Unprecedented, coordinated action by major governments appears to have saved the world’s banking system, at least for now. The global bear market in stocks, however, is still in full swing because of rising worries about a deep worldwide recession.

Demand for natural resources waxes and wanes with the level of economic growth. Torrid demand growth, particularly from the rapidly growing developing world, spurred massive price gains for everything from copper and molybdenum to grains over the past few years. And those gains have largely unwound during the financial panic of the past several months.

Copper prices are down nearly 40 percent from recent highs. That makes the red metal a relative outperformer, compared to the more than 60 percent drop in nickel. And the declines are mirrored in raw materials from soybeans to iron ore and steel.

As for the current 16 Vital Resource Investor Portfolio holdings, 14 are now trading where they were at the beginning of 2007. Seven are back to levels last seen in mid-2005.

Unfortunately, until there’s some visibility on the global economy, commodity prices and producer stocks will remain under pressure. Earnings of many producer stocks have already been under pressure this year by rising costs, as they’ve had to go ever further and deeper to meet demand. And the steep drop in commodity prices since mid-year will depress revenue.

The US dollar’s rise this year also continues to hurt, as vital resources tend to move countercyclical to paper money. As we said last spring, a rebound by the buck was long overdue after the currency’s brutal declines of past year. Recent gains by the greenback, however, have been largely driven by purchases of US Treasuries by foreign investors, looking to lock up a “risk-free” return in a very volatile and uncertain market.

Why Buy

There is good news, in three parts. First, stocks of strong vital resource companies–including all of our portfolio selections–are already trading at levels that reflect prices for commodities that we haven’t seen since early in the decade.

Recovery even from such deep value won’t occur until there’s visibility on how far the global economy will sink. In fact, there could well be more near-term downside. But these prices do represent another chance to buy these vital resources at prices that guarantee an explosive recovery, once a bottom for the economy is in sight.

Second, the primary factor behind the US dollar’s current strength–the financial crisis–is temporary in nature. Once the crisis fades and market fears are tempered, investors will look to bigger returns than the less than 2 percent offered by two-year Treasury notes, or the less than 1 percent paid by Treasury bills. The greenback will retreat even faster than it’s risen in recent weeks, spurring commodity prices.

Of course, we don’t know when the economic/market situation will reverse. But third and most important, the key underpinnings of this decade’s bull market in vital resources are still very much intact. Demand in the developed world countries such as the US for metals such as copper is set to stay depressed for awhile. But that’s becoming less and less of a factor, as the developing world accounts for an ever-greater slice of demand.

China, for example, now accounts for roughly 27 percent of global copper demand, up from 12 percent in 2003. In contrast, the US has gone from 25 percent of global use of the red metal to only around 12 percent. And despite the ongoing economic crisis, the developing world’s importance continues to grow.

China remains committed to its goal of keeping the nominal growth of its fixed-asset investment at 25 percent year-over-year as it’s done in the past six years. A lot of these funds go to infrastructure buildout, and the government always covers the difference during times when the private sector scales back. That’s an enormous and growing call on global resources that won’t falter, even if US growth goes negative this year. Investment is further aided by the minor problems China’s banking system will have to face as a result of the global credit crisis, a stark contrast with Europe and the US.

Of course, even Chinese economic growth will weaken if the global recession really turns nasty. In fact, signs that commodity imports may be slowing there were a major factor pushing down prices the past couple weeks.

For many vital resources, the dip in global demand is already being matched by lower production. For example, for the first time ever, global steel producers have basically cut their output in unison. That’s a function of being a far more efficient industry than in the past. Meanwhile, resource nationalism and labor unrest are challenging supplies for other raw materials, in Chile, for example, where non-union workers blocked entry to the Port of Antofagasta to protest wages.

Every commodities boom in history has eventually been ended by a combination of permanent demand destruction via conservation and switching to alternatives and extensive development of new supplies. Neither is in evidence today. In fact, the recent precipitous drop in raw material prices has likely postponed their appearance, very likely by several years.

That means one thing: When global economic growth does revive, so will the bull market in vital resources. And as we’ve seen on certain trading days over the past few weeks, the resulting surge in producer stocks will be nothing short of explosive. The upshot is this is the time to build positions in strong companies that produce these resources, particularly our Portfolio picks.

