Rising cases of coronavirus put a question mark over metal stocks rally

Analysts see downside risk in stocks as the world economy faces the prospects of fresh lockdowns

A sudden and sharp fall in the equity markets on Monday not only brought fear back on the Street, but also raised a question mark over the sustainability of the rally in metal stocks. Metal producers, such as Tata Steel, Hindalco, JSW Steel, Hindustan Zinc, Steel Authority of India, and National Aluminium, saw big cut in their shares on Monday as investors fretted about the future trajectory of the demand and prices of industrial metals.

This is a sharp reversal for the sector that has been a rally leader until recently. The combined market capitalisation of India’s top eight industrial metal producers is still up 31 per cent in the past three months, against a 20 per cent rally in the Sensex.

The rally was fuelled by rising metal prices and sequential increase in demand for industrial metals due to pent-up demand and a continued expansion of the Chinese economy that accounts for nearly half the world’s demand for industrial metals.

Analysts now see a downside risk in metal stocks as the world economy faces the prospects of another round of lockdowns after detection of a new strain of coronavirus in the UK. That country is already under lockdown and major economies in Europe and Asia have banned flights from the UK. This is likely to delay the recovery in the world economy from the Covid-19-triggered slump.

“The rally in metal stocks and metal prices was always on thin ice given a likely contraction in major economies in 2020, with the exception of China. Global GDP even in 2022 is likely to be less than that in 2019, even with continued growth in China. This will weigh on metal demand,” says G Chokkalingam, founder & MD Equinomics Research & Advisory Services.

According to him, the recent rally in metal space was driven by speculation and benign liquidity in the financial markets, rather than fundamentals.

The rally also made metal stocks expensive. The top eight stocks are currently trading 1.3x their book value, against 0.8-1.0x on average historically. Individual stocks, such as JSW Steel, Hindalco, and National Aluminium, are more expensive and trading at 50-100 per cent premium to their historical P/E multiples. This raises the downside risk for investors if the earnings growth in the sector is disappointing.

Margins in the industry are also likely to come under pressure due to a steady rise in input prices. The industry gained handsomely from record low energy and raw material prices in the June quarter.

Investors should also remember that metal stocks are volatile by nature and tend to outperform during a rally, but fall harder when sentiment turns sour. But the sector had been an underperformer over the long-term, given the companies’ low return on equity and lack of secular industrial growth in India. The pandemic did little to change this equation.