What happens to metal stocks after the Credit Suisse downgrade
After a heady rally in recent months, the metal stocks got a sharp jolt in the last couple of weeks. Metal stocks showed signs of stabilizing in the last few days after China gave a positive perspective on metal prices. But it may be a tough call, going by the Credit Suisse report.
Sharp metal rally falters
Look at any steel stock in India in 2021 and the rally has been frenetic. Stocks like Tata Steel, JSW Steel, Hindalco have all rallied by 3-4 times, something you do not get to see frequently. While the reasons are many, most investors were betting on a global economic boost to benefit industrial metals the most. However, such rallies are never too easy to sustain and the recent doubts raised by Credit Suisse have underlined the concern that metal stocks in India may have just become too steeply valued.
COVID 2.0 may be a dampener
The brokerage house has pointed out that the resurgence of COVID and the uncertainty over its trajectory will only exacerbate the outlook for these metal stocks. We have seen the demand for oil dampening and a similar outcome is expected for industrial metals also. The pace of industrial recovery is expected to be slower as the resurgence is likely to once again hit supply chains. Clearly, the analysts and investors may have just about overestimated the extent and depth of recovery in most metal stocks.
Supply squeeze story over
In the last few months, most of the steel consumers became victims of what is now being called an extreme kind of inventory cycle. The ESG regulations in China reduced the supply as fresh steel capacities were put off. This led to most of the steel users finding their books short on inventory. This resulted in an inventory accretion binge, which offered a boost to the metal stocks, especially the steel stocks, in the first place. But, Credit Suisse is of the view that supply squeeze story may have largely played out and at high prices, you could see a lot of opportunistic supply back in the steel markets. That would limit the play of this extreme inventory cycle phase.
Valuations are not favorable
When it comes to steel and other metal stocks it is not just P/E that matters as these stocks are more aligned to the overall commodity cycle. Take two very critical parameters. Firstly, the price to book value relative to the market is very close to a 10-year high level. Secondly, the all-important aluminum / steel price ratio is at a 20-year low. Both clearly are hinting at a likely correction in steel prices and also steel stocks. Of course, the intermittent bounces may always be there but these exceptions only prove the rule that metal stocks are heated up in India. As Credit Suisse puts it, when the input stocks get heated, it is time to play the output stocks in the market.