Industrial Metals Reel Under Topsy-Turvy China

It did not come as a surprise when China, being the world's top metals consumer, during its recent economic crisis dragged down the industrial metals market along with it. Commodities are now languishing at multi-year lows. To add to the industry's woes, the latest data on the U.S. manufacturing sector showed an unexpected slowdown in growth to its weakest pace in almost two years in August as output, new orders and employment all grew at a slower pace. Moreover, the threat of oversupply looms large on the industry as inventory continues to pile up, while the once-frenzied demand in China has fizzled out.

Iron

Iron ore prices dropped to their lowest levels owing to a weaker Chinese steel market and surging low-cost supplies from Australia and Brazil, leading to a supply glut. The world's largest miner, BHP Billiton Limited (BHP), posted its worst underlying profit in a decade of $6.4 billion for the year ended Jun 30, less than half of last year's profit of $13.3 billion.

Vale S.A. ( VALE ) reported a 50% drop in second-quarter earnings while Rio Tinto plc ( RIO ) suffered an unceremonious drop of 42.9% in underlying earnings for first-half 2015. Macroeconomic issues such as recession in China, Greece debt negotiations and weak prices of commodities in the global mining industry were responsible for the dismal results across the board.

Notwithstanding the low prices, Vale reported record second-quarter iron ore production and aspires to produce even more down the line. BHP Billiton beat its own production guidance for iron ore in fiscal 2015 and stated that it was on track for additional growth in the current year, following major expansion work.

Aluminum

In 2015, falling oil prices took a toll on aluminum prices as aluminum is an energy intensive industry, with energy costs accounting for nearly 30% of the total cost of production. Further, growing exports from China and oversupply in different regions exerted pressure on aluminum prices throughout the first half of 2015 leading to record low aluminum prices. The average LME aluminium price decreased by 10.1% from $1,968 per ton in the fourth quarter of 2014 to $1,769 per ton in the quarter ended Jun 30 2015.

Theglobal marketexperienced a surplus due to the 47% surge in export of aluminum semis from China. In order to generate cash flow, aluminum manufacturers had to export even at a loss, due to the slowdown in the domestic market.

Major aluminium producers, like Alcoa Inc. ( AA ) and RUSAL reported sequential drop in second quarter profits due to the price slump. RUSAL cut its 2015 demand growth forecast to 6% from the previous 6.5% due to weaker-than-expected demand in Russia, Brazil and Asia. Chinese apparent consumption growth is expected to slow to 9% in 2015. Alcoa reiterated its expectation of 6.5% global aluminum demand growth for 2015.

Copper

Concerns about Chinese economic growth rates, apprehensions surrounding Europe, continued U.S. dollar strength and weakness in commodity prices put pressure on copper prices during second-quarter 2015. LME copper prices averaged $2.74 per pound in the quarter and are currently sitting at six year lows of approximately $2.25 per pound.

Stockpiles tracked by the London Metal Exchange climbed to the highest in almost two years. China's shrinking appetite for copper has hit the metal particularly hard as the country is responsible for over 45% of copper consumption. Demand from China has declined by 3% so far this year, even as global production has increased 3%, according to the International Copper Study Group.

After suffering its second straight quarterly loss, copper miner, Freeport-McMoRan Inc. ( FCX ) plans to trim its capital spending plans for 2016 by 26% from its July estimates. The company also intends to slash its 2016 minerals exploration costs from $100 million to $50 million and plans to cut copper sales by about 150 million pounds per year in 2016 and 2017. Freeport also intends to lower unit site production next year by 20%. The miner will suspend operations at its Miami mine in Arizona, halve production at its Tyrone mine in New Mexico and adjust rates at other of its seven copper mines in North America.

Industry Ranking & Outlook - Negative

Within the Zacks Industry classification, the iron mining and non-ferrous mining industries (aluminum, copper, etc.) are grouped under the Basic Materials sector (one of 16 Zacks sectors). We rank all of the 257 industries in the 16 Zacks sectors based on the earnings outlook for the constituent companies in each industry. This ranking is available on the Zacks Industry Rank page. http://www.zacks.com/stocks/industry-rank

The way to align the ranking and outlook from the complete list of Zacks Industry Rank for the 257+ companies is that the outlook for the top one-third of the list (Zacks Industry Rank of #86 and lower) is positive, the middle one-third (Zacks Industry Rank between #87 and #173) is neutral, while the outlook for the bottom one-third (Zacks Industry Rank #174 and higher) is negative.

The non-ferrous mining industry and the iron mining industry are ensconced in the bottom tier with respective Zacks Rank of #232 and #235, indicating a negative outlook.

Sector Level Earnings Trend

Q2 Earnings Scorecard, Projection for Coming Quarters

The Basic Materials sector has put a meager earnings growth of 3.7% on the board. This, however, looks better when compared to the 9.9% decline in revenues in the quarter. (For a detailed look at the earnings outlook for this sector and others, please read our Earnings Trends report.)

The earnings graph is expected to pick up with 17.1% growth projected in the third quarter. However, the euphoria will be short lived with growth again falling to 3.2% in the fourth quarter.

What's in Store?

Iron: The threat of oversupply remains for the iron ore industry as major producers continue to ramp up production. As per the World Bank, the raw material will average $63 a metric ton this year and $77.90 a metric ton in 2016.

Per the World Steel Association, global apparent steel use is expected to slow considerably, with meager growth of 0.5% projected for 2015 and 1.4% for 2016. Chinese steel use will continue to record negative growth of 0.5% in both 2015 and 2016. China is currently the largest producer of steel and consequently the largest consumer of iron ore, accounting for around 60% of the global seaborne market. Thus, the mismatch between the excess supply and demand for iron ore will keep iron ore prices subdued in the near term.

Aluminum: LME aluminum prices will remain under pressure given the oversupply of the metal in the market as evidenced by large aluminum inventories in LME warehouses. However, the automotive, packaging and airline industries are expected to support demand. India appears promising given its current low level of aluminum consumption and high urban population growth. With demand being strong, the industry needs to pull the reins on supply which will lead to deficits for a prolonged period and create the backdrop of higher aluminum prices going forward.

Copper: Major low-cost producers continue to sell even as prices fall, in a bid to force the high cost producers out of the market as prices fall below their cost of production. Eventually, when markets recover, the dominant producers, given their increased market share, will be in a position to make even more profits during the next bull market.

A weak global economic landscape, increased supply and a strong dollar are all contributing factors to the persistence of a bearish copper market. Notwithstanding the current volatility in prices, we have a long-term bullish stance on copper, supported by its widespread use in transportation, manufacturing and construction, limited supplies from existing mines and the absence of new significant development projects.

To Sum Up

Overall, industrial metal prices will remain depressed until the supply glut is eased by production cuts. We expect slashing of capital expenditure, suspension of operations and cost saving initiatives to be in the cards. All these factors, along with recovery in the Chinese economy will revive the industry.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.