Metal stocks likely to underperform broader market during H2 2021

The dollar-denominated hot rolled steel prices in China are up 27 per cent in 2021 against 13.4 per cent rise in S&P 500 index, but some analysts are turning cautious

The rally in industrial metal prices, especially steel, has proved to be more durable than thought initially. The London Metal Exchange Index (LMEX) that tracks the prices of non-ferrous metals continues to outperform the S&P 500 stock index - the bellwether of global equity markets - despite some weakness in recent weeks.

Similarly, steel prices in China - the world's top metal producer and consumer  - remain stubbornly high. The prices of hot rolled (HR) steel in China are up 7 per cent in July and are close to May's high.

The HR steel prices in China and priced in US dollar are up 27.2 per cent since the beginning of 2021 against 13.4 per cent rise in S&P 500 index in the same period. HR steel is now trading at close to its all-time high of $892 per tonne in China (around Rs 66,600 per tonne) up from $701 per tonne at the beginning of the year. In the same period, S&P 500 index has rallied from 3,756 at the beginning of the year to 4,258 now.

The LMEX, on the other hand, is up 20 per cent year-to-date signalling strong demand and price outlook for non-ferrous metals such as copper, aluminium, zinc and lead. The non-ferrous metals are, however, now underperforming steel prices.

The recent gains in metal prices come on the back of an equally strong rally in 2020. In all, HR steel prices in China are up 86 per cent since the end of March last year, while LMEX has gained 75 per cent during the period. This is much higher than the rally in S&P 500 during the period. (See the adjoining chart).

The global rally in industrial metal prices reflected in the performance of BSE Metal Index that tracks the share price of Indian metal and mining companies such as Tata Steel, JSW Steel, Hindalco, Hindustan Zinc, Vedanta, Steel Authority of India (SAIL), NMDC and Coal India among others.

The continued firmness in industrial metal prices in the international market would mean another year of strong earnings for domestic metals and mining companies.

Not surprisingly, the BSE Metal Index continues to stay ahead of the broader market. The BSE Metal Index is up 61 per cent since the beginning of the current year against a 9 per cent rally in the benchmark BSE Sensex during the period. The metal index is now up 235 per cent since March last year against a 75 per cent rally in BSE Sensex during the period.

This also means that metal prices may continue to put upward pressure on retail and wholesale inflation in the coming weeks. Initially, many analysts believed that the impact of metal prices on inflation will be transitory and it will fade away by the middle of 2021. Higher inflation is bad for the broader equity markets as it puts pressure on central banks to tighten money supply and raise interest rates.

Some analysts have, however, now turned bearish on metals. "Metal stocks have done phenomenally better than the rest of the market so far, but they are likely to underperform the broader market during the second half of 2021," says Dhananjay Sinha, MD and chief strategist JM Financial Institutional Equities.

According to Sinha, the demand for industrial metals is now moderating in key markets of China, European Union and North America after a surge earlier during the year due to a pent-up demand. This, coupled with more plants resuming full production due to the end of the Covid-19 restrictions, is likely to put a downward pressure on metal prices globally.

Last week, analysts at Edelweiss Securities in a report said, "Domestic HR coil and rebar prices continue to slip on subdued domestic demand. Going ahead, we expect spreads to decline as coking coal price has strengthened and export realisation has withered." However, they believe that declining crude steel production in China is positive for steel fundamentals and would help maintain market balance, possibly leading to a reduction in exports going ahead.

The biggest overhang for metal prices and metal stocks is the strong possibility of a demand slowdown in China in the second half of CY21 once the post-pandemic fiscal stimulus fades away.