Metals & Mining Stock Outlook - May 2015 - Industry Outlook

Industrial Metals to Sail Despite Near-Term Headwinds

Industrial metals are used in a wide variety of applications, including numerous constructions and manufacturing businesses and hence, tend to exhibit a strong correlation to global equity markets. Since the fourth quarter of 2014, the slump in global oil prices , a strengthening US Dollar and slowdown in the Chinese economy have emerged as major headwinds for the global metal industry.

Iron - Prices Going Downhill

In the first quarter of 2015, iron ore prices suffered its largest quarterly loss since 2009 and subsequently fell to a decade low of $47.08 on Apr 2, as surging low-cost supplies from Australia and Brazil swamped theglobal market leading to glut as demand slowed in China, the top consumer. Three big iron ore miners Vale S.A. ( VALE ), Rio Tinto plc ( RIO ) and BHP Billiton Ltd. ( BHP ) announced record production numbers, while global steel production declined 1.8% in the first quarter of 2015. This was mainly caused by a 5% year-on-year slowdown in China's steel demand.

In the wake of low prices of iron ore, which accounts for about 90% of the company's overall earnings, Rio Tinto has been cutting costs to protect its margins. Vale posted its lowest earnings in six years and the third straight quarterly loss. Cliffs Natural Resources Inc. ( CLF ), the largest U.S. iron ore producer, posted better-than-expected first-quarter earnings after the company rationalized is operations in the face of weaker commodity prices. The company has decided to close one of its three iron ore pits in Western Australia. BHP Billiton has also decided to slow the pace of its $2 billion expansion plan in the Pilbara. Though these factors led to a temporary spike in iron prices, they plunged soon thereafter.

Aluminum - Prices Down in 2015

Last year, the global aluminum industry went through a substantial change to rectify the supply-demand imbalance that affected prices through 2013. Major aluminum producers like Rio Tinto and Rusal and Alcoa Inc. ( AA ) effectively cut their aluminum production. This, along with a pickup in aluminum demand from key end users, helped aluminum inventories to descend from peak levels. This tightening of aluminum supply lifted aluminum prices from the four and a half year low of $1,675 per ton in February.

However, in the past few months, falling oil prices and weak industrial data from China have again resulted in a fall in aluminum prices. Aluminum is an energy intensive industry, with energy costs accounting for nearly 30% of the total cost of production. Falling oil prices tend to have a deflationary effect on aluminum.

Copper Prices Worst Hit

During the first quarter of 2015, copper prices were caught in a downward spiral due to the slowdown in China, weakness in Europe and a stronger greenback. Oversupply of this red metal also continues to weigh on its prices. Overall, copper fared the worst among all industrial metals, with prices declining 12% so far in the year.

Industry Ranking & Outlook - Positive on Aluminum and Copper, Negative on Iron

Within the Zacks Industry classification, the iron mining and non-ferrous mining industries (aluminum, copper, etc.) are broadly grouped under the Basic Materials sector (one of 16 Zacks sectors). We rank all of 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 non-ferrous mining industry features in the top tier with a Zacks Rank of #54 indicating that the outlook is positive. The iron mining industry, however, is in the bottom tier with a Zacks Industry Rank #199, indicating a negative outlook.

Sector Level Earnings Trend

Sector Q1 Earnings Scorecard - Overall Decline So Far

The 61.9% of the companies in the Basic Materials sector that have reported their results put an earnings decline of 3.3% on the board. Taking into account the other companies that are yet to report their results, earnings of the sector is expected to go down 2.2% in the first quarter. (For a detailed look at the earnings outlook for this sector and others, please read our Earnings Trends report.)

Q2 & Beyond - Growth to Pick Up Eventually

The earnings graph is expected to take a nosedive with the basic material sector expected to log declines of 2.4% in the second quarter and 5.8% in the third quarter. In the fourth quarter, the graph will eventually pick up with 2.4% growth. Nevertheless, overall in 2015, the sector will log earnings growth of 0.4%. In 2016, the sector's earnings growth is projected to pick up by 19.5%.

What's in Store?

Iron - The threat of oversupply looms large over the iron ore industry as major iron ore producers continue to ramp up production. As per the World Bank, the raw material will average $63 a metric ton this year, down from the prior $75 given in the bank's January's report. The forecast for 2016 was cut to $66.60 from $77.90.

Per the World Steel Association, global apparent steel use is expected to slow considerably, with meager growth of 0.5% projected for 2015 and 1.4% for 2016. The slowdown in China's steel demand will continue to be a drag on steel demand. Chinese steel use will continue to record negative growth of 0.5% in both 2015 and 2016.

China is currently the largest producer of steel and consequently the largest consumer of iron ore, accounting for around 60% of the global seaborne market. Thus, the mismatch between the excess supply and demand for iron ore will keep iron ore prices subdued in the near term.

Aluminum - Aluminum consumption is expected to improve on a global basis spurred by the automotive and packaging industries, its key consumer markets. The airline industry is also expected to boost demand for the metal. 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 being strong and the industry pulling in the reins on supply, the aluminum market is likely to witness deficits for a prolonged period. This will support high aluminum prices going forward.

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

Therefore, it is likely that copper prices will continue to remain under pressure. A weak global economic landscape, increased supply and a strong dollar are all contributing factors to the continuation of a bearish 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

Revival in the Chinese economy on the back of policy support and correction of the supply-demand imbalance will be instrumental in driving growth in the industry. Moreover, a projected earnings growth for 2015 and increased momentum in 2016 instills optimism in the industry.

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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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