacture and distributor, has clients around the world and will be big beneficiaries of this focus on yield expansion.
"There's going to be fairly steady demand, while supply is going to be harder to come by, so I love the long-term dynamics," Welo said.
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2. Specialty metals. While de los Reyes may not be keen on the sector as a whole, there is one part of the market he's excited about: specialty metals.
These are companies, including API Technologies and Carpenter Technology, which create products, such as lightweight alloys, using several different metals. Carpenter Technologies' metals, for instance, have been used in turbine engines, landing gear and air frames that end up on Boeing and Airbus jets.
There are two main reasons why de los Reyes likes this part of the metals and mining sector. Since these companies use numerous metals, they are not as subjected to price fluctuations as actual miners are, and many of the end-users are in industries that are still recovering from the recession, such as aerospace and autos.
Because these companies are not tied into one or two commodities and can sell directly to large and growing industries, specialty metal operations are often more stable and have better margins than their mining and metals counterparts, said de los Reyes, and while they're still cyclical, the ups and downs are often not as great.
Look for companies that have some propriety materials, long-term contracts with successful partners that sell to brand-name corporations—Carpenter Technologies sells to Boeing and Airbus, for example—and can maintain sales and margins during rough economic patches, he said.
3. Basic materials. Buying metals and mining companies are the most controversial way to play the market, but could also have the most upside. Many of these companies have seen values drop by double digits.
While the short-term picture still looks rocky, MacDonald likes the long-term fundamentals. He pointed out that although China is growing slower now, its GDP is still expanding much faster than developing nations. As well, it's not just China that consumes these materials.
"All I need to make money is for the global economy to grow by about 3 percent," he said. "That's not too onerous."
It's also getting harder to find high quality-grade materials, especially in copper and zinc, he said, because a lot of the highest grade metals have already been mined. MacDonald also pointed out that many of these mines are in locations with unpredictable governments.
While this latter problem might hurt the companies that operate in hostile countries, anything that puts pressure on supply is a good thing. "Supply is more challenged," he said. "There's been a degradation of grades, and it takes longer to get a mine up and running."
A number of these companies are trading at a relatively inexpensive six times cash flow; historically, these companies trade at 9 or 10 times, MacDonald said.
So there are some potential buys even during a materials-sector cyclical downturn. Stick with companies that have positive earnings growth, that are shareholder-friendly—they buy back stock or issue a dividend—and that don't sway from their strategy when things get rough.
"Anything in materials will be cyclical," Nelson said, "but if you can buy a good long-term play within the sector, then you'll do just fine."
—By Bryan Borzykowski, Special to CNBC.com