Why metal stocks are wilting: Slowing China, warring Trump

Investors in metal stocks would be rooting for the US and China to kiss and make up. Shares of non-ferrous metal companies have declined on the back of falling metal prices and an uncertain outlook. A tightening of interest rates in developed markets and the strength of the dollar are factors that reduce the attractiveness of commodities as an asset class. But this was known. The escalating trade war between two big economies has the potential to hurt China’s economic growth. The US is hoping that a threat to its economic growth will bring China to the negotiating table, to give the US more access to China’s market. But so far, public muscle-flexing has been the stock response.

Fears of a real impact on China may not be overblown. Even before these tariffs could begin to hurt growth, activity has already slowed down. A 2 July Reuters report said the Caixin/Markit Purchasing Managers Index declined in June, with export orders contracting. In May, the Chinese economy had slowed as well.

If this continues, and tariffs slow down China’s exports to the US, then the situation could worsen. That uncertainty is driving metal prices down, dragging shares of producers along.

Take copper. The metal is popularly called Dr Copper for being a bellwether for global economic growth. It is flashing red at the moment with prices falling by 12.9% over a month ago and down by 11.7% since the start of 2018. However, it is still up by 8.1% over a year ago. The recent decline is partly due to signs of an economic slowdown in China and what that could do to copper demand.

In the domestic market, copper prices matter chiefly to state-owned Hindustan Copper Ltd, which runs an integrated copper operation. The others such as Vedanta Ltd and Hindalco Industries Ltd run custom smelting operations, importing copper concentrate, and their profitability depends on the treatment and refining charges they earn.

Zinc prices have fallen more than copper has and are down by 17.9% over a month ago and down by 21.3% over a year ago. Apart from the above mentioned reasons, an improving supply outlook for zinc is also a reason for the decline. That’s a challenge for Vedanta’s zinc business, though it is also expected to benefit from higher volumes.

Lastly, aluminium has done relatively better in 2018 so far, with its prices down by 8.1% over a month ago and by 6% over early 2018. Over a year ago, it’s up by 12%. That bodes well for the domestic operations of both Hindalco and Vedanta. Depreciation of the rupee against the dollar should also mean higher realizations, since prices are benchmarked to the landed price of imports.

The situation can turn around very quickly if China is able to patch up with the US. Prices will rebound as a big uncertainty is taken off the table. That some metal prices (such as copper and aluminium) are still up over a year ago is a positive sign. But prices could fall further. While it’s anyone’s guess which way metal prices go, some equity investors are not waiting around to find out.