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Industrial metals such as iron, aluminum and copper are essential to regular technology and infrastructure. President Trump’s promise to go on an infrastructure binge naturally gave a boost to the price of industrial metals. Growth in U.S. GDP and continued improvement in end-use sectors like automotive, aerospace, construction and packaging also bode well for metals.

In fact, in the third quarter of 2017, base metals (copper, lead, nickel, zinc) were the best-performing commodities sector, recording a 10.74% gain. At the end of the quarter, the prices had gained around 16% since the onset of the year. This was mainly driven by aggressive buying of metals and other raw materials in China during the quarter.

The Chinese economy has lately been showing signs of improvement. China is widely expected to stimulate growth with further construction and infrastructure building projects. Prices have also gained on China's drive to clean up its environment and improve infrastructure.

Also, the U.S.-North Korea imbroglio may have pushed China to add on its strategic stockpiles of commodities. Tight supplies also aided in boosting prices, with zinc, aluminum and copper boasting the biggest gains. Industrial metals are sensitive to Chinese GDP growth, inflation and the U.S. dollar — all of which were tailwinds to the industrial metals in the quarter.

Let’s take a closer look at the recent price movement of a few important metals and what lies ahead.

Iron

Iron, the main ingredient in steel moved in the opposite direction of the non-ferrous metals, dipping 0.32% in the third quarter and 22.79% so far in 2017.

The decline in iron ore prices was due to expectations of a fall in China’s steel demand as authorities tighten creditconditions. As steel capacity cuts planned for Chinese mills in winter months are approaching, the prospects of iron ore demand is looking bleaker. To curb pollution, the government has mandated steelmakers to cut as much as 50% of production. China consumes more than two-thirds of the seaborne iron ore market and produces as much steel as the rest of the world combined.

In September, imports of high-quality iron ore fines and lump ore from Australia, Brazil and South Africa crossed 100 million tons, a record high. The scene reversed in October with a 23% plunge to 79.5 million tons. The record import caused domestic inventories to swell while requirements from Chinese steelmakers dwindled given regulatory restrictions.

The second reason for weakness in the iron ore market is seasonal as China’s imports of iron ore tend to move to their lowest level in October because of a National Holiday and weather issues that impact construction during winter months.

Aluminum

Over the last few years, the slowdown in Europe and China has not been positive for the metal, as it weighed on demand. There were massive stockpiles of aluminum in LME warehouses. However, aluminum industry fundamentals have improved considerably since 2016 with its markets recording a supply deficit in 2016 – the first in a decade.

Aluminum increased 11.42% in the third quarter of 2017 and recorded a 25.37% gain in 2017 at the close of the third quarter. Aluminum prices have been gaining this year owing to improved supply-demand dynamics, Trump’s win and higher coal prices. China’s directive toward capacity cut and Trump’s insistence on trade reforms spread optimism in the market, lifting aluminum prices.

Copper

After vastly underperforming other metals in 2016, copper experienced a sudden spike at the end. Pick up in global manufacturing activity and hopes of Trump's $500 billion infrastructure drove the red metal’s recovery. Renewed optimism about economic strength in the top consumer China and indications of tighter global mine supply aided prices this year.

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 a 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. Another factor that contributed to copper’s rally is a sharp drop in output from Codelco — the world’s biggest copper producer. On Sep 5, the Chilean state copper company said that production for first-half 2017 from its copper operations fell to 798,000 tons from 843,000 tons a year ago.

At Q3 end, copper was at $2.9475 per pound, having gained 9.21%. In the first three quarters of this year, copper prices have gained 17.50%.

Industry Positioning – Positive

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 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 #60, is in the top 23%. The iron mining industry occupies space in the top 46% of the Zacks classified industries, with a Rank of #117.

Improved Performance

Year-to-date, the Mining-Iron and Mining-Non Ferrous industries have recorded a respective rise of 32.9% and 24.9%. The industries have outperformed both the Basic Material sector’s increase of 19.3% and the S&P 500’s corresponding advance of 16.9%.

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 4.27 and the mining-ferrous industry has a trailing 12-month EV/EBITDA multiple of 7.93.

Both these compare favorably with the broader Basic Materials Sector’s EV/EBITDA multiple of 10.39 and S&P 500 EV/EBITDA multiple of 11.35. The industry’s lower-than-market positioning calls for more upside.

Q3 Earnings Scorecard, Projections

The basic materials sector logged a 2.6% increase in third-quarter earnings. The earnings growth graph for the sector will pick up fourth quarter onward. Earnings growth will be 29.9% in fourth-quarter 2017, 18.3% in first-quarter 2018, 13.7% in the second and 9.7% in third-quarter 2018. (Read more: Plenty of Positive Retail Surprises).

What’s in Store?

Iron: Global steel production rose 5.6% year over year during the first nine months of 2017 to 1267 million tons. The World Steel Association forecasts global steel demand to go up 7% in 2017 and 1.6% in 2018. China’s steel demand is expected to increase by 3.0% in 2017. 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 Limited’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. 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. China’s demand, which accounts for about half of 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 checked.

Moreover, in North America, demand should remain robust, mainly due to the 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 tons in 2017 and about 105,000 tons in 2018. Copper prices are likely to be influenced by demand from China, India and emerging markets, as well as economic activity in the United States 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 that pulling the reins on supply will stabilize prices. Trump's infrastructure push should also provide some support. Projection of earnings growth also instils 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 #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

In the last 30 days, earnings estimates for Amerigo Resources have gone skyrocketed 500% for 2017 and surged 75% for 2018. The company has an average positive earnings surprise of 54.17% in the trailing four quarters.

Lundin Mining Corp. (LUNMF - Free Report) is another good pick, with a Zacks Rank #1. It has an average positive earnings surprise of 50% for the trailing four quarters. The earnings estimate for fiscal 2018 has gone up 5% for Lundin Mining over the last 30 days.

However, we suggest staying away from or getting rid of stocks such Coeur Mining, Inc. (CDE - Free Report) . Coeur Mining carries a Zacks Rank #5 (Strong Sell) and has a negative average earnings surprise of 283.33% for the trailing four quarters. Its estimates for 2017 have gone down to a loss per share of 5 cents from the prior estimate of earnings of 16 cents, over the last 30 days. The earnings estimate for 2018 has plunged 44% over the same time frame.

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