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Jan. 23, 2008, 1:43 p.m. EST

Materials move

Commentary: Materials-related Fidelity funds up agriculture and chemicals

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By Sam Subramanian, AlphaProfit Investments

SUGAR LAND, Texas (AlphaProfit) -- Materials were a good place to be in 2007. Most stocks and groups in this sector outperformed the broad U.S. market. Demand for materials from Brazil, Russia, India and China remained strong as the BRIC nations continued to build out their infrastructure.

Materials Select Sector SPDR /zigman2/quotes/204467551/composite XLB -0.02% , which consists of materials stocks in the S&P 500 index gained 22% in 2007 outperforming the Standard & Poor's 500 Index's 5.5% advance. Actively managed Fidelity Select Materials /zigman2/quotes/200537855/realtime FSDPX +0.83% did better gaining 29%. Among individual groups within the materials sector, steel stocks performed well with shares of global giants ArcelorMittal /zigman2/quotes/202790215/composite MT -3.20% and Rio Tinto nearly doubling in price. Market Vectors Steel ETF /zigman2/quotes/206568157/composite SLX -0.87% sizzled to an 84% gain.

Most materials stocks performed well during the first half of the year. Strong cash flow and easy credit availability spurred takeovers and enthusiasm for such activity in the materials sector was high. Losses suffered by financial institutions on subprime mortgages reduced availability of credit and quenched takeover enthusiasm during the latter part of the year. Sensing a lower probability for deals, investors selectively bid down prices of materials company shares. Additionally, demand for materials also weakened from a slump in the U. S. residential housing and auto markets.

Gold mining shares however bucked the overall trend performing better during the second half. The sub prime crisis took a toll on the U.S. dollar and added to the 'safe-haven' appeal of gold. A falling dollar along with the surge in the price of oil kindled fears of inflation. streetTRACKS Gold Shares /zigman2/quotes/200593176/composite GLD +2.36% , that seeks to track the price of gold, gained 31% in 2007 while Fidelity Select Gold /zigman2/quotes/208026063/realtime FSAGX +0.28% returned nearly 25%.

Fears of the U. S. economy slipping into recession have increased substantially in recent weeks. Fidelity recently updated the top 10 positions of its mutual funds as of Dec. 31, 2007. We look at the changes to the top 10 holdings for insights on how managers of the materials-related Fidelity Select funds are positioning their funds for this challenging environment.

Agriculture is popular

Fertilizer manufacturer The Mosaic Company /zigman2/quotes/203825795/composite MOS +0.29% enters Fidelity Select Chemicals' /zigman2/quotes/200563237/realtime FSCHX +0.89% top 10 holdings list to beef up a lineup that is spearheaded by Monsanto and DuPont /zigman2/quotes/203606582/composite DD -0.57% , leaders in agricultural chemicals and genetically-engineered seeds. Monsanto and DuPont continue as the top two holdings of Fidelity Select Materials.

Prefer chemicals and gases to metals

With paint and chemical maker PPG Industries /zigman2/quotes/202418877/composite PPG -1.80% replacing conglomerate 3M /zigman2/quotes/205029460/composite MMM +0.97% , 7 of the 10 top holdings in Fidelity Select Materials are chemical or gas manufacturers. During the fourth quarter, 3M informed investors that it is lowering the price of its LCD films. Alcoa /zigman2/quotes/200686102/composite AA -3.21% , Freeport-McMoRan Copper & Gold /zigman2/quotes/200215692/composite FCX -1.29% , and Nucor /zigman2/quotes/201889722/composite NUE -0.85% continue as the three mining and metals-related holdings in the top 10 list of this fund.

Essentially status quo in gold

Fidelity Select Gold made just one change to its top 10 list, replacing Channel Islands-based gold exploration company Randgold Resources /zigman2/quotes/201432642/composite GOLD +3.67% with Toronto-based Yamana Gold /zigman2/quotes/201751186/composite AUY +3.46% . Yamana's persistence in pursuing the takeover of Meridian Gold bore fruit recently.

Shying away from specialty REITs

With the popularity of REITs waning in the fourth quarter, Fidelity Select Paper & Forest Products removed specialty REITs, Rayonier /zigman2/quotes/207968084/composite RYN -1.31% and Plum Creek Timber , from its top 10 list. Packaging companies MeadWestvaco and Packaging Corp. of America /zigman2/quotes/207413697/composite PKG -0.18% also depart from the fund's top10 list. The vacancies are filled with Glatfelter /zigman2/quotes/201799418/composite GLT -1.08% , Sunoco /zigman2/quotes/208614298/composite SUN -1.23% , Bemis , and Schweitzer-Mauduit International /zigman2/quotes/208081440/composite SWM -1.57% .

Our take

Even though international demand for materials remains strong, U.S. demand for most materials is being impacted by weakness in the housing and auto markets. Takeover appeal that has hitherto been a key driver of stock prices in the materials sector has diminished as credit availability is tight. We prefer to play the materials theme with the less volatile chemicals group.

Investments in the chemical group represent a lower risk play on the materials sector as demand for some chemicals and gases tends to be less cyclical. Dow Chemical and DuPont yield 4.7% and 3.6%, respectively. These dividends can come in handy during rough times.

Fidelity Select Chemicals /zigman2/quotes/200563237/realtime FSCHX +0.89% offers a pure-play on the chemicals group. In the absence of pure-play ETFs for the chemicals group, iShares Dow Jones U. S. Basic Materials /zigman2/quotes/208111671/composite IYM -0.12% , Materials Select Sector SPDR /zigman2/quotes/204467551/composite XLB -0.02% , and Vanguard Materials /zigman2/quotes/202119071/composite VAW -0.14% represent reasonable alternatives. Each of these materials sector ETFs has close to 50% of its assets invested in chemical companies.

We do not favor gold at the present time since downside to the dollar may be limited if European economies slow. As for the paper and forest products group, the slump in residential construction activity has caused demand for timber to decline. We're avoiding this group.

Sam Subramanian is managing principal of AlphaProfit Investments and editor of the independent AlphaProfit Sector Investors' Newsletter. The Newsletter makes recommendations on exchange-traded funds and Fidelity mutual funds. Subramanian owns shares in 3M, Alcoa, Freeport McMoRan Copper & Gold, and Fidelity Select Chemicals. (alphaprofit.com)

Content found in The Guru's Corner is subject to the terms and conditions found in the Disclaimer and does not represent a recommendation of investment advice. Investors should seek the advice of a qualified investment professional prior to making any investment decisions. (disclaimer)

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