Should You Buy Industrial Metal Stocks Now?

Industrial metals are the building blocks of an economy. At present, even though concerns over China’s future growth has added an element of uncertainly to the outlook, there are plenty of reasons to be optimistic about the industrial metals industry for both the short and the long term. Below, we have discussed some of the key reasons and what investors in the industrial metals sector can look forward to in the coming months and years:

Correction of the Aluminum Demand-Supply Imbalance

After aluminum prices bore the brunt of chronic surplus, the global aluminum industry shutdown a significant portion of its production capacity, which eventually led to firmer prices. In the first six months of 2014, Rusal effectively cut aluminum production by 10.8%. Likewise, Alcoa Inc. (NYSE:AA) undertook a number of restructuring measures (including closure of smelters) and is aggressively pursued cost-cutting actions.

Alcoa curtailed 655,000 metric tons of smelting capacity during 2013. The company, in second-quarter 2014, reduced 147,000 metric tons of smelting capacity in Brazil and also closed a 190,000-metric ton smelter in Australia in the third quarter. With these curtailments, the company will have 1.2 million metric tons of reduced capacity from 2007 levels.

In addition to closures and curtailments, Alcoa plans to aggressively accelerate actions to reduce the cost of raw materials used by its Primary Products business and will adjust capacity across its global refining system to reflect internal demand as well as prevailing market conditions. Alcoa has set the goal of lowering its position on the world aluminum production cost curve to the 38th percentile by 2016.

Future of Aluminum Tied to Automotive & Aerospace Industries

On the demand side, aluminum consumption is expected to improve on a global basis spurred by the automotive and packaging industries -- its key consumer markets. The automobile market is becoming increasingly aluminum-intensive, given the metal's recyclability and light-weight properties. The global push to improve fuel efficiency in vehicles is expected to more than double the demand for aluminum in the auto industry by 2025.

The airline industry is also expected to boost demand for the metal. To capitalize on the lucrative aerospace market, Alcoa has agreed to buy U.K.-based leading jet engine components maker Firth Rixson, a significant milestone in its portfolio transformation strategy. This transaction will reinforce the company’s aerospace business and add a broad spectrum of high-growth, value-added jet engine components. Alcoa’s recent $1.1 billion agreement to supply key parts (including forgings) for Pratt & Whitney engines also underscores Alcoa’s continued efforts to profitably grow its aerospace business.

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Following China, which accounts for over 40% of the global aluminum consumption, India appears promising given its current low level of aluminum consumption and high urban population growth. With demand remaining strong and the industry pulling the reins on supply, the aluminum market is likely to witness supply deficits for a prolonged period rendering a supportive backdrop for high aluminum prices.

Pickup in Economic Activity to Drive Copper Demand

Copper is a major industrial metal playing a particularly important role in emerging countries. Given its varied applications, it is often considered that the trends in the copper market are a useful indicator of the state of the global economy.

Developments in the world economy have a strong correlation with movements in copper prices. Trends in Chinese GDP growth and world trade play a major role. Given that China accounts for the largest share by far of global copper consumption (around 46%), and also has a large share in the total production of pure copper (around 34%), the correlation with China is a key factor. A pickup in China’s economy will be instrumental in driving copper prices.

It is expected that the rising middle class in Asia, particularly in India and China, will spend more on consumer goods such as air conditioners and refrigerators in the years to come, which require a lot of copper. Rio Tinto plc (NYSE:RIO) and BHP (NYSE:BHP) are planning to mine millions of additional tonnes of copper, despite envisaging an oversupplied market for the next few years.

The economic outlook for 2015 is upbeat in the U.S. while the European economy is recovering slowly. In China, the government remains committed to maintaining control over the gradually slowing economy. Expectations are high that Beijing will roll out more stimulus to avert a sharper slowdown. Overall, as the global economic activity improves, copper as well as other industrial metals will move in tandem.

Rebound in Construction

The housing and construction sector is the largest consumer of steel today and consequently of iron ore. Building construction (pipes and wires) is also the largest market for copper. An uptrend has been noticed in real estate activity in the U.S., like new home starts and construction spends, over the past few quarters.

The U.S. Architecture Billings Index (ABI), an economic indicator that provides an approximately nine-to-twelve-month glimpse into the future of non-residential construction spending activity, remained over 50 for most part of 2014 and reached 55.8 in July, its highest level since 2007. Any score above 50 indicates an increase in billings. The ABI has been positive for seven consecutive months.

Long-stalled construction projects are being renewed. Moreover, easier access to credit from lending institutions along with an increasing comfort level in the overall economy has helped revitalize the commercial real estate sector in recent months. The requirement for emerging projects, such as education facilities and government buildings, is also leading to demand in the sector.

In the long term, as the urban population increases worldwide, so will the need for steel to build skyscrapers and public-transport infrastructure. Emerging economies will also continue to be major demand drivers for increasing urbanization and industrialization. The demand for iron ore is thus expected to remain strong in the years to come. Thus, a rebound in construction bodes well for the iron ore and copper industries.

Bottom Line

As you can see, there is no reason not to be optimistic about the industrial metals industry over the long haul. But what about investing in the space right now?

Check out our latest Industrial Metals Outlook here for more on the current state of affairs in this market from an earnings perspective, and how the trend is shaping up for this sector going forward.

Original post

Written By: Zacks Investment Research