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Metals: Strong enough? - Views on News from Equitymaster
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  • Jul 11, 2005

    Metals: Strong enough?

    Markets continue to make new highs, and it would not be entirely incorrect to say that they have been doing this practically every day now! While until recently, it was the large-caps hogging all the limelight with mid-cap stocks having taken a backseat, last week saw the latter get back into the reckoning, as they rallied handsomely on the bourses. While gains have been coming thick and fast across sectors/stocks, investors must be very careful about their investment options. A case in point being metal stocks, which registered strong gains last week as was evident from the near 5% gains in the BSE Metals Index!

    Fathom this, international metal prices - both steel and aluminium - have been on the downtrend over the past 3 to 4 months now and have corrected by as much as 20% to 25%. The sharp correction, particularly in steel prices, has been the result of a build up of steel inventory on the back of increased supply as China, the largest consumer of steel has been increasingly meeting its requirements internally, thus adversely affecting the demand-supply dynamics. And, Indian metal prices, which are benchmarked against international prices, were quick enough to react to this trend reversal.

    The reaction by Indian metal manufacturers has been much faster and the impact much stronger this time owing to the considerably reduced import tariffs. Import tariffs, which until the latest Budget had acted as buffer for Indian manufacturers, were reduced considerably thus, making the linkage between domestic and international prices much stronger owing to lower landed cost of products. This explains the sharp correction in domestic steel prices and consequently in metal stocks on the bourses as reflected by the BSE Metals Index, which has grossly under performed the overall market (see left-hand chart above). However, what has baffled us is the sharp bounce back in these over the last one-month (see right-hand chart above). Most of the metal stocks (see table below) have managed smart gains on the bourses outperforming the Sensex by a considerable margin!

    Metals: Beating the Sensex…
    BSE-Sensex 5.2%
    Jindal Stainless 28.1%
    Essar Steel 22.3%
    Sesa Goa 14.0%
    Hindalco 8.9%
    Tisco 6.5%
    Jindal Steel 5.6%

    But, considering that everything is against these stocks currently and we believe that times would only get tougher for them as supply contracts come up for renewals for manufacturers, we really do not see any fundamental reason for such a sharp bounce back in these stocks. While the market grapevine indicates that steel prices would rebound in 2HFY06 as the inventory position becomes much more favourable, we believe that even if it does come to be true, it would be only a temporary phenomenon. Thus, there is every possibility that these stocks would again correct sharply, in the process benefiting only the market movers who are currently taking advantage of the positive sentiment being build up around these stocks and this would once again leave retail investors in the lurch.

    While our cautiousness should not be construed as being negative on all the above stocks, we believe that these definitely warrant a cautious approach. However, it must be noted that our long-term view for the metal sector remains positive considering the low per capita consumption of steel and aluminium in the country vis-a-vis other developing and developed economies. Further, the fact that Indian steel and aluminium players have the distinction of being amongst the lowest cost producers in the world is a big positive.



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