Industrial metals such as iron, aluminum, copper are essential for most of the technology and infrastructure used in our daily lives. Thus, President Trump’s promise to invest heavily in infrastructure provided a boost to industrial metals prices. Growth in the U.S. GDP and continued improvement in end use sectors like automotive, aerospace, construction and packaging will sustain increased demand for metals.
Further, industrial metals have been benefiting from China’s drive to halt some of the metal’s production to fight air pollution. Let’s take a closer look at the price movement of a few important metals so far this year and what lies ahead.
Iron ore prices have been on a roller coaster ride so far this year. After marching toward a high of $95 per ton in Feb 2017, prices slumped to $57 per ton in June. Of late, prices have again picked up to the $70 per ton level in July.
China has been the primary catalyst for the recent surge in iron prices. Release of strong second-quarter GDP figures renewed optimism. The official sub-index for activity growth in construction sector hit 62.5 in July, the highest in almost four years. Also, tougher and more frequent environmental inspections on steel plants guilty of polluting have dented steel production and have impacted iron ore prices significantly.
Chinese traders are worried about a supply crunch and low stockpiles; consequently, imports have picked up. In the first six months, imports rose 9.3% to 539 million tons.
Aluminum industry fundamentals have improved considerably since 2016 and aluminum markets recorded supply deficit in 2016, the first in a decade. During the first six months of 2017, the average LME aluminium price touched USD 1,880.56 per ton, a 22% increase from the prior-year average.
Aluminum prices have been gaining this year owing to an improved supply-demand dynamics, the Trump win and higher coal prices. China’s directive towards capacity cut and Trump’s insistence on trade reforms have inflicted positivity in the market lifting aluminium prices.
After vastly underperforming compared with other metals in 2016, copper experienced a sudden spike at the end of 2016. Pick up in global manufacturing activity and hopes about Trump's $500 billion infrastructure drove the red metal’s recovery. Copper has gained 13% so far this year and is trading 28% higher than last year. Renewed optimism about economic strength in top consumer China and indications of tighter global mine supply aided prices.
Supply disruptions at some of the key copper mines including BHP Billiton Limited’s (BHP - Free Report) Escondida mine in Chile earlier this year and strike action at Freeport-McMoRan Inc.’s (FCX - Free Report) Grasberg operations in Indonesia led to the decline in mined copper production and provide a boost to the price.
Industry Positioning - Mixed Bag
The Zacks Industry Rank relies on the same estimate revisions methodology that drives the Zacks Rank for stocks. The way to look at the complete list of industries is that, we put our X industries (all 265 of them) into two groups: the top half (i.e., industries with the best average Zacks Rank) and the bottom half (the industries with the worst average Zacks Rank).
In the last 10 years, using a one-week rebalance, the top half beat the bottom half by a factor of more than 2 to 1. (To learn more visit: About Zacks Industry Rank)
Within the Zacks Industry classification, the Mining-Iron and Mining-Non Ferrous industries (aluminum, copper, etc.) are grouped under the Basic Material sector (one of 16 Zacks sectors). The non-ferrous mining industry, with a Zacks Industry Rank #123, remains in the top half. However, the iron mining industry occupies a space in the bottom 6% of the Zacks classified industries with a Rank of #241.
In the past year, the Mining-Iron and Mining-Non Ferrous industries have recorded respective rise of 76.5% and 22.5%. The industries have outperformed both the Basic Material sector’s increase of 14.6% as well as the S&P 500’s corresponding advance of 13.5%.
Attractive on the Valuation Front
Valuation looks attractive for both the industries going by the EV/EBITDA (Enterprise Value/ Earnings before Interest Tax Depreciation and Amortization) multiple, a preferred valuation metric for cyclical industries like iron and non-ferrous industries. The mining-iron industry has a trailing 12-month EV/EBITDA multiple of 4.85 and the mining-ferrous industry has a trailing 12-month EV/EBITDA multiple of 8.65.
Both of these compare favorably with the broader Basic Materials Sector’s EV/EBITDA multiple of 11.49 and S&P 500 EV/EBITDA multiple of 10.81. Both of the industry’s lower-than-market positioning calls for more upside ahead.
Q2 Earnings Scorecard, Projections
So far, 60% of the S&P 500 members in the basic materials sector have reported second-quarter results and logged a 9.7% increase in earnings. Taking into account the rest of the companies that have yet to disclose numbers, earnings will rise 6.2% for the quarter. (Read more: Q2 Earnings Season Past the Halfway Mark)
What’s in Store?
Iron: Global steel production rose 4.5% year on year during the first six months of 2017 to 695 million tons. Despite contracting in June by 1.7% US steel output still grew 1.3% in the first half after two years of contraction as higher prices encourage the revival of idled plants. Strong steel demand growth in developing countries will offset stabilizing demand in developed economies. This will boost demand for iron ore.
The supply surge resulting from Vale S.A. (VALE - Free Report) S11D, Rio Tinto plc’s (RIO - Free Report) Pilbara projects, and BHP Billiton’s projects will create a surplus in the already well supplied iron ore market. However, China is planning to cut steel capacity to reduce pollution in the country and by 2020, the government aims to trim 100-150 million tons of steel capacity. Sustained capacity rationalization could lead to higher steel prices, which in turn should support iron ore prices.
Aluminum: Global aluminium markets are expected to be in a deficit in 2017. Chinese demand, which accounts for about half of the total demand, is likely to be sustained by the building and construction sector as well as the automotive and railway sectors. With the country deciding to cut capacity, supply will also be in check.
Moreover, in North America, demand should remain robust, mainly due to building and construction, automotive, packaging and airline industries. India appears promising given its current low levels of aluminum consumptionand high urban population growth.
Copper: As per the International Copper Study Group (ICSG), copper is headed for a deficit of about 150,000 metric tons in 2017 and about 170,000 tons in 2018. Copper prices are likely to be influenced by demand from China and emerging markets, as well as economic activity in the U.S. and other industrialized countries.
The timing of the development of new supplies of copper, along with production levels of mines and copper smelters are also anticipated to influence price. The long-term fundamentals of the metal remain positive, supported by its significant role in the global economy and a challenging long-term supply environment.
To Sum Up
We believe, pulling the reigns on supply will help stabilize prices. Trump's infrastructure push shouldalso provide some support. Projection of earnings growth also instills investor confidence in the industrial metals space.
For investors keen on playing these industries, we recommend Amerigo Resources Ltd. (ARREF - Free Report) which carries a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here. Earnings estimates for Amerigo Resources for fiscal 2017 have gone up 25% in the past 30 days.
We suggest investors to add Coeur Mining, Inc. (CDE - Free Report) , Lundin Mining Corp. to their watch list. These stocks carry a Zacks Rank #3 (Hold) and their estimates have move north recently. Earnings estimate for fiscal 2017 for Coeur Mining has gone up 12% and for Lundin Mining the estimate for fiscal 2017 has moved up 9%.
However, we suggest staying away from or getting rid of Zacks Rank #4 (Sell) stocks such as KAZ Minerals plc (KZMYY - Free Report) and Fortescue Metals Group Ltd. (FSUGY - Free Report) .
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