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Bumpy Road Ahead for Industrial Metals

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 for growth in automotive and construction, 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 should be wary of 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), BHP Billiton Limited (BHP), Vale S.A (VALE) and Fortescue Metals Group Limited ramped up production in recent years. They intend to continue exploring for iron ore in Australia ignoring lower growth forecasts from China and weaker iron ore prices, while 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 its shipments.

Rio Tinto has trimmed its target for production next year to between 330 million and 340 million tons, from 350 million tons previously. BHP had also followed suit by having stated its plans to cut annual production by 10 million tons to rest at 229 million tons this year. Vale, too, revealed its expectations of full-year iron ore production coming in at the lower end of the previous guidance of 340­­–350 million tons.

However, as well-intended as the plans are, they may not be sufficient to balance the demand-supply gap. Excess supply over demand, economic downturn in China 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), markets should remain essentially balanced in 2016. For 2017, the group expects a surplus of around 160,000 metric tons. This is higher than the deficit of 55,000 tons and a surplus of 20,000 tons for 2016 and 2017, respectively, forecast at its Mar 2016 meeting driven by better-than-expected actual growth so far this year.

World mine production is expected to increase by around 4% in 2016 to 19.9 million tons, benefiting from new and expanded capacity brought on stream in the last two years. In 2017, world mine production is expected to remain flat. Although output from the currently operating mines is expected to improve, growth will be offset by a 6% decline in SX-EW production and the dearth of new major mine projects. Peru and Mexico are the main contributors to growth this year with Chile to contribute meaningfully to growth in 2017.

Freeport-McMoRan Inc.’s (FCX) Grasberg mine in Indonesia and Cerro Verde operation in Peru, BHP Billiton’s Escondida, the world's largest copper mine and First Quantum's Sentinel mine in Zambia are adding output early next year. 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 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.

The International Monetary Fund’s growth forecast for China is 6.6% for this year and 6.2% for 2017. The predicted rate of growth remains well below 6.9% growth achieved in 2015. 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. Metal prices are, therefore, projected to decline 14% in 2016 and a 1% in 2017.

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.

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 can lead to a drop in industrial metals’ prices.

Interest Rate Hike

As widely expected, the Fed raised benchmark interest rates – for the second time in a decade – by a quarter of a percentage point to 0.5% to 0.75% from 0.25% to 0.5%. The central bank also hinted at three rate hikes in 2017, up from the prior expectation of two. The Fed, in its statement, said that economic growth has picked up since mid-2016 and that the labor market continues to strengthen. 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 other metrics also indicate that they are not profitable investment options for now.

Arconic Inc. (ARNC) currently has a Zacks Rank #5 (Strong Sell). The 2016 earnings estimates have gone down by 13% in the last 60 days.

Amerigo Resources Ltd. (ARREF) currently has a Zacks Rank #4 (Sell) and has seen its earnings estimates gone down in the last 60 days. The average negative surprise for the last four quarters is 37.50%.

Earnings estimates for Lundin Mining Corporation (LUNMF) have gone down over the last 60 days. The company currently has a Zacks Rank #4.

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

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