Nifty Metals Surge: Can They Sustain the Rally Amidst Global Headwinds?

In recent quarters, companies reliant on metals as key raw materials have benefited from low input costs, driven by a downtrend in metal prices as compared to year 2022. Notably, steel and important metals such as copper and aluminium surged to record highs in early 2022 amidst the Russia-Ukraine war fears, leading to supply disruption concerns. The prices in 2022 plummeted due to weak demand and central bank-initiated rate hikes, with the S&P/TSX Global Base Metal Index experiencing a notable decline from its peak in April 2022. Since hitting their lowest in July 2022, prices have been going up again, slowly getting back to where they were in April 2022. This suggests that demand is increasing and there might be anticipation of rate cuts in the latter part of 2024.

Similarly Nifty Metal Index, which is designed to reflect the behaviour and performance of the Metals sector including mining comprises 15 stocks that are listed on the NSE has delivered 67.28% return from its 52-week low following a similar trend as in global markets.

Excess Supply to Dampen Steel and Metal Prices

A key factor influencing metal prices is the anticipated growth in supply outpacing demand. According to the World Steel Association, steel demand is expected to increase by a modest 1.9% to 1,849 million tonnes toward the end of 2024. However, overcapacity in China, coupled with the absence of stringent decarbonisation measures, is likely to lead to production exceeding consumption, putting downward pressure on steel prices. In 2023, supply exceeded production by 77 million tonnes, and this gap is expected to widen further.

A similar trend is expected for other base metals. The International Copper Study Group forecasts a shift in the global copper balance from a 27,000-tonne deficit in 2023 to a surplus of 467,000 tonnes in 2024. The International Lead and Zinc Study Group anticipates a global lead and zinc surplus of 52,000 tonnes and 367,000 tonnes, respectively, in 2024, representing a nearly 50% increase compared to 2023. This surplus is largely due to rising primary lead production in countries like Australia, Canada, China, India, and South Korea. For zinc, a strong rebound in Chinese production and expanded supply from large projects in the Democratic Republic of Congo, Russia, and South Africa are expected to result in production outpacing demand growth this year. The aluminium market is also expected to see continued supply flow, with expansion plans underway in Southeast Asian countries like Indonesia, even as China nears its self-imposed production cap of 45 million tonnes per year.

Geopolitical Tensions and Macroeconomic Headwinds Pose Upward Risks

While a global economic slowdown and rising supply are expected to exert downward pressure on prices, potential supply disruptions due to geopolitical tensions or extreme weather events could cause prices to surge. The ongoing Russia-Ukraine war and the possibility of escalation in the Middle East are cited as potential risk factors. Additionally, government restrictions on new mine development due to environmental concerns and production outages caused by power or water constraints could also lead to price spikes.

Geopolitical tensions and a potential slowdown in the global economy, particularly in large economies like China and the US, are also significant factors to consider. The IMF forecasts China’s growth to slow down to 4.6% in 2024 from 5.2% in 2023. Similarly, US growth is expected to decelerate to 2.1% this year compared to 2.5% in 2023. Higher interest rates in the US could further dampen demand for commodities.

Steel Demand to Slow Down in FY25

Steel companies in India are likely to face challenges in the coming fiscal year due to a slowdown in domestic steel demand. ICRA, a rating agency, predicts a growth of only 8% in FY25, compared to an estimated growth of 13% in FY24. This slowdown is attributed to the moderation of government spending around the upcoming Lok Sabha elections.

Indian steel companies are also facing headwinds in the export market due to a surge in Chinese steel exports. China’s exports reached a seven-year high of 90 million tonnes (mt) in 2023 (up from 65 mt in CY2022) due to multiple structural headwinds in its domestic economy. With weak economic activity in most other major steel-consuming regions globally, high volumes of steel are being redirected to high-growth markets like India. This has led to a rise in India’s finished steel imports, particularly from China and Vietnam, causing domestic steel prices to correct by 8-10% in the second half of FY24. Consequently, India is poised to become a net finished steel importer in the current fiscal year for the first time in five years.

Profitability Squeeze for Steel Companies

Steel companies are expected to experience margin pressure due to rising input costs and subdued steel prices. Coking coal prices, a key raw material for steel production, have remained elevated for a third consecutive year. Spot prices of premium Australian coking coal cargoes are likely to average around $290 per tonne in FY24. Additionally, a 25-30% increase in domestic iron ore prices in August 2023 is expected to further erode profitability in the second half of FY24, leading to lower earnings for steel mills compared to the first half.

Non-Ferrous Indian Companies May Fare Better

The outlook for non-ferrous metal companies appears slightly brighter compared to ferrous companies in the fourth quarter of FY24. While ferrous companies may see realisations (selling prices) decline by Rs 2,000-3,000 per tonne, a slight decrease in LME (London Metal Exchange) prices might be offset by lower e-auction prices and improved domestic coal availability for non-ferrous companies. Additionally, working capital unlocking is expected to result in debt reduction for most ferrous companies.

The Nifty Metal Index has delivered 64% returns in the past 3 months indicating increased demand and exceptional performance of the Index constituents. Following are the top 10 Nifty Metal Index constituents sorted as per last 1 year return.

Some stocks worth keeping in the watchlist include NMDC , Hindalco, Hindustan Zinc, National Aluminium, as well as major players like Tata Steel and Jindal Stainless. However one should keep in mind that as we can see all of the stocks are currently above their average 5 year PE levels

Conclusion

The Nifty Metals Index’s ability to sustain its rally depends on a delicate balance between these opposing forces. While potential supply disruptions and increased demand offer upside potential, the threat of excess supply and a global economic slowdown act as counterweights. Investors should closely monitor geopolitical developments, economic indicators, and supply chain disruptions to make informed decisions within the sector.

Disclaimer: This blog has been written exclusively for educational purposes. The securities mentioned are only examples and not recommendations. The information is based on various secondary sources on the internet and is subject to change. Please consult with a financial expert before making investment decisions.