Industrial Metals: Good Bet For The Long Haul?

Industrial metals are the building blocks of any economy. At present, even though global concerns have added an element of uncertainty to the outlook, there are plenty of reasons to be optimistic about the space for the long term.

Here we discuss some of the key reasons and what investors in the industrial metals sector can look forward to in the coming months and years:

Strong Demand in Automotive & Aerospace

On the demand side, aluminum consumption is expected to improve on a global basis, spurred on by the automotive and packaging industries – the key end markets. The automobile market is becoming increasingly aluminum-intensive, given the metal's recyclability and light-weight properties. Automakers consumed a record amount of aluminum last year as plummeting prices and technological breakthroughs made it a viable alternative to steel.

The global push to improve fuel efficiency in vehicles is expected to more than double the demand for aluminum in the auto industry by 2025. In line with this, Alcoa (NYSE:AA) has completed an expansion at its Tennessee facility dedicated to supplying aluminum sheet to automakers like Ford Motor (NYSE:F) Co. (F), General Motors Company (NYSE:GM) (GM) and Fiat Chrysler Automobiles N.V. (FCAU).

The airline industry is also expected to boost demand for the metal. In Jan 2016, Alcoa (AA) clinched a long-term agreement from The Boeing Company (NYSE:BA) (BA) to supply multi-material aerospace parts, marking its fourth multi-year contract with the aerospace giant in a series of recentdeals.

Moreover, in December last year, Boeing had awarded Alcoa two multi-year supply contracts worth more than $2.5 billion. The agreements built on Alcoa's 2014 aluminum sheet and plate deal with Boeing, with its worth being more than $1 billion. Alcoa also has big aerospace deals with Airbus and Lockheed Martin Corp (NYSE:LMT). (LMT), both inked in Oct 2015. Recently, Alcoa landed a multi-year supply contract with Brazil-based leading commercial jets maker Embraer (ERJ) worth around $470 million. The deal makes Alcoa the sole supplier for proprietary wing skins and fuselage sheet to Embraer.

To capitalize on the lucrative aerospace market, Alcoa acquired RTI International, which broadened its titanium offerings and added advanced technologies and materials to its portfolio. Moreover, the buyout of UK-based leading jet engine components maker Firth Rixson has placed Alcoa to grab more opportunities in the growing aerospace market through a broad spectrum of high-growth, value-added jet engine components.

In addition, the acquisition of Tital, the Germany-based leading provider of titanium and aluminum structural castings, has strengthened Alcoa’s position to leverage growth in the commercial aerospace sector and, therefore, capture rising demand for advanced jet engine components made of titanium.

Improvement in Construction

The housing and construction sector is the largest consumer of steel today and, consequently, of iron ore. Building construction (pipes and wires) is also the largest market for copper. An uptrend has been noticed in real estate activity, like new home initiatives and construction spends, in the U.S. over the past few quarters. Long-stalled construction projects are being renewed. Requirement for emerging projects, such as education facilities and government buildings, is also creating demand in the sector.

In the long term, as the urban population increases worldwide, so will the need for steel increase in tandem with the need to build skyscrapers and public transport infrastructure. Emerging economies will also continue to be major demand drivers to support increasing urbanization and industrialization. Naturally, a rebound in construction bodes well for the iron ore and copper industries.

Pickup in Economic Activity to Drive Copper Demand

Copper is a major industrial metal playing a particularly important role in emerging countries. Given its varied applications, the trends in the copper market are often considered useful indicators of the state of the global economy.

Developments in the world economy are strongly correlated with movements in copper prices. Given that China accounts for the largest share of global copper consumption as well as its having a large share in the total production of pure copper, it’s no surprise that there is a strong correlation of the metal with China’s ups and downs in economy. .

In the long run, expectations of a rising middle class in Asia, particularly in India and China, who will spend more on consumer goods such as air conditioners and refrigerators in the years to come, will spur demand for copper. Chinese demand for the metal will likely grow to comprise 46% of the worldwide copper consumption by 2018.

Rectifying the Aluminum Demand-Supply Imbalance

After aluminum prices bore the brunt of chronic surplus, the global aluminum industry underwent substantial changes to correct the supply-demand picture. This will eventually lead to firm prices. RUSAL is contemplating further aluminum production cuts totaling approximately 200,000 tons per annum. This came after a reduction of 316,000 tons in 2013, 256,000 tons in 2014 and 38,000 tons in the last quarter of 2015.

Likewise, Alcoa has undertaken a number of restructuring measures (including closure of smelters) over the past few years, apart from aggressively pursuing cost-cutting actions. In the first quarter, the new Alcoa closed 269,000 metric tons of smelting capacity at its Warrick smelter in Indiana, and in the second quarter, it completed the curtailment at its Point Comfort, TX facility.

As a result of these activities, the new Alcoa remains on track to meet or even exceed its 2016 goals of moving to the 38th percentile on the global aluminum cost curve and the 21st percentile on the global alumina cost curve.

For 2016, Alcoa projects a global aluminum deficit of approximately 775000 metric tons as 5% global demand growth outweighs the 2.5% improvement in global supply of the metal. RUSAL estimates a global aluminum market deficit of 1.2 million ton this year compared to a surplus of 0.6 million tons in 2015.

India to Be a Growth Driver

As per the World Steel Association, India’s prospects look bright due to low oil prices, the reform momentum and favorable policies to improve infrastructure and manufacturing output. The sub-continent expects steel demand to increase 5.4% in 2016 as well as in 2017, reaching a peak of 88.3 Mt in 2017.

Also, IMF projects India’s GDP growth to rise to 7.5% this year, above last year’s already robust growth rate of 7.3%. Given that India's consumption of metals has almost doubled over the past 20 years, it will be a major consumer in the years to come.

Bottom Line

As you can see, there is no reason for not being optimistic about the industrial metals industry over the long haul. But what about investing in the space right now?

Check out our latest Industrial Metals Outlook here for more on the current state of affairs in this market from an earnings perspective, and how the trend is shaping up for this sector going forward.