Metal stocks: Bulls have upper hand, Copper at a five-year high

After a few weeks of uncertainty, the global commodities markets have seen a new rally in industrials. Traders have to weigh up two opposing chains of logic. The pessimists expect China to see a slowdown in growth, or a growth-reversal if the real estate bubble bursts, given defaults by Evergrande, and high levels of debt. Economic activity in the global economy is also slowing, going by downgrades in the International Monetary Fund’s projections. The optimists, on the other hand, see a squeeze on the supply side, coupled with demand that remains robust, even if it is somewhat lowe.....
After a few weeks of uncertainty, the global commodities markets have seen a new rally in industrials. Traders have to weigh up two opposing chains of logic. The pessimists expect China to see a slowdown in growth, or a growth-reversal if the real estate bubble bursts, given defaults by Evergrande, and high levels of debt. Economic activity in the global economy is also slowing, going by downgrades in the International Monetary Fund’s projections.

The optimists, on the other hand, see a squeeze on the supply side, coupled with demand that remains robust, even if it is somewhat lower than earlier projections. They expect supply to shrink more than the commensurate fall in demand.

Europe’s energy crisis has meant lower production of metals. China has also seen a drop in metal production, due to power shortages, and also deliberate cutbacks in coal use. Since China is an enormous player, both in production and demand, the latter may continue to exceed supply and, hence, prices will rise.

This trend may be especially significant. LME Week — the annual event where the global metals community meets in London — has just concluded. Consensus in various seminars and discussions there was optimistic and as of now, the bulls are clearly winning this “argument”.

Copper is at a five-year high on the Shanghai Futures Exchange and the London Metal Exchange (LME), while zinc and aluminium are trading at highs that have not been approached since before the 2008 financial crisis. Steel prices are also elevated.

The continued bull market in metals also means a continuing bull market in metals miners, and primary metals producers. This is relevant to India, where the metals sector had a spectacular performance through the past four quarters. Cutbacks in Chinese production could lead to even stronger performances by Indian metals players.

 
There are several blue-chips in the Indian metals sector, or sectors, if we consider ferrous and non-ferrous metals separately. Their Q2 results should be good anyhow, since prices remain high and demand has stayed strong.

Costs will have increased due to higher fuel prices (extraction from ores, refining and smelting, etc, are all energy intensive). But both sequentially and on year-on-year (YoY) terms, most metals producers will declare higher revenues and higher profits, maybe with margin expansion. In addition, the trend of deleveraging we have seen from the second half of FY21 may continue since interest rates have stayed low.

Investors will be looking forward to the next six months and the trends seem good. Domestic demand should strengthen and supply constraints should lead to prices staying high, with correspondingly high realisations.

The Nifty Metals index has returned 177 per cent in the last 12 months and 7.6 per cent in the last month, beating the market hollow. It’s worth noting the index has surged 8.4 per cent in the last five sessions, reversing losses in the three weeks before. Companies such as Vedanta, National Aluminium, Welspun Corp, Hindustan Copper, Hindustan Zinc, Hindalco, and Jindal Steel have all seen double-digit returns in the last month. Hindalco and Vedanta have hit record highs. The momentum has clearly returned to the sector. China’s real estate is the only obvious worry.



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