According the International Monetary Fund October 2015 forecasts, world real GDP should increase to 3.6% in 2016, up from a projected 3.1% in 2015. Growth should accelerate to 3.9% in 2017-2020. S&P Capital IQ believes strong global economic data as a bullish demand indicator for the metals & mining industry, leading to tighter markets for raw materials and industrial metals. We think long-term fundamentals look more promising than the current environment, which is characterized by global gluts of metals and excess manufacturing capacity.
An appreciating U.S. dollar, excess global capacity due to weaker demand in China and the influx of cheap imports has negatively impacted U.S. domestic steel producers’ market share and margins due to the extreme price competition.
However, S&P Capital IQ equity analyst Matthew Miller believes the worst is over for steel producers and we see upcoming catalysts from pending trade case determinations. He thinks that imports will revert back down to historical levels, allowing steel producers to benefit from a gradually improving construction market, impressive automobile demand, and an aerospace industry poised to experience a long-term secular uptrend.
In late September, aluminum company Alcoa (AA) announced plans to split into two independent companies. This would separate the upstream mining business from the rapidly growing engineered products & solutions business. Miller thinks this move has potential to unlock value, as the value-added products business which is 40% levered to the growing aerospace industry, commands a higher multiple. During the third quarter, within AA’s engineering products & solutions segment, aerospace revenue climbed 39%, while global rolled products automotive revenue more than doubled.
Meanwhile, S&P Capital IQ has three strong buy recommendations on U.S. domiciled steel companies. Nucor (NUE) is the largest with a $13 billion market cap.
According to Miller, NUE's strategy to become more vertically integrated with its new Louisiana direct reduced iron plant will result in generally less volatile production costs. The new plant will enhance NUE's low-cost position in the U.S. steel industry. For the longer term, he sees earnings rising on U.S. economic growth, strong automotive demand, and a recovery in U.S. nonresidential steel demand and better control of raw material costs.
SPDR S&P Metals & Mining (XME), an approximately $300 million ETF, is the most direct way to get exposure to the industry. Steel (48% of assets), diversified metals & mining (13%) and gold (10%) were the three largest sub-industries. The ETF has a 0.35% expense ratio and trades with a $0.04 bid/ask spread.
For investors that want more exposure to gold miners, Market Vectors Gold Miners (GDX) is the largest materials ETF. GDX has $5 billion in assets and it trades on average 63 million shares on a daily basis with a $0.01 bid/ask spread. ABX and Newmont Mining (NEM) are two of the fund’s top-10 holdings that recently comprised 55% of assets. Many of these companies are Canadian.