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Reasons Why Industrial Metals Are Slouching

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For the industrial metals industry, demand will remain strong in the years to come given their varied uses. While industrial metals would gain from healthy momentum in Automotive and recovery in the Construction space, the industry remains saddled by a number of headwinds. Below, we have discussed some of the key reasons and what investors in the industrial metals sector can look forward to in the coming months as well as over the long term:
The Perennial Problem of the Industry - 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 (FMG.AX), have ramped up production. They intend to continue exploring for iron ore in Australia despite lower growth forecasts from China and weaker iron ore prices, betting on continued strength in iron ore demand over the long term. Hence, Australia, the world's top exporter of iron ore, will rev up its shipments.

The surging output are already overwhelming Chinese demand growth, leading to a supply glut. Iron exports from Brazil, the second largest exporter, have risen as a result of Vale increasing its production. Vale, which alone contributes almost 85% of Brazil’s iron ore, will continue to increase its iron output.

In case this excess supply is not matched by adequate demand, it will expose the market to a risk of further price declines. Excess supply over demand, economic downturn in China and severe rivalry between mining giants will keep iron ore prices subdued. Weakening market prices of iron ore continue to hurt miners’ aggregate revenues and margins.

Aluminium: Alcoa (AA) now expects global aluminum markets to be in a surplus of 760,000 tons, 4,000 tons higher than previously estimated, and surplus of 2.2 million metric tons in China.

Copper: The International Copper Study Group has projected that the copper market, after five straight years of deficits, should swing into a 2015 production surplus of roughly 390,000 tons. This is less than a month of current daily demand. According to ICSG projections for 2016, the copper market may show a second consecutive production surplus relative to demand. However, this is expected to be lower at 230,000 tons as demand growth outpaces production growth.

Despite seeing an oversupplied market for copper in the next few years, 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 the 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.

China’s GDP in the first quarter grew at the slowest pace since 2009 and its manufacturing activity also slowed down. China's economic growth for the second quarter rose 7% year over year. Analysts have slashed their forecasts for China's growth over the next three years amid broadening pessimism over the health of the world's second largest economy. The gloomy outlook is the latest setback for China which has had a tumultuous few weeks.

The move by the country's central bank to devalue the yuan startled investors and roiled equity markets all over the world. Seeing a feeble impact from efforts to prop up jittery stock markets, Chinese authorities are now reportedly scaling back their market intervention plans.

The earliest economic indicator available for August -- the preliminary Caixin manufacturing purchasing managers' index (PMI) -- suggests persistent sluggishness in the country's vast factory sector. The index fell to a near six-and-a-half-year low of 47.1 in August, below Reuters’ forecast of 47.7 and down from 47.8 in the previous month.

Eurozone Worries Persist

The European economy has not recovered enough, as evident from the meager Eurozone GDP growth. The Gross Domestic Product in the euro area expanded 0.30% in the second quarter of 2015 over the previous quarter. Its biggest economy, Germany, expanded 0.4% while France remained flat. These two countries combined make up a significant chunk of the Eurozone's GDP. GDP Growth Rate in the euro area averaged 0.36% from 1995 until 2015.

The European Commission is projecting 1.8% increase in the EU and 1.5 % in the euro area, 0.1 and 0.2 percentage points higher, respectively, from the figures projected three months ago. For 2016, the Commission forecasts growth of 2.1 % in the EU and of 1.9 % in the euro area.

A 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 has led to a drop in industrial metals’ prices. An interest rate hike is likely to make the dollar stronger which does not bode well for industrial metal prices.

Falling Oil Prices

The slump in oil prices to five-year lows had a visible impact on industrial metal prices. A sharp and sustained drop in oil is generally associated with declining sales and prices of other commodities. The entire commodities sector may be impacted negatively in the wake of the current oil price carnage.

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.

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