Metals to remain soft

Weak demand, high inventories expected to dent prices.

Recent days have not been good for the metals sector globally, with prices of base metals and steel dropping by five to 16 per cent, compared to end-April. The market’s reaction was led by concerns of sovereign default by Greece and the likelihood of the contagion spreading to other European countries. The news of China tightening liquidity to control a property bubble and to cool its growth added to the problem. So, what is the outlook now?

Global demand down
The recovery in prices from 2009 lows was driven by the multi-billion dollar stimulus packages in the US and China, the world’s two largest consumers of metals. While economic recovery in the US is still in the early stage, China has grown at robust rates, reflecting in its metal output for 2009 (see table). Notably, since China accounts for 27-48 per cent of global metal demand, its move to slow down its heating economy has turned analysts cautious.

Says Navneet Damani, base metals analysts, Anand Rathi: “There will be less demand for metals from here, because China is slowing. The $1-trillion package will also not be sufficient to push demand higher, as it will take some time for demand to kick in from Europe.” Apart from soft demand, there are other issues as well.

High inventory
Most non-ferrous metals such as copper, aluminium and zinc could have a surplus this year and inventories are already at the highest level over the past year at the London Metal Exchange (LME). Aluminium supply is expected to be higher by about 10-12 per cent compared to demand in 2010. But, prices may not crash, considering current LME per-tonne prices, at $2,103, are trading near to the production cost of about $2,000.

The outlook for copper, too, is not good, considering high prices and International Copper Study Group’s prediction of a surplus of 5,78,000 tonnes in 2010 and 2,43,000 in 2011.

Despite higher inventories, zinc LME prices have almost doubled at $2,115 per tonne. Zinc, largely used in steel making, has got support from higher steel production.

In this context, analysts believe prices will remain soft in the near-term. Damani expects base metal prices to be weaker in the second and third quarter (of calendar year 2010), with some revival expected in the fourth quarter.

In the ferrous space as well, global steel production is expected to be almost equal to consumption, at 1,229 million tonnes (mt) in 2010. However, supply is expected to outpace demand marginally in 2011. In the near term, steel prices (China HRC) are expected to remain flat to marginally lower, as compared to $680 per tonne currently. The situation in the domestic market, however, is likely to be better, for in 2010-11, consumption is expected to be 63.26 mt against the supply of 61.78 mt.

India outlook
Within steel, analysts prefer domestic-focused companies such as Steel Authority of India Ltd. Tata Steel could face problems due to its exposure to European markets (almost 80 per cent revenues). In Europe, supply is expected to exceed demand by about 45-48 mt this year. Lower utilisation, pressure on operating margins and depreciation of the euro against the dollar could pose challenges for Tata Steel, whose stock price appears expensive. For National Aluminium Co, delay in expansion and cost pressures could remain a concern. Hindalco’s concerns are due to its significant exposure in the US and European markets through Novelis.

Hindustan Zinc (HZL), which recently entered into an agreement for the value-accretive acquisition of Anglo American’s zinc assets, is largely a domestic play, having a low cost ($670 per tonne) of production.

Also, considering the estimated 40 per cent increase in volumes and reasonable valuations of 11 times 2010-11 earnings, along with surplus cash in its books, it makes HZL a preferred choice.