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Industrial Metals Stock Outlook - Jan 2016

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2015 will go down in history as one of the worst years for industrial metals, which are trading near their multiyear lows. The slowest pace of economic growth in 25 years in China, the world's top metals consumer, has dragged the industrial metals market along with it.

Moreover, the interest rate hike gave a boost to the dollar, which makes dollar-denominated commodities like base metals expensive, bringing them lower. To stay afloat, mining companies have been cutting costs, slashing dividends and production, and selling assets.

Iron

Iron ore prices have been in a free fall, losing 43% so far this year. This was due to a weaker Chinese steel market and surging supplies from big miners like BHP Billiton Ltd. ( BHP ), Rio Tinto plc ( RIO ) and Vale S.A. ( VALE ). Prices of the metal sank below the level of $40 in December for the first time since spot prices were introduced in 2008.

BHP Billiton posted its worst underlying profit in a decade, Vale reported a loss per share of 19 cents for the third quarter while Rio Tinto suffered an unceremonious drop of 42.9% in underlying earnings for the first half of fiscal 2015. Macroeconomic issues such as the recession in China, Greece debt negotiations and weak prices of commodities in the global mining industry were responsible for dismal results across the board.

Notwithstanding low prices, Vale reported record iron ore production in the third quarter and aspires to mine between 340 million and 350 million metric tons of iron next year. BHP Billiton's iron ore production for the September quarter increased 7% to a record 61 metric tons and its guidance for fiscal 2016 remains at 247 metric tons. Rio Tinto hiked its production in the quarter by 12% and expects to ship around 340 million tons of iron from its operations in Australia and Canada.

Aluminum

Falling oil prices took a toll on aluminum prices as the metal belongs to an energy intensive industry. Further, growing exports from China and oversupply in different regions exerted pressure on aluminum prices. In the third quarter, London Metals Exchange ("LME") aluminium price tumbled to a six-year low of $1,589 per ton.

Alcoa Inc.'s ( AA ) profits for the third quarter sank roughly 70% year over year while Russian aluminium giant RUSAL reported an 11% drop in third-quarter core earnings, hurt by lower metal prices. Alcoa reiterated its expectation of 6.5% global aluminum demand growth for 2015. RUSAL cut its 2015 demand growth forecast to 5.6% due to weaker-than-expected demand in some emerging markets.

The aluminum price rout has also triggered Alcoa's move to separate its smelting and refining business from those that cater to rapidly growing aerospace and automotive markets. The transaction, which is subject to specific conditions including final approval by Alcoa's board, is expected to close in second-half 2016.

Copper

Concerns about Chinese economic growth rates, apprehensions surrounding Europe, continued U.S. dollar strength and weakness in commodity prices put pressure on copper prices during 2015. Demand in China, which accounts for over 45% of copper consumption, has been affected by soft export demand for electronics, a weak construction market and slow progress on implementing investment in electric grid infrastructure. Copper prices are hovering around its worst levels since 2009.

After suffering its third straight quarterly loss, copper miner, Freeport-McMoRan Inc. ( FCX ), announced plans to defer investments in various long-term projects and also trimmed capital spending to $1.8 billion in 2016 and $1.2 billion in 2017. Moreover, Freeport has suspended its annual dividend to save cash amid a weak commodity price environment.

In the wake of low prices, Freeport plans to reduce copper production by 350 million pounds, mainly due to the closure of its Sierrita mine in Arizona. Glencore Plc ( GLNCY ) stated that it would reduce its copper production by 455,000 tons by the end of 2017. Anglo-American Plc ( AAUKY ) is undergoing a major restructuring by selling assets and closing mines. Meanwhile, Codelco has restated it would push ahead with its annual target of producing 1.6 million to 1.7 million metric tons this year and the next.

Industry Ranking & Outlook - Positive on Iron, Neutral on Aluminium, Copper

Within the Zacks Industry classification, the iron mining and non-ferrous mining industries (aluminum, copper, etc.) are grouped under the Basic Materials sector (one of 16 Zacks sectors). We rank the 257 industries in the 16 Zacks sectors based on the earnings outlook for the constituent companies in each industry. This ranking is available on the Zacks Industry Rank page.

The way to align the ranking and outlook from the complete list of Zacks Industry Rank for the 257+ companies is that the outlook for the top one-third of the list (Zacks Industry Rank of #86 and lower) is positive, the middle one-third (Zacks Industry Rank between #87 and #173) is neutral, while the outlook for the bottom one-third (Zacks Industry Rank #174 and higher) is negative.

The iron mining industry features in the top tier with a Zacks Rank of #60, garnering a positive outlook while the non-ferrous mining industry is in the mid tier with a Zacks Rank of #100, indicating a neutral outlook.

Sector Level Earnings Trend

Q3 Earnings Scorecard, Projection for Future Quarters

Performance of the Basic Materials sector was disappointing with an 18.5% decline in the third quarter. Though the sector is expected to somewhat recover in the fourth quarter, it will remain in negative territory with a 7.5% drop.

The scenario will remain stagnant in the first half of 2016, with a 7.7% decline projected for the first quarter, which will worsen further to a drop of 13.3% in the second quarter. However, a dramatic improvement is prophesied for the third with 19.4% growth. (For a detailed look at the earnings outlook for this sector and others, please read our Earnings Trends report.)

What's in Store?

Iron: The threat of oversupply remains for the iron ore industry as major producers continue to ramp up production. Per the World Steel Association, global apparent steel use is expected to slow considerably, with a decline of 1.7% projected for 2015 and meager growth of 0.7% for 2016. Chinese steel use will decline 3.5% in 2015 and 2% in 2016.

China is the largest consumer of iron ore, accounting for around 60% of the global seaborne market. Thus, the mismatch between excess supply and demand will keep iron ore prices subdued and analysts apprehend that prices for the steel-making ingredient will stay under $40 a ton for the next few years.

Aluminum: Aluminum prices will remain under pressure given the oversupply of the metal in the market. However, the automotive, packaging and airline industries are expected to support demand. India appears promising given its current low level of aluminum consumption and high urban population growth. With demand being strong, the industry needs to pull the reins on supply, which will lead to deficits for a prolonged period and create the ground for higher aluminum prices going forward.

Copper: Major low-cost producers continue to sell even as prices fall, in a bid to force the high-cost producers out of the market, as prices of copper fall below their cost of production. Eventually, when the markets will recover, the dominant producers, given their increased market share, will be in a position to make even more profits during the next bull market.

A weak global economic landscape, increased supply and a strong dollar are all contributing to the persistent bearishness in the copper market. Notwithstanding the current volatility in prices, we have a long-term bullish stance on copper, supported by its widespread use in transportation, manufacturing and construction, limited supplies from existing mines and the absence of new significant development projects.

To Sum Up

Overall, industrial metal prices will remain depressed until the supply glut is eased by production cuts. Moreover, a stronger dollar will keep prices in check. We expect slashing of capital expenditure, suspension of operations and cost saving initiatives to be in the cards. All of these factors, along with a recovery in the Chinese economy, will revive the industry.

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VALE SA (VALE): Free Stock Analysis Report

RIO TINTO-ADR (RIO): Free Stock Analysis Report

GLENCORE PLC (GLNCY): Free Stock Analysis Report

FREEPT MC COP-B (FCX): Free Stock Analysis Report

BHP BILLITN LTD (BHP): Free Stock Analysis Report

ALCOA INC (AA): Free Stock Analysis Report

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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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