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Headwinds Aplenty for Industrial Metals

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For the industrial metals industry, demand will remain strong in the years to come, given their varied uses. But while industrial metals would gain from healthy momentum in Automotive and Construction, the industry remains saddled by a number of headwinds.

Below, we discuss some of the key reasons and what investors in the industrial metals sector should be wary of in the coming months as well as over the long term:

The Perennial Problem of Oversupply

Iron: The threat of oversupply continues to plague the industry as major iron ore producers Rio Tinto plc (RIO - Free Report) , BHP Billiton Limited (BHP - Free Report) , Vale S.A (VALE - Free Report) and Fortescue Metals Group Limited ramped up production in recent years. These producers intend to continue exploring for iron ore in Australia, ignoring lower growth forecasts from China and weaker iron ore prices, while being optimistic about continued strength in iron ore demand over the long term. Hence, Australia, the world's top exporter of iron ore, will gear up for reinforcing shipments.

Excess supply over demand and severe rivalry between mining giants will keep iron ore prices in check. Weakening market prices of iron ore continue to hurt miners’ aggregate revenues and margins.

Copper: As per the International Copper Study Group (ICSG), there will be a surplus of around 160,000 metric tons in 2017. In 2017, world mine production is expected to remain practically unchanged as although output from the currently operating mines is anticipated to improve. However, growth will be offset by a 6% decline in SX-EW production and the dearth of new major mine projects. Chile is expected to contribute significantly to growth in 2017.

Freeport-McMoRan Inc.’s (FCX - Free Report)   Grasberg mine in Indonesia and Cerro Verde operation in Peru, BHP Billiton Limited’s (BHP - Free Report) Escondida, the world's largest copper mine and First Quantum's Sentinel mine in Zambia are adding output in 2017. MMG Limited’s Las Bambas mine in Peru is also ramping up production.

Rio Tinto and BHP (separately and in joint ventures) plan to mine millions of additional tons of copper. They are amassing vast copper holdings to capture a greater chunk of the $140 billion global market in a bid to eventually squeeze out high-cost producers just as they did in the global iron ore business.

Slowdown in China

Demand in China, that alone accounts for a major portion of industrial metal demand, has slowed down due to the country's tepid property market and weaker infrastructure investment growth. China’s economic growth has cast a shadow on investors' view of commodities demand and, as a result, brought down demand for metals, leading to price weakness.

The International Monetary Fund’s (IMF) forecast for growth in China is pegged at 6.5% for 2017. However, the predicted rate of growth remains well below 6.9% growth achieved in 2015 and 6.7% in 2016. As per the IMF, a faster slowdown in China could have a serious impact on trade, commodity prices and investor confidence, and lead to a more generalized slowdown in the global economy.

Given that China is responsible for approximately half of the global metal demand, the slowdown in the world’s second largest economy will likely hurt commodity prices. Consequently, metal prices are, expected to decline.

Weakness in Emerging Economies

Steel demand in some emerging economies continues to be weak. A deteriorating external environment, in the form of weak exports, low commodity prices, capital outflows and currency devaluation, adds to the woes of these economies. Moreover, geopolitical undercurrents and internal tensions remain a major concern for these nations.

Stronger U.S. Dollar

Base metals, as commodities, move in opposite directions to the dollar. Both markets remain closely linked to each other as every turn in the dollar is either followed by, or coincides with, a turn in the price of commodities. The strengthening of the dollar can lead to a drop in industrial metals’ prices.

Interest Rate Hike

As widely expected, the Fed hiked the interest rate from a range of 0.5–0.75% to 0.75–1% “in view of realized and expected labor market conditions and inflation.” This marks the second rate hike since Dec 2016 and third in the decade. The Fed hinted at two more rate hikes this year. Higher rates normally translate into a stronger dollar which leads to lower metal prices.

Bottom Line

Global uncertainties and oversupply conditions of base metals are some of the sector’s worst detractors. But what about investing in the space right now; are there opportunities for short-term investors overriding the headwinds?

Check out our latest Industrial Metals Industry Outlook here for more on the current state of affairs in this market from an earnings perspective, and how the trend is looking for this important sector of the economy now.

Stocks to Avoid for the Time Being

We presently recommend investors to stay away from the following industrial metal stocks as they presently have an unfavorable Zacks Rank. The downward estimate revisions also indicate that they are not profitable investment options for now.

Particularly, we suggest staying away from  stocks such as Coeur Mining, Inc. (CDE - Free Report) , Fission Uranium Corp. (FCUUF - Free Report) , Energy Fuels Inc. (UUUU - Free Report) and Fortescue Metals Group Limited (FSUGY - Free Report) , which carry a Zacks Rank #4 (Sell).

Estimates for fiscal 2017 for Coeur Mining have gone down 13% over the past 30 days and for Fortescue Metals Group have dipped 5% over the past 60 days. Energy Fuels delivered an average negative earnings surprise of 249.72% in the last 4 quarters. The estimate for fiscal 2017 for Fission Uranium has worsened from a loss per share of 1 cent to 2 cents per share over the past 30 days.

You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

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