Investors go for solid ground

They're neither pretty nor fragrant, but during the second quarter, Wall Street's earthiest industries - metals, forest products, and chemicals - came into full bloom.

Mutual funds that invest in basic materials stocks flourished during a broad shift from expensive growth stocks to cheap cyclicals. The "rotation" followed hints of revival in the global economy, especially in Asia.

Along with such sunny expectations came concerns of inflation, which hit the smoldering embers of commodity prices like gasoline.

As commodity prices flared, mutual funds that invest in commodity producers bolted upward from a long sleep. A jump in the price of oil, for instance, lifted oil-service stocks by more than 30 percent in the second quarter.

But despite continued signs of foreign strength, funds that invest in basic materials producers might have already seen most of their gains for the foreseeable future, say equity analysts.

Investors might have overloaded on commodity producer stocks.

"This group has been on its back for so long, that when there was a rotational move, investors and analysts realized how cheap they were and everyone had to have the shares," says Tore Stole, paper and basic industries analyst at A.G. Edwards in St. Louis. "I think people realize they shouldn't have ignored the sector for so long," he says.

Hereafter, "it's a slow rebuilding," says James Wilbur, chemical sector analyst for Salomon Smith Barney. "For more gains, we see it as clawing our way up rather than bouncing our way up," he says.

Take wood- and paper-products companies. After a boom of several months, the housing sector has begun to lag because of higher mortgage rates. In May, sales of new homes fell 5.1 percent. And since the beginning of the year, fixed mortgage rates have risen from 6.75 percent to about 7.6 percent.

"Home sales should decline even more in the months ahead," says Bruce Steinberg, chief economist at Merrill Lynch in New York.

With domestic demand flagging, producers can look to Asia. Between January and April, for example, Chinese paper imports shot up 20 percent.

Chemical producers can also find hope across the Pacific. Economic recovery means East Asia will once again account for 20 percent of the growth in global demand for chemicals. In recent years, says Mr. Wilbur, the region has been a net exporter.

Results by fund category

5-yr.

Type of fund 2nd qtr.19991-yrannualized

US STOCK 10.2% 13.7% 20.6%

S&P 500 Index 6.9 22.2 27.3

Growth 7.1 18.9 22.6

Growth & income 9.0 14.5 21.7

Mid-size company 12.5 13.4 19.7

Small company 15.6 1.9 16.5

Natural resources 18.4 2.5 8.3

Technology 14.2 67.7 31.9

Telecommunication 11.8 50.8 23.9

Utilities 10.4 16.8 17.2

Financial services 5.1 2.2 22.9

Real estate 11.6 -5.6 10.3

WORLD STOCK 11.3% 13.1% 6.7%

Europe 1.0 -4.8 16.1

Asia-Pacific 23.7 48.9 -2.0

Emerging market 24.9 16.0 -1.5

Latin America 15.6 -2.7 0.6

Gold 2.1 -5.2 -12.1

US BOND -0.5% 1.6% 6.8%

WORLD BOND -0.8 -1.3 6.4

CONVERTIBLE BOND 8.1 8.8 14.0

BALANCED 4.4 10.0 16.2

WHITNEY DODDS WOODRUFF - STAFF