Dr. Marc Faber, one of the world’s most respected market watchers, wrote recently that only time will tell if the current carnage indicates a change in direction or just a pause. As he was one of the first to forecast the resource bull market, commodities featured prominently in his analysis.

The good news is he seems to agree with us that the great cycle isn’t over. In fact, it will run for a long time, in the process rewarding patient investors handsomely.

We’re also on board with his assessment that the current slump is likely to last at least a while longer, and as long as it does, volatility in resource stocks will remain high. As has been the case now for 15 months, the big problem is that the world is trying to adjust to the woes of the credit crisis, recession in the US and the potential for a lengthy general global economic slowdown. And until there’s some visibility on these issues, the prevailing market psychology will remain negative.

As we’ve stated repeatedly here, this sector isn’t for the risk-averse. Rather, success requires agility in terms of taking profits, as well as cutting losses along the way, with an eye on the specific risk tolerance and investment horizon each investor has.

For the past few months, lower demand for resources across the board has featured prominently in market chatter. We agree that demand has slowed down. But we would again like to point out that it’s not the only factor shaping the market. Mainly, supply is a growing part of the case for investing in the sector and has been for some time.

First, the world’s infrastructure (from transportation to machine availability) wasn’t–and still isn’t–ready to supply the materials needed to support global economic growth. And that’s the case even if this growth isn’t as strong as in prior years. In fact, unless the US and Europe completely collapse, the current demand slowdown won’t be enough for the supply bottlenecks to go away.

Second, it’s extremely unlikely that the Chinese economy will fall off a cliff. The government recently affirmed the continuation of its infrastructure and urbanization plans. That’s a call on natural resources the scale of which is without precedent.

Finally, cost increases are a growing burden on resource companies, and a corresponding deterrent to needed supply increases. In recent months, some Portfolio favorites have reported operating-cost increases ranging from 3.5 to 9 percent.

The good news is the current slowdown is relieving some of the pressure. For example, diesel fuel prices are down 25 percent from their highs. Companies are also being helped by the weakness in the currencies of the commodity producer nations, which should boost margins over the next three to six months.  

To be sure, our Portfolio picks have taken on water and may slip further. But the bottom line is recovery in commodity prices and in producing stocks still looks assured in coming months, and that’s still our bet. The key question: Are we in the best stocks to ride what should be an explosive move.

In this vein, we’re looking into making some changes to the Portfolio in coming weeks. Our goal is to best position ourselves for the eventual turnaround, while picking up some value along the way. Despite the recent volatility and downward action in resource prices, this sector still offers strong cash flows, excellent growth prospects and solid balance sheets. Identifying and buying the companies that best combine all those should prove a rewarding exercise, particularly at the lower prices we’re seeing now.

Given our long-term bullishness on the sector, it’s no surprise we see the emergence of great value. The problem is one of timing, as in when is the right time to start buying in earnest. Unfortunately, the answer is far from cut-and-dried.

Given the climatic nature of some of the selling–as our colleague George Kleinman has noted in VRI’s companion bi-weekly Commodities Trends–recovery could literally begin any time. On the other hand, the absolute best buying opportunity could also occur two to three months down the road. And we’ll only know for sure well after the fact.

What we do know now is that resource stocks are discounting a great amount of bad to horrific future developments. Markets will do their own thing regardless of what we think or the fundamentals for that matter. But our strong view is that now’s an ideal time to invest at least incrementally in our favorites.

At this point, the best place to start is the diversified miners. Rio Tinto (NYSE: RTP), Xstrata (OTC: XSRAF), Companhia Vale do Rio Doce (NYSE: RIO) are our favorites. The latter two also offer great exposure to coal (thermal and metallurgical) and iron ore, the two key elements of steel.

Steel is in its best place in decades right now, and demand is surging, in large part due to the continued brisk pace of emerging market urbanization. As the chart below indicates, China’s consumption of steel remains strong and continues to grow rapidly. Industry experts expect that China’s cumulative steel consumption will surpass that of the US in the entire 20th century.

We also like steel over the long term, and we’re assessing our steel stocks with an eye on making some changes. We should have more on this next week.

Source: International Iron and Steel Institute

Uranium is another key vital resource, and we expect strong prices will again become the norm. We continue to recommend leveraged exposure through Australia-based Paladin Energy (Australia: PDN, OTC: PALAF).

Agriculture-related companies are also good bets. Our preference is for seed producers, with Monsanto (NYSE: MON) topping the list. We also advocate some exposure to food growers; China Green Holdings (Hong Kong: 904, OTC: CIGEF) is the favorite.

On the negative side, we expect short-term weakness in copper. Inventories remain high and demand in the top four copper users (China, EU-15, US and Japan) fell by 1.3 months in first five months of the year. On the plus side, demand in the rest of the world increased by 3.3 percent in the same period. Meanwhile, on the supply side, Chile–which produces a third of the world’s copper–suffered a 5.5 percent drop in production for July.  Freeport-McMoRan Copper & Gold (NYSE: FCX) remains the favorite company for gaining exposure to copper.

Nickel has also been a disappointing bet for us, as the commodity has been hit dramatically, as the graph below illustrates. Given the magnitude of its decline, we don’t expect any major further deterioration in nickel. The problem is near-term catalysts for recovery are currently lacking. We’ll be looking to add to positions only later in the year.