President Trump’s election provided a boost to industrial metals prices, owing to his promise to go on an infrastructure-spending binge that would revive demand for basic materials and metals. Growth in U.S GDP and continued improvement in end-use sectors like automotive, aerospace, and construction will sustain increased demand for metals.
Industrial metals have been benefiting from China’s proposal to halt some 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.
2016 was the comeback year for iron ore, finishing the year with an 85% increase in prices. This can largely be attributed to a surge in demand from Chinese steelmakers after state-mandated capacity cuts improved buying. The momentum was carried forward in the earlier part of 2017.
However, after marching towards a high of $95 per ton in Feb 2017, it seems to have lost the momentum lately and is currently at around $75 per ton. So far this year, the commodity has dropped 3.1% due to the mounting inventory at Chinese ports, which are currently at the highest levels since 2004. Moreover, fresh supply coming from recently opened mines is weighing on prices. Notably, Vale (VALE) had shipped first cargo from its giant new mine, S11D, in Dec 2016.
Aluminum, which has been saddled with huge production surpluses in prior years, came under further pressure by surging aluminum exports from China (the world’s biggest producer) amid waning domestic demand. Aluminum industry fundamentals have improved considerably since Jan 2016, when prices were in the danger of falling below their 2009 lows. Notably, aluminum markets recorded a supply deficit in 2016, the first in a decade. Aluminum prices have been gaining this year owing to an improved supply-demand dynamics, the Trump win and higher coal prices.
After vastly underperforming when compared with other metals and steelmaking raw materials 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 are the primary reasons for the red metal’s recovery. Further, it has been fueled by a pick-up in Chinese imports that accounts for almost 50% of global copper demand, which is seen as a good omen for the industry’s health.
Industry Positioning – Mixed
Within the Zacks Industry classification, the iron mining and non-ferrous mining industries (aluminum, copper, etc.) are grouped under the Basic Materials sector (one of 16 Zacks sectors). We rank all the 265 industries in the 16 Zacks sectors based on the earnings outlook and fundamental strength of the constituent companies in each industry. To learn more visit: About Zacks Industry Rank.
The bullish Zacks Industry rank of 45 carried by the non-ferrous mining industry is a testimony to the fact that it is back in favor. The favorable rank places the industry in the top 18% of the 250+ groups listed. Our back-testing shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.
The iron mining industry, however, occupies a space in the bottom 42% of the Zacks classified industries with a Rank of #202.
Over the past year, the Zacks categorized Mining-Iron and Mining-Non Ferrous industries have outperformed the broader market with respective rise of 90.6% and 31.9%, higher than S&P 500’s corresponding return of 17.6%.
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 6.99 and the mining-ferrous industry has a trailing 12-month EV/EBITDA multiple of 9.11. Both of these compare favorably with the S&P 500 EV/EBITDA multiple of 10.82. Both of the industry’s lower-than-market positioning calls for some more upside moving ahead.
Sector Level Earnings Trend
Q4 Earnings Scorecard, Projection for Future Quarters
Looking back at the fourth-quarter scoreboard, the basic materials sector logged a 3.5% increase in earnings. In 2017, earnings growth is expected to remain positive with 8.3%, 6.7%, 8.2% and 16.5% in the first, second, third and fourth quarters, respectively. (For a detailed look at the earnings outlook for this sector and others, please read our Earnings Trends report.)
What’s in Store?
Iron: The supply surge resulting from Vale’s S11D, Rio Tinto plc’s (RIO) Pilbara projects, and BHP Billiton Limited’s (BHP) projects, as well as tepid demand growth will affect iron prices. However, China has been reeling due to overcapacity in the steel industry and is planning to cut 50 million tons of steel capacity this year. Steel production capacity elimination in 2016 surpassed targets, with a total of 85 million tons of capacity closed.
These cuts are intended to reduce pollution in the country. By 2020, China’s government aims to close 100 to 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 total demand, is likely to be maintained 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 currently low levels of aluminum consumptionand high urban population growth.
Copper: 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 attributable to difficulty in replacing output of existing large mines with new production sources.
To Sum Up
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. However, base metals have been stable despite the rate hike.
We believe pulling the reigns on supply will help stabilize prices. Trump's infrastructure push should also provide some support. Projection of earnings growth also instils investor confidence in the industrial metals space.
At this juncture, we recommend stocks such as Amerigo Resources Ltd. (ARREF) and Arconic Inc. (ARNC). Amerigo has delivered a positive earnings surprise history of 12.50% in the trailing four quarters and sports a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here. Arconic, a Zacks Rank #2 (Buy) stock, has delivered an average positive earnings surprise of 79.97% in the past four quarters, respectively.
However, we suggest staying away from or getting rid of Zacks Rank #4 (Sell) stocks such as Coeur Mining, Inc. (CDE) and Fortescue Metals Group Limited (FSUGY).
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VALE S.A. (VALE): Free Stock Analysis Report
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