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Is the rally in metal stocks sustainable?
Apr 23, 2016

After a prolonged weakness in commodity prices, metals stocks have been on fire in the last three months. The BSE Metal index is almost up by 27% since mid-February. Does this mean turnaround time for metal stocks?

The recovery in the prices globally can be attributed to the lower production and capacity curtailment. Similarly, the increase in domestic steel prices is backed by an imposition of MIP. To have sustainability in steel prices, China needs to cut more capacity to adjust to the falling demand. China accounts for half the world's steel output. Any improvement in global steel outlook, therefore, hinges on a revival in Chinese demand and supply-side reforms. However, it is important to note that the current rally is not driven by a fundamental improvement in demand. Temporary price rally may increase steel mill's profitability, but it could also stimulate more output.

We have also seen a rally in non-ferrous metal stocks since Mid-February. Although the underlying fundamentals remain unchanged, in Budget 2016-17, the government has increased custom duty marginally on primary aluminum products to 7.5% from 5% and custom duty on other aluminum product increased from 7.5% to 10%. In the current weak pricing environment, companies from this space have been focusing on increasing volumes and improving the percentage of value-added products (VAP) in the overall metal production.

To have a sustainable rally in metal stocks, it is essential to minimise the demand-supply mismatch. Excess supply from the market should dry out. With improved demand, the metal sector can bounce back. But it all depends upon China. If China continues to slow more than the markets currently anticipate, there could be further downside risks for commodity prices.

This Chart Of The Day was published in The 5 Minute WrapUp - An Equity Investor's Most Potent Weapon: Cash

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