Commodity stocks: Fall from grace... - Views on News from Equitymaster

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Commodity stocks: Fall from grace...

May 4, 2004

The stock markets seem to have caught a cold right in the middle of summer. We are pointing towards the fall the indices have witnessed in the last one-month, mainly on account of poll jitters. In this context we take a look at the major losers among the BSE-A group stocks. Among the 25 results we searched for five belonged to the ferrous and non-ferrous metal sectors, like steel, aluminium and copper. This clearly indicates that the commodities sectors like the ones mentioned above have dominated the losers list over the last one month.

May 3, 2004 (Rs) Apr 02, 2004 (Rs) H/L (Rs)
BSE-Sensex 5,585 5,788 -3.5% 6,250 / 2,935
S&P CNX Nifty 1,767 1,841 -4.0% 2,015 / 931
Sesa Goa Ltd. 379 521 -27.2% 725 / 82
Hindalco 1,066 1,315 -18.9% 1,503 / 614
Sterlite Industries 445 533 -16.5% 815 / 79
Nalco 163 194 -16.0% 209 / 81
Tata Steel 343 403 -15.1% 466 / 131

The reason for the same is not difficult to find. China is blamed as the main culprit behind the same. While our central Asian neighbour continues to consume steel, aluminium and copper at a robust rate, recent developments from the country have scared commodities producers across the world. With global steel, aluminum and copper consumption being primarily driven by the Chinese consumption, news of a forced slowdown will always be unwelcome. The Chinese government has indicated that it will take steps to abate the overheating of the economy due to the rapid growth seen in the last 5-6 years.

For instance take the case of steel, India exported nearly 4 m tones of steel in FY03 (a growth of 37% over last year), this was primarily driven by exports to China. On the other hand domestic consumption grew by a dismal 5% compared to nearly 21% growth in consumption from the Chinese economy. This indicates that most of the volume growth seen among the Indian steel companies may have been due to strong exports to China and any news of a slowdown from the same spells bad news for Indian steel companies.

Indian steel majors like SAIL and TISCO have already announced aggressive capacity expansion plans in India. This means that any shortfall in the demand from China will lead to overcapacity in the Indian context. While steel demand in India is expected to grow in the region of 4% to 5% in the near future, it may not be able to absorb the capacity additions expected in the future. Indian companies have benefited from the strong improvement in steel prices in the last 2-3 years. This had been more than reflected in the stellar performance of steel and other commodity stocks on the bourses.

Investors must now recognize the fact that all commodities have cycles of upturns and downturns and we may be at the beginning of a downturn in the commodity cycle, after an upturn witnessed in the last 2-3 years. While Equitymaster has always advocated a long-term approach to investing in the stock markets, investors need to understand that identifying the cyclical behaviour for commodity stocks is a very important aspect of long-term investments in this sector. Investors may have to wait a while before they even make any decent returns on their investments if they bought commodity stocks at their peak in any cycle. While it may be difficult to time the cycle, it is advisable to look out for signals that the trend is reversing and to get out of the sectors when adequate returns are made. This is where disciplined investing plays a major part.

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