Metals outlook brighter, but volatility may still linger

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Metal companies in India have reason to be upbeat. This year began on a weak footing as companies battled falling prices, uncertain market conditions and a debt mountain that threatened to bury them, especially steel makers.

Companies are still not out of the woods and debt restructuring packages are still being negotiated. But the situation is less dire. Although the prediction is for metal prices to rise in 2017 as well, that should be taken with a pinch of salt given how the 2016 consensus of a bad year proved wrong.

Investors are not complaining, though. The S&P BSE Metals Index returned a gain of 34%, much better than the broad market, which has actually declined slightly. What went right for companies? One common trend was that companies cut future capex plans and even shut capacity, which was unviable at these prices. That tightened the supply side. Take the ferrous sector. Although new mines came on stream and began to steadily pump up output, leading to fears of lower prices, a revival in China’s steel output saw a sharp jump in iron ore prices.

China’s benchmark imported iron ore price has risen by 78.5% since the start of the year.

The surge in iron ore prices and an increase in coal prices as well has led to a cost-push rise in steel prices. That was a welcome development for Indian companies, as rising steel prices are much more beneficial to them than the harm caused by rising iron ore prices. The result was an improving trend in the domestic performance of integrated steel companies such as Tata Steel Ltd and JSW Steel Ltd in FY17 so far.

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Initially, they were helped by the government’s measures to limit steel imports, but later the increase in prices lifted their performance.

The domestic steel sector still appears to be in a good shape, but the blow to the real estate sector from demonetization is a concern. While automobile sales have been hit too, they are likely to come back to normal levels. Consumption demand remains a concern, even if you ignore demonetisation’s impact, as private sector capital investments are not picking up.

In the non-ferrous sector, zinc had started the year on a strong note as a tight supply situation was favourable for producers. That prediction was spot on but the increase in prices has been stronger than expected at 68% in 2016 so far—much better than the 19.3% increase in copper prices and the 18.4% increase in aluminium prices.

Zinc continues to be in a good spot and there is talk that premiums paid for faster delivery of aluminium may improve. These had declined in 2016. On copper, however, the trends in treatment and refining charges in FY18 indicate weakness, which is not good news for domestic smelters. Hindustan Zinc Ltd is best poised to benefit from the increase in zinc prices although parent Vedanta Ltd too should benefit from higher iron ore output and prices, as well as higher crude oil prices. Hindalco Industries Ltd should benefit from higher aluminium realisations.

China continues to be a risk to the metals sector as any change in demand or supply, due to government policy or otherwise, can play havoc with prices. The US has emerged as a new factor, with expectations that it may spend more on infrastructure under its new president. Also, the possibility of rate hikes by the US Federal Reserve in 2017 may keep metal prices a bit volatile, as funds could get reallocated away from commodities. Metals may start 2017 on a bright note, but it may still be as volatile a year as 2016 has been.