Below, we’ve identified five targets to buy now. All are leaders in their core businesses. Each has seen its shares tumble to multiyear lows in recent weeks. But all are still in very solid shape and have the ability to weather even much steeper declines in the prices of what they produce.

All are takeover targets as well, as the natural resource production sector continues to consolidate. And more than a few pay record dividends, backed by strong cash flows and first-rate balance sheets. We advise buying on their home exchanges if possible, but US-listed shares convey the same ownership rights and should work just as well.

The Stocks

China Green Holdings (Hong Kong: 904, OTC: CIGEF) is a China-based producer and supplier of fresh produce, processed and pickled products, branded food and beverage, rice and rice flour products.

The company sells its products both domestically and internationally through a highly integrated business, operating large-scale standardized plantations, food processing units and a distribution network of supermarket and retail outlets. Its ownership of every segment ensures stable supplies and a rare degree of control over raw material price fluctuations.

China Green Holdings doesn’t have control over essential raw materials such as seed crops, fertilizers and pesticides, hence the reason we also recommend holding Monsanto (NYSE: MON). Nevertheless, product quality is more easily maintained and costs curtailed as many layers of middlemen are removed.

China is the company’s primary and fastest-growing market. Japan, however, contributes 32 percent of total sales and Europe 9.5 percent. This exposure offers respectability for the company’s products because of the exacting quality standards in these markets. That ensures the same for its domestic outlets.

China’s recent milk scandal should work to the company’s advantage, given that it’s long advocated high production standards. China Green has 100 percent of its milk powder sourced from New Zealand. The company also has a decade-long record in exporting to Japan, where food safety standards are extremely high. The company continues to inform consumers on the issues and is boosting its reputation as a safe, healthy, green company. That consumers are becoming more quality-conscious represents a great opportunity for China Green.

Exports should play a more important role in the future; China’s agricultural shipments abroad have been on an uptrend, especially vegetables and fruits. Vegetable exports grew by 22 percent last year, up from 7 percent four years ago.

We also expect that China Green will be the supplier of choice for the big foreign retailers operating in China, such as Carrefour (Paris: CA, OTC: CRERF) and Wal-Mart (NYSE: WMT).

China Green has transformed itself from an export-oriented vegetable supplier into a company with a growing presence in domestic China, and management remains committed to a balance between domestic and export businesses. It’s also improved its profitability because it put more weight behind its processed business, which offers higher margins. Buy China Green at current prices.

There’s no better time to buy into Monsanto, the undisputed leader in the genetically modified (GM) seed industry. Monsanto’s stock has underperformed this year, and now it’s playing catch up. After beginning to selloff towards the end of June, prices have begun to rebound after posting a better than expected performance in its fourth quarter, a traditionally weak period for the company. See VRI, October 9, 2008, Buying Agriculture.

Although the stock will be affected by the market’s shorter-term gyrations, the impact will be muted because the seed business is currently in a sweet spot as global food demand changes dramatically.

The big cycle in food demand has begun (although as the chart below indicates food prices have also been coming down with the market) and Monsanto will continue to play a vital role in this process for years to come.

Rising demand for food is a well-known problem. The world needs to increase production from existing or, in some cases, diminishing arable land. As incomes around the world rise, so does demand for food, boosting the importance of companies such as Monsanto, which will play an integral role in the future of GM food production.

In addition, even developed economies are turning toward higher-yield seeds as global economic growth strains supplies. And last but not least, biofuels will continue to put pressure on food prices, regardless of whether current, unrealistic plans are modified.

This practically guarantees industry leader Monsanto greater earnings growth and solid pricing power. This, in turn, allows for high cash flows and financial strength–a condition that gives the company the opportunity to allocate more funds toward research and strengthening its product pipeline. Buy Monsanto at current prices.

Source: Bloomberg

Australia-based Paladin Energy (Australia: PDN; OTC: PALAF) is a pure-play uranium producer with a strong portfolio of developed assets and developing properties in Africa and Australia, but it’s currently focusing on its African projects, Langer Heinrich in Namibia and Kayelekera in Malawi. The company has a mine in production, one that will be starting output early next year and six more that are in various planning stages.

Its relatively new production status is the company’s main advantage: It’s not locked into long-term contracts as its more established peers are, so it can benefit from stronger uranium prices–especially if our assessment that uranium prices are near a bottom is correct. It’s also one of the most leveraged players, with only 1.1 million pounds of uranium per year hedged out to 2012.

