Bull markets are never uninterrupted streams of rising profits. Rather, it’s usually two steps forward, one step back. And when it comes to volatile sectors such as vital resources, the wild action is known for routinely shaking out weak hands.

Price action has been truly wild for materials stocks over the past couple months. And there are few, if any, signs that the markets are going to calm down soon. Further, there’s a good chance we’ll see more downside as the markets sort through developments concerning the weakened US economy and the floundering US financial system.

More important, however, is the fact that nothing has really changed for long-term vital resource sector fundamentals. The world is still in the grip of historic demand and supply pressures that will only reverse with real demand destruction and huge, long-term investment, which is highly likely over a period of many years.

Fears that the US recession will trigger something worse overseas are having a massive impact on commodity prices and even more so on producer stocks. But even if the contagion does spread, it will only provide temporary relief from the underlying supply/demand pressures, which will squeeze tighter than ever when the economy inevitably revives.

As for the short term, many of our favorite resource stocks appear to be pricing in a greater contagion already. They can still have down days. But short of a complete catastrophe in the global economy, that does limit the potential downside from here.

The upshot is a buying opportunity for vital resource stocks of all stripes. Below, we look at several strong buys that have now reported second quarter earnings. We also highlight our water stocks, including new VRI Portfolio addition Suez Environnement (Paris: SVE.PA, USD17.80).

Several VRI Portfolio holdings have reported second quarter earnings. We noted South Korea steelmaker Posco’s (NYSE: PKX) results in the July 17 issue, The Switch. The stock has rallied a bit since, but Posco is still a solid buy up to 140.

Russian integrated mining and steel play Mechel (NYSE: MTL) has reported very strong operating results for the first half of 2008. Strength in hardware and finished products, as well as the mining operation, more than offset weaker sales of semi-finished products. The company also took full advantage of its control over input costs (iron ore, coking coal and electricity). Revenue surged 64.1 percent over last year’s levels, while net income rose 162 percent and cash flow margins soared 151.1 percent.

Mechel faces other challenges. As we reported last week, Prime Minister Vladimir Putin pointedly criticized the company’s business practices, triggering a waterfall drop in the stock. Shares took another dive earlier this week, when he accused the company of tax evasion by selling products abroad more cheaply and driving up steel prices in Russia.

At this point, our judgment is Mechel shares are pricing in a lot of bad news that’s still unlikely to come to fruition. Management is reportedly cooperating with the authorities in their investigation. And First Deputy Prime Minister Igor Shuvalov has said that Mechel is unlikely to share the fate of Yukos, the major oil company that was ultimately busted up by then-President Putin on corruption charges. Shuvalov went on to say the most probable outcome of the investigation is that the state and the company will work together.

Mechel shares face a great deal of uncertainty at this point. But the violence of the past week’s selling has a lot more to do with memories of what happened to Yukos than actual developments for Mechel. In short, a lot more negativity must take place to justify the selling we’ve seen thus far. Our bet is that we won’t see any further bearish news from Mechel and that this strong business justifies a much higher share price.

We wouldn’t bet the farm on this play or any other VRI stock. And we wouldn’t want to minimize the risk, should this turn out to be more than we expect. But at this point, we’re sticking with the stock. And Mechel remains a buy for those who don’t already own it and can handle the risk.

Mining company Freeport McMoRan Copper & Gold (NYSE: FCX) came in with headline earnings that were somewhat lower than year-earlier levels, as output of copper and gold lagged in 2007 and operating costs rose. The reason was mainly that the company was mining lower grade ores, offsetting a 33 percent rise in production of molybdenum, which is in increasing demand for manufacturing more durable strains of steel.

Results appeared to disappoint Wall Street. More important, however, Freeport remains on track to increase its future output of copper, both by tapping into higher-grade ores at Indonesia’s Grasberg mine and by firing up expansion plans at a range of facilities. Gold output is also still projected to rebound close to 2007 levels in 2009, while molybdenum production will reach 100 million pounds a year by 2010, up from 69 million pounds in 2007.

Much depends on global copper, gold and molybdenum prices, which, in turn, are increasingly linked to Asian demand. But if its strength is anything close to what we expect, Freeport’s earnings and shares are headed a lot higher over the next year. Meanwhile, those light on the stock have another chance to buy at a very good price. Note the company has also increased its annual dividend to $2 a share.

Rio Tinto (NYSE: RTP) reported a 13 percent boost in its global iron ore output over last year’s levels, including record production in Australia. Copper production surged 15 percent, bauxite was up 100 percent, alumina was up 231 percent and aluminum exploded 374 percent, reflecting the impact of solid internal growth and acquisitions. Coking coal output improved 25 percent, and minerals saw similar gains.

Coupled with higher prices for all of those products, the result was another strong quarter for the company, which remains a takeover target for rival BHP Billiton (NYSE: BHP). BHP also had very strong earnings. Rio Tinto remains a cornerstone buy for the VRI Portfolio.

