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Jubak: 5 metals stocks set to bounce back
Stocks in the sector have had a tough time, but long-term trends indicate that the declines are creating opportunities for investors.
By Jim Jubak
Metals stocks are suffering a major meltdown. And it's no wonder.
With an interest rate hike from the Federal Reserve looming, speculators who bought these industrial commodities with borrowed cash have been unloading, and investors who fear that higher rates will hurt commodity prices have been selling. Very visible efforts by Chinese government officials to slow their economy before it overheats and to rein in runaway lending were the last straws last week. Speculators and investors sold on worries that slower growth in China would consume less raw material, pushing commodity prices down.
The result? Nickel miner Inco (N, news, msgs) is down 21% since March 1. Copper giant Phelps Dodge (PD, news, msgs) is down 24%. Alcoa (AA, news, msgs) has fallen 18%.
These declines have created a major buying opportunity. But there's one major caveat: Its hard to tell if the punishment is over. Most of these stocks have plunged through major technical support at their 200-day moving averages like a hot knife through butter. The cautious course would be to dollar cost average into these shares over the next three months or so.
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If the short term is so uncertain, why do I like stocks in this sector so much?
Dissipating worries
First, the short-term worries that have crushed this sector are dissipating.
The Federal Reserves interest rate hikes are likely to be slow enough not to cut into U.S. economic growth, which should keep commodity demand high. Rate hikes also are unlikely to be enough to reverse the dollar's long-term downward trend, which makes commodity stocks attractive currency hedges.
The Chinese government may want to slow its economy, but it doesnt want to do so by much. And many of these commodities are in such short supply that a modest easing of growth in China wont send prices tumbling.
Speculators have unwound most of their positions in many of these commodities, leaving the price free to rise and fall on real demand by users.
Second, the long-term story, that demand from rapidly growing countries such as China and India will keep supplies tight and prices inching upward, remains intact.
So what metals stocks would I consider buying on this dip?
I mentioned these three in my 11:20 a.m ET appearance on CNBCs "Morning Call" on Wednesday.
The list
Inco. Nickel is in such short supply that a modest drop in Chinese consumption (for making stainless steel among other products) is almost irrelevant to the world price of this industrial metal.
Despite production increases from Inco and Russias Norilsk Nickel, nickel supply will run about 37 to 40 kilotons short of demand in 2004, according to estimates from UBS and Goldman Sachs. In 2005, the global supply deficit is likely to be about 19 kilotons, according to UBS. With China making up about 10% of global nickel demand, a drop of one percentage point in the growth rate of the Chinese economy would represent just about 10% of the global supply deficit. UBS calculates that the potential upside to nickel prices from the current spot price is about 38%.
Alcoa. For aluminum, any slowing of Chinas economy just about balances out. Slower growth in China would certainly mean less Chinese consumption of aluminum, but it would also mean a reduction in Chinese production of the metal. Growth in Chinese production may be set to slow with or without government action this year since the country is experiencing shortages of electricity that will hamper the production of this notoriously energy-intensive metal. Goldman Sachs puts the global deficit of aluminum at almost 600 kilotons in 2005, and UBS is calling for aluminum prices to climb about 13% from recent lows by September.
Phelps Dodge. Among metals, copper has taken the biggest price beating as speculators sold. Open long positions in the metal on the New York Commodity Exchange, which peaked at 650 kilotons in October 2003, have tumbled to about 100 kilotons. Theres no assurance the speculative selling is over, but with copper stocks on the London Mercantile Exchange near 10-year lows, a bottom in copper prices isnt too far away. UBS is projecting demand growth of about 6% in 2004, with China representing about 35% of that growth. (In 2003, China made up about 95% of demand growth.) Goldman estimates that global supply will fall 374 kilotons short of demand in 2005.
Exclusive picks
And here are two more stocks to study exclusively for CNBC.com on MSN.
Southern Peru Copper (PCU, news, msgs). The case for this company is built on some simple math. In its first-quarter earnings announcement, Southern Peru Copper reported that the cost of producing a pound of copper was about 40 cents. UBS projects that copper prices will hit a peak of $1.60 a pound in September. Bear Stearns figures they'll average $1.10 a pound this year.
The company's copper sales are likely to rise substantially from the 155 million pounds recorded in the first quarter, which means that kind of price increase should provide a big boost to earnings. Bear Stearns estimates that every 5 cents a pound increase in the price of copper adds about 35 cents a share to earnings.
Peabody Energy (BTU, news, msgs). Peabody Energy isnt a metals company, per se, but the growth story for this coal producer is in metallurgical coal, the type used in steel production.
The global supply of metallurgical coal moved to a deficit at the end of 2003 thanks to production problems at several mines and to Chinas initial purchases of hard-coking coal from Canada and Australia. This supply tightness has gotten worse, with some steel mills running at less than capacity because they cant get enough coal.
The supply deficit has just started to work its way into metallurgical coal prices as long-term supply contracts began to be renegotiated this spring. Recent contracts have included price jumps of more than 25%. Recent deals by Peabody in Colorado and Australia have effectively doubled the companys potential coking coal sales with much of the new capacity, according to J.P. Morgan, set to renegotiate long-term contracts in 2005 and 2006.
In the case of all five of these stocks, remember to keep your eye peeled for further near-term weakness. But dont let those short-term problems distract your attention from the long-term potential.
Editor's Note: A new Jubaks Journal is posted every Tuesday and Friday.
E-mail Jim Jubak at jjmail@microsoft.com.
At the time of publication, Jim Jubak owned or controlled shares in the following equities mentioned in this column: Southern Peru Copper. He does not own short positions in any stock mentioned in this column.
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