The best bets on uranium’s resurgence are going to be younger companies. See VRI, May 22, 2008, Driving Demand. These have the choice to sell mainly on spot market and/or negotiate longer-term contracts with higher prices than the average USD20 to USD30 per pound that’s been the norm in the past 10 years.

If our long-term price assessment for uranium is correct, Paladin offers an excellent opportunity to capitalize in the multiyear bull market in nuclear energy as we noted in VRI, September 18, 2008, Buy Gold and Russian Stocks. There are some caveats, however.

First, the company could face delays in its project development that would hurt short-term performance. Second, two of the company’s major assets are in Africa, a continent known for potential political risks as nationalistic political agendas can become an obstacle for smooth operations. See VRI, January 10, 2008, Gold, Nationalism and Steel.

Third, Paladin’s management has been quite open about its desire for future mergers and acquisitions to enhance the company’s resource base. On the plus side, they’ve been prudent and successful in this area in the past, and we expect only more upside to come. The company’s balance sheet is strong with a net debt balance of USD127 million and cash of USD149 million. And it’s been able to easily secure financing for future expansion.

Paladin, in a joint venture with Cameco Australia, was granted license last week to explore the Angela and Pamela uranium prospects in Australia’s Northern Territory. Believed to contain more than 12,000 tons of uranium oxide with a market value of as much as AUD2.5 billion, could nearly double Paladin’s reserves if the area is as rich as believed. Buy Paladin Energy at current prices.

Switzerland-based Xstrata (London: XTA; OTC: XSRAF) is the world’s fourth-largest copper producer. It also has substantial positions in nickel, thermal and metallurgical coal, zinc, aluminum and an alloys division for chrome, vanadium and platinum group metals. The project pipeline includes further investment in all of these areas and extends to six continents.

The coal division has targeted a 54 percent production increase by 2015. Alloys are projecting annual growth of 8 percent to 2015. South Africa holds approximately 70 percent of the world’s chrome, with reserve-poor China a major customer. Xstrata looks for ferrous chromium demand to outpace stainless steel demand. And with its costs half China’s and the second-lowest in the world to Kazahkstan, Xstrata figures to get a major share of that business as well.

We expect the company will benefit from the surge in global power generation. A recent International Energy Agency report suggests a 3.5 percent combined annual growth rate in global power generation from 2005 to 2015, with China accounting for 40 percent of the demand growth.

The most bullish aspect of the company is that it is the world’s largest producer of coking coal, used for smelting iron ore in the steelmaking process, of which there has been a global shortage. That’s weighed particularly heavily on China, which is both the largest producer and the largest consumer of steel. That gives Xstrata a large degree of pricing power, which has been a major driver of earnings. Xstrata is a buy at current prices.
 
Our favorite major diversified miner right now is UK-based giant Rio Tinto (NYSE: RTP). The company is one of the premier iron ore produces in the world, and it’s also the largest aluminum producer following its acquisition of Alcan.

Demand growth for iron ore continues to be strong. China’s steel production (up 161 percent in the last five years) and supply constraints are the main factors for iron’s continued strength.

Demand has been extremely strong in the past five years, but the supply side has been relatively slow in catching up. As a result, supply slowed to 8 to 9 percent in the past couple years.

The iron ore market is dominated by Australian and Brazilian producers, the main ones being Rio Tinto, Companhia Vale do Rio Doce (NYSE: RIO, CVRD) and BHP Billiton (NYSE: BHP).

BHP Billiton has been in hot pursuit of Rio Tinto for more than a year now, with the latter having spurned several offers at prices it considered too low. A merger would create a mining behemoth, combining the second and third largest iron ore producers, requiring regulatory approval, which the EU appears set to grant. That would clear the way for offer letters to be sent directly to Rio Tinto shareholders in coming months, in a deal worth USD80 billion.

And much like Xstrata, Rio Tinto has a large degree of pricing power over iron ore, of which it is the second largest producer, largely because China is the company’s fourth largest export destination of the commodity. And while Asian growth is tempering in the face of a global slowdown, China’s GDP is still projected to grow at 10.1 percent in 2008, it will take massive quantities of commodities to fuel the growth. Given its strong market position and a potential buyout, Rio Tinto is a buy at current prices.