Credit concerns around the globe have left few sectors untouched by a recent flight to quality, and this holds true for commodities-related stocks, which have seen outsized losses relative to the broader market as investors have been quick to book profits after hefty advances.
"As these highly leveraged hedge funds have had to sell stuff out into the market, they've had to sell their best stuff," says Diane Swonk, chief economist at Mesirow Financial. "That's really important because it means these are good companies with good cash on their balance sheets, they've got good prospects for profit going forward and they're a buying opportunity more than ever."
Fundamentals don't change overnight or over a few weeks, assert market analysts, and now could be the right time to start building positions in some of the best-performing sectors of the last two years. There's some concern, however, that this market event may be different, given the uncertainty regarding the extreme leverage used by some hedge funds and even big banks such as Goldman Sachs .
Commodities Boom or Bust?
"We still believe that we're in a period of globalization and industrialization that's taking place on an unprecedented scale and that's going to be positive for commodities and raw materials going forward," says Brian Hicks, co-portfolio manager at U.S. Global Investors.
"We've been tested several times during this bull market cycle where we've seen 10% to 20% corrections but we've rebounded every time."
Donald Coxe of BMO Financial says companies in the energy sector, base metal producers, precious metals miners, and food companies focusing on grain should continue to benefit from a long-term bull market for commodities.
"Invest in scarcity rather than what's created on Wall Street's computers," says Coxe.
William Rutherford, president of Rutherford Investment Management, says he remains steadfast in his positive outlook on energy stocks, which have been a long-term portion of his holdings for quite some time.
"I like energy services in particular because with all the money the energy companies are making they need more reserves, they need more exploration and they need to service what they have," Rutherford says.
Steel And Coal
"I would be putting cash to work in those stocks," he says. There's less vulnerability in the steel stocks."
U.S. Steel and Nucor look cheap on a valuation basis, he says, and are currently valued at less than nine times the cash held on their balance sheets, while Carpenter Technology, a specialty play on metals technology, is selling at just four times the cash on its balance sheet.
For copper producers and other base metals-focused companies, says Larkin, it may be a little too early. Southern Peru Copper and Freeport-McMoRan have both seen declines of more than 20% since hitting new all-time highs on July 23.
"I think copper has been a little bit overextended this entire year," he said. "Demand is up in China but it's been down in the U.S. and demand will not recover meaningfully until 2009."
Brian Kabot, a trader with Sun Capital Partners, likes coal companies and is focusing on , the largest U.S. exporter of metallurgical coal.
"If you're bullish on the global steel cycle and near-term energy needs, Alpha Natural Resources trades at 60% of its net asset value which is a significant discount to its peers and they have the top management in the industry," said Kabot. "So that's one place we're putting our money."
"The coal producers themselves are getting hammered but there is indiscriminate selling going on in the markets with the subprime," said Chris Nelder, senior analyst at investment newsletter Energy and Capital.
"All those guys have great opportunities ahead of them," Nelder said. They are certainly on sale right now but the market is so sketchy right now. Essentially, the bottom line is that the tide of speculative money flowed in and flowed out."
"It's like catch the falling knife out there, it's just really tough right now," he says. "In this environment with the enormous influence of hedge fund money in the energy complex, they will get bid up and down and it has nothing to do with them so it's just hard to invest."
Nelder says he has whittled down his portfolio recently and currently owns just three stocks: Valero , Raser Technologies, a geothermal electricity play, and SulphCo, which says it has developed a way to cheaply remove sulfur from heavy sour crude.
"The market took them down along with everyone else but once the pressure came off a little bit they bounced right back," said Nelder. "As soon as this stuff wrings out a little bit I think they are going to jump."
Fadel Gheit, senior energy analyst at Oppenheimer, says he was also concerned with what he sees as intense speculation in energy stocks on the part of hedge funds and big investment banks.
As crude oil profit margins narrowed dramatically in late July due to rising crude prices and lower fuel prices, the analyst warned clients to expect increasing volatility.
"We are concerned that unwinding hedge positions by financial institutions in the next few weeks could create a selling stampede," he wrote in a July 30 note, saying "excessive speculation" has exacerbated deteriorating margins.
A week later, Gheit downgraded the entire oil and gas sector -- more than 20 stocks -- to "neutral" from a previous rating of "buy."
"We sent a warning signal two weeks ago to pull the plug on everyone," Gheit said in a recent phone interview. "The industry fundamentals in our view have weakened and the inventory consumption is really weaker than what it appears to be."
In the current environment, the analyst contends, big banks such as Goldman Sachs have more to do with oil prices than the oil companies themselves.
"There's tremendous speculation by not only hedge funds but by financial institutions, which have much more money to play with and have more access to information," he said.
Nevertheless, Gheit says he is still unquestionably bullish on energy companies' long-term outlook.
"The world does not run without energy, we will need every source of energy we can get our hands on, but the low-hanging fruit has been picked," he said. "Ninety percent of the people in the market today are short-term oriented, they want instant gratification. That's not investing."
Peter Kang is a markets writer at CNBC.com and can be reached at firstname.lastname@example.org.