4 dirt cheap commodity stocks the market is forgetting

Two with P/Es under 6!

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Volatility. How I've missed you!

The Dow tumbled over 300 points on Friday, extending the fall on Monday, before staging a semi-recovery overnight Tuesday. It was the biggest 3-day sell-off since June 2013.

Stating the obvious, Mark Luschini, chief investment strategist at Janney Montgomery Scott LLC told Bloomberg…

"The ride probably will not be as smooth as we have seen in the last couple of years."

Yes Foolish readers. Prepare for some turbulent waters ahead, and prepare to dust off your stock picking skills.

Speaking of stock-picking, the ASX has opened nicely higher today, with mid-cap commodity stocks Drillsearch (ASX: DLS) and Atlas Iron (ASX: AGO) both jumping 6% higher after both lifted production guidance.

I've got my eye on Drillsearch. The company has developed a very pleasant habit of exceeding expectations.

An investment is not without risk, but hey, apart from boring old term deposits, what investment doesn't have an element of risk?

And as for Atlas Iron, on my back of the envelope calculation, after backing out their cash balance, the stock is trading on a P/E ratio of just 2.5.

Holy iron ore, Foolish readers.

Unlike Motley Fool Share Advisor guru Scott Phillips, I think the iron ore price will stay relatively high for some time.

A portfolio of 4 dirt cheap commodity stocks

If I was going to make a play in the sector, a portfolio of Atlas Iron, BC Iron (ASX: BCI) and Mount Gibson Iron (ASX: MGX) might be an interesting mix.

Unlike debt-heavy Fortescue Metals Group (ASX: FMG), all have bucket loads of cash.

Add Drillsearch to the list — a stock trading at a forecast P/E of around 5 — and I might have myself an interesting portfolio of 4 dirt cheap commodity stocks. 

If nothing else, such a portfolio promises to be a wild ride!

Like everyone, I prefer lower prices to higher prices. Unlike many investors, I therefore prefer more stock market volatility.

Yes, Foolish readers. Volatility sees your portfolio whip-sawed up and down, but it also brings lower share prices.

Geoff Wilson from Wilson Asset Management (WAM) sums it up well in this video

"We hope there will be more carnage, and there will be more opportunities. As a fund manager, that's when you make money."

Over the past three years, WAM Capital has generated annual average returns of 13.8% compared to the S&P/ASX All Ordinaries Accumulation index (which includes dividends) return of 8.0%, so he knows a thing or two about stock picking.

But are we due for a fall?

Let's be honest.

It has also been a sensational couple of years for investors and the ASX.

In 2013, the key S&P/ ASX 200 index returned 15.1%, and that's before dividends! They add another 4 or 5 percentage points.

That just betters the 14.6% returned in 2012.

Of course those with longer memories will know the ASX has gone down twice in the past five years.

I don't know about you, but my Crystal ball is a tad cloudy…

I'm still positive about the year ahead, despite the poor early showing, and won't be pulling my money out of the market any time soon.

Of course I could be wrong.

The law of averages says that we will see the stock market fall over a twelve month period. It could happen this year. Or next.

But that's nothing to fear at all.

In fact, we as investors should embrace market falls. Yes I know it hurts to see your portfolio values tumble and your super account balance slide – but there is an upside.

Down markets produce just the opportunities we investors want – the ability to pick up high quality companies at attractive prices.

The time to pluck up courage is coming…

One of Warren Buffett's most repeated quotes is "to be greedy when others are fearful, and fearful when others are greedy".

But it can be psychologically hard to buy when the market is dropping, and may well drop for days or months after you've dipped your toe in. You question whether you've done the right thing, or got in too early, or whether you should be selling up rather than buying. But going against the crowd is when you will make your best returns.

Remember investors, like Wilson Asset Management, who were buying stocks at the depths of the GFC in 2008 and 2009 – and the returns they've achieved since then.

After a bad start, this stock turned into a double…

I remember topping up my shares in GUD Holdings (ASX: GUD) for $4.90 in October 2008, only to see them fall to $3.65 the next month, before they steadily climbed over $10 in 2010, as the ASX staged a recovery.

I eventually went on to sell my holding in GUD in September 2012 for a decent profit – but still wishing that I had been braver during the dark old days of 08/09.

Yes, a falling market hurts your retirement nest egg, but if you continue to invest through those very same market falls, you're getting cheaper prices for the companies you want in your portfolio.

Buy your own golf course?

It's a practice known as dollar-cost averaging. And the end result usually means wonderful long-term returns, frequent holidays to exotic destinations and your own golf resort complete with dinosaurs.

Ok, I exaggerate slightly, but you get the picture.

As Motley Fool Share Advisor's Scott Phillips recently told subscribers,

"While the forces of progress propel our civilisation ever higher, the path of progress is never smooth."

Markets never go up in straight lines, and despite the combined 30% gains in the ASX over the past two years before dividends, we've still had several large dips and many smaller pullbacks.

Remember the fears over the US debt ceiling?

How about Greece, Italy, Spain and Ireland's debt troubles?
US Fiscal Cliff?
US air strikes on Syria?

All consigned to history – and our market still managed double-digit annual gains.

Don't bug out now

Those investors that were scared out of the market in 2008 very likely missed the massive recovery in 2009, when the ASX rose 30%.

And if they were scarred for life, very likely the past two years of above-historical market returns.

Some of our biggest companies posted strong returns in that time, including theCommonwealth Bank (ASX: CBA) with a 50% return over two years,Macquarie Group (ASX: MQG) up 112% and even boring old Woolworths(ASX: WOW) up an impressive 32% – all before those lovely dividends.

And the much unloved (at the time) Harvey Norman Holdings (ASX: HVN) was called a buy by Scott Phillips in this article for Fairfax media in March 2012. It's up an impressive 76% since then, including dividends.

One of his latest buy recommendations is another overlooked, unloved retailer.

The stock is up over 20% including dividends for Motley Fool Share Advisor subscribers, but Scott thinks there's room ahead for the stock to grow… so much so he just named it in his January list of ASX best buys now stocks.

The bottom line is those who hold the line in the face of market volatility, putting more of their money to work in the market, are likely to see their portfolios grow substantially.

So as we enter a period of uncertainty, now is not the time to jump off the horse, but to stay the course.

And for those who may be tempted to wait for the market to fall before they jump in, I say…

"Don't wait, you may miss the boat!"

That's what I'll be doing, and it's what I intend on doing throughout the rest of 2014, regardless of whether a crash comes this year or not.

Motley Fool writer/analyst Mike King owns shares in Woolworths. You can follow Mike on Twitter @TMFKinga

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