Morningstar recently published its outlook for basic materials stocks on Morningstar.com.
According to the report, despite a recent rise in global equities, the basic materials sector continues to trade slightly below analysts’ fair value at a median price/fair value of 0.96 compared with a market price/fair value of 1.04. We recently had a chance to discuss the outlook with Morningstar Basic Materials Lead Analyst Daniel Rohr, who explained the trends he sees in the market.
- Iron ore prices dropped off a cliff in 2014, and analyst Jeffrey Stafford and the rest of Morningstar’s team does not expect a return to heady prices anytime soon.
“Low prices are a permanent phenomenon,” Rohr said. “Looking at 2015 before getting into the long-term, we view this as a year of countervailing forces. New seaborne capacity certainly doesn’t help. I think we’re looking at another year of weak steel demand in relative terms out of China.
Rohr further explained that if that is all that we were talking about you’d be looking at further declines in the price of iron ore, but what is likely to offset that and keep us right around where we’re at today is lagged closure decisions among both seaborne players and domestic Chinese players.
“It takes some time before a mine that’s underwater ultimately decides to throw in the towel and gives up on a meaningful rebound,” he said. “I think we’ll see more of that in the months to come and, I believe, that will keep iron ore from flipping materially further behind. That and we’re starting to bite into a pretty large part of the seaborne curve that should give some price support at current levels.”
- While Copper prices held up relatively well through November, the report states that “Dr. Copper” will be the next shoe to drop from China’s inevitable slowdown in fixed-asset investment.
“Back in November, I think copper was holding up and people were pleasantly surprised about it, just how well it was holding up,” Rohr said. “Relative to iron ore, at least. Our view is that you’re going to have lag leverage in construction. Starting a building doesn’t demand the material as much, it’s only halfway through construction that copper is applied.”
While Morningstar is predicting a sharp fall-off in copper prices, they do not believe copper’s fall should be looked at as a bellwether for the rest of the economy, or even the construction market, overall.
“As to whether Dr. Copper still merits his PhD? It’s been a long time since I think he merited it as far as the pulse of the global economy is concerned,” Rohr said. “That expertise has grown far more narrow over time. The real-time quality isn’t there. If anything iron ore is more of a leading indicator because it’s used so much earlier in the construction process.”
- Markets cheered China’s interest-rate cut as effective medicine for the country’s slowing economy, and thus good news for commodities, but Morningstar analysts see this as nothing but a short-term fix—a shot of whiskey to cure a hangover.
Bloomberg put out a piece recently that said China’s National Development and Reform Commission was fast-tracking $1 trillion in infrastructure spending. Many believed it was a sign of stimulus coming from Beijing.
“We just had one of the NDRC guys come out and say ‘this isn’t stimulus. This was planned spending all along,'” Rohr said. “I don’t think we’re likely to see a whole lot of fiscal stimulus out of China, which is good news as far as getting the country on a more sensible long-term growth plan. Infrastructure spending was never the problem there. You don’t cure the problem by spending even more on infrastructure and throwing more at it.
That’s why the rate cut was a bit of a concern to Rohr and his team. Were Xi Jinping and Li Keqiang losing some of their mettle?
“It’s so difficult to ascertain what, exactly is going on in China,” he said. “As far as total fixed-asset infrastructure is concerned, that infrastructure slice where spending is targeted really pales in size to the real estate slice of China’s fixed-asset investment. That’s an area where the government can influence outcomes. The government will exercise less influence over whether to build infrastructure such as bridges or roads.
For more on the Basic Materials Report go to Morningstar.com.