We’ve been convinced for a long time that investing in water and waste treatment offers substantial growth opportunities. See VRI, Nov. 29, 2007, Water…Water Nowhere. The beauty of this kind of investment is that the opportunity comes from both the developed and the developing economies.

In the former, growth is principally from upgrading existing systems and building more sophisticated structures as the need for a better environment becomes increasingly important. In regards to the developing economies, water infrastructure is often nonexistent. Consequently, growth potential is even more impressive with China as the epicenter of the water story.

Strong economic growth, the growing global population and the strong trend toward urbanization are the three pillars of growth for the water and waste treatment industry. As China has discovered, the right usage of water contributes substantially to economic growth because resources aren’t wasted. Studies have concluded that China’s GDP growth could be at least a few percentage points higher per year if it weren’t wasting water and polluting water reserves.

It’s very difficult to demand high-quality water standards in a fast growing, developing economy, particularly one of China’s size. That’s because emphasis is rightly placed on creating jobs and allowing people to grow their businesses.

But as economic and production scales are built, the focus gradually shifts, and changes are implemented. That’s especially true if the leadership is well aware of the problems, is determined to solve them and has the money to do so, as is the case in China.

The arguments for continuing global population growth and urbanization are well known. The US Census Bureau estimates the global population will grow by an average of 1.1 percent per year between 2006 and 2020, while the United Nations (UN) expects over half the world’s population to be living in urban centers by 2015.

Clearly such profound changes will demand access to water, which, in turn, will escalate the need for reuse and recycling. The United Nations estimates that around 1 billion people don’t have access to permanent drinking water, while another 2.6 billion lack decent wastewater treatment.

Bringing safe drinking water and wastewater services where needed it’s the business of VRI Portfolio holding Hyflux (OTC: HYFXF), our long standing, niche player in the water sector. Today we’re adding one more company to the mix: Global operator, Suez Environnement (Paris: SVE.PA, USD17.80). The company has the market positioning, technical expertise and financial resources to capitalize on the water/waste investment opportunity.

The company was spun off from its parent Suez after the latter merged with GDF earlier this summer. Its association with its parent, GDF Suez, also offers a lot of benefits, especially in the energy-intensive desalination business. And Suez Environnement’s waste-to-energy operations can only benefit from its parent’s global electricity presence and associated engineering skills.

Suez Environment also has the strongest balance sheet in the global water treatment sector, with relatively lower debt levels and a strong investment program of EUR4.5 billion for the next three years. Annual earnings growth of 10 percent looks set, with considerable room on the upside as well.

Furthermore, the company has a great reputation in research and development (R&D). Sector R&D is becoming ever-more important as the water/waste sector advances and the global need for highly sophisticated operation becomes paramount.

Europe remains the company’s main market. But overseas expansion is also a part of the strategy, as long as it’s in management’s words, “not expansion at any price.”

The international division of the company contributes 22 percent of Suez Environnement’s earnings and is split roughly 50/50 between water and waste. In recent years, the company has been expanding its international water and desalination operations in the US, China and the Middle East, while its waste business has found new growth avenues in Australia, Hong Kong and Morocco.

Its subsidiary Degremont and Safege, which specializes in water treatment, has a presence in over 70 countries, allowing Suez Environnement to explore new market opportunities.

Degremont is often used as a way to enter new markets, initially in a small, leveraged manner (i.e., the construction of a water treatment or wastewater treatment plant). Once the local relationships have been developed and the viability of bigger projects established, then Suez Environnement comes in for the much larger projects.   

Although smaller operators can occasionally be extremely competitive for certain of Suez Environnement’s business, the company’s integrated business model and global presence often allows it to get the whole contract, using the knowledge of the smaller competitor for a specific part of the project.

Suez Environnement is the new addition to the VRI portfolio and rates a buy at current prices.

You’re invited to tune in as KCI’s LIVE Webcast events air from the 30th annual Money Show San Francisco. The editors will be presenting their latest insights and recommendations surrounding this year’s central theme “Tech and Biotech Investing.”

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I also have a special invitation for readers to join me and my colleagues Elliott Gue, Gregg Early and Neil George aboard an exciting 11-day investment cruise Dec. 1-12 through the Caribbean and Panama Canal.

This will be a unique opportunity to step away from your daily routines, relax in one of the most beautiful parts of the world and share analysts’ knowledge and passion for the markets. During the sail, you’ll not only explore the cerulean splendor of the Caribbean, but you’ll also delve deep into current markets in search of the most profitable opportunities for your portfolios. You’ll also have the rare chance to sail through one of the world’s engineering marvels, the Panama Canal.

It’s always a special treat to meet and talk with subscribers in person, and we couldn’t have picked a better setting than aboard the six-star Crystal Serenity. This is sure to be an especially memorable experience. We hope you’ll join us.

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