Factors Pinning Industrial Metals Down

For the industrial metals industry, demand will remain strong in the years to come given their varied uses. While industrial metals would gain from healthy momentum in Automotive and recovery in the Construction space, the industry remains saddled by a number of headwinds.

Below, we have discussed some of the key reasons and what investors in the industrial metals sector should be wary of in the coming months as well as over the long term:

The Perennial Problem of the Industry - Oversupply

Iron: The threat of oversupply continues to plague the industry as major iron ore producers, Rio Tinto plc ( RIO ), BHP Billiton Ltd. ( BHP ), Vale S.A ( VALE ) and Fortescue Metals Group Ltd. have ramped up production. They intend to continue exploring for iron ore in Australia despite lower growth forecasts from China and weaker iron ore prices, betting on continued strength in iron ore demand over the long term. Hence, Australia, the world's top exporter of iron ore, will rev up its shipments.

The surging output is already overwhelming Chinese demand growth, leading to a supply glut. Iron exports from Brazil, the second largest exporter, have risen as a result of Vale increasing its production. Vale, which alone contributes almost 85% of Brazil's iron ore, will continue to increase its iron output.

In case this excess supply is not matched by adequate demand, it will expose the market to a risk of further price declines. Excess supply over demand, economic downturn in China and severe rivalry between mining giants will keep iron ore prices subdued. Weakening market prices of iron ore continue to hurt miners' aggregate revenues and margins.

Aluminium: Alcoa Inc. ( AA ) now expects global aluminum markets to be in a surplus of 551,000 tons in 2015. Rusal raised its forecast for a global aluminium surplus this year to 373,000 tons from an earlier estimate of 277,000 tons.

Copper: The International Copper Study Group (ICSG) expects the market should remain balanced, while in 2016 a small deficit of around 130,000 tons is likely as demand growth outpaces production growth. Earlier, at its April meeting, ICSG had guided a surplus of 360,000 tons and 230,000 tons for 2015 and 2016, respectively. Although a downward revision has been made to global usage in view of lower-than-anticipated growth in China, larger downward adjustments have been made to production as a result of recent announcements of production cuts.

While some companies are announcing production cuts, Rio Tinto and BHP (separately and in joint ventures) plan to mine millions of additional tons of copper. They are amassing vast copper holdings to capture a greater chunk of the $140 billion global market in a bid to eventually squeeze out high-cost producers just as they did in the global iron ore business.

Slowdown in China

Demand in China that alone accounts for a major portion of the industrial metal demand has slowed down due to the country's tepid property market and weaker infrastructure investment growth. China's economic growth has cast a shadow on investors' view of commodities demand and, as a result, brought down demand for metals, leading to price weakness.

China's GDP in the third quarter slowed down to a six-year low to 6.9%, lower than the 7% growth in the first half of the year despite repeated interest rate cuts and other stimulus measures. It was the slowest since the 6.2% recorded in the first quarter of 2009 during the global recession. Analysts have slashed their forecasts for China's growth over the next three years amid broadening pessimism over the health of the world's second largest economy.

The Caixin Manufacturing PMI in China was at 48.6 in November this year, up from 48.3 in October. Even though the reading was the highest since April, it remained below 50 for the ninth straight month. In November, output stabilized and ended its sixth month sequence of reduction while total new business declined at the same pace as in the prior month.

Eurozone Worries Persist

The European economy has not recovered enough, as evident from meager Eurozone GDP growth. GDP in the euro area expanded 0.3% in the third quarter of 2015 compared with 0.4% expansion in the previous period, the lowest performance in a year. Germany and France, which together make up a significant part of Eurozone's GDP, grew 0.3% each. GDP growth rate in the euro area averaged 0.36% from 1995 until 2015.

A Stronger U.S. Dollar

Base metals, as commodities, move in opposite directions to the dollar. Both markets remain closely linked to each other as every turn in the dollar is either followed by, or coincides with, a turn in the price of commodities. The strengthening of the dollar has led to a drop in industrial metals' prices. The interest rate hike has made the dollar stronger which does not bode well for industrial metal prices.

Falling Oil Prices

The slump in oil prices to five-year lows had a visible impact on industrial metal prices. A sharp and sustained drop in oil is generally associated with declining sales and prices of other commodities. The entire commodities sector may be impacted negatively in the wake of the current oil price carnage.

Bottom Line

Global uncertainties and oversupply conditions of base metals are some of the sector's worst detractors. But what about investing in the space right now; are there opportunities for short-term investors overriding the headwinds?

Check out our latest Industrial Metals Industry Outlook here for more on the current state of affairs in this market from an earnings perspective, and how the trend is looking for this important sector of the economy now.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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