Morningstar: ‘Tectonic’ Shift in Chinese Demand For Basic Materials

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Morningstar recently published its Basic Materials Outlook. Like most analysts, Daniel Rohr, director of basic materials research is bullish on the overall commodities sector and cautions investors that the transitioning Chinese economy will continue to depress both prices and consumer spending.

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“You are already seeing a knock on effect from the slowing fixed-asset investment environment and deflation of asset prices on households’ willingness to spend,” Rohr said. “That would more broadly fit the pattern that you observe when you look back through history at prior episodes of profound economic rebalancings. Japan, Taiwan, South Korea all had spectacular investment-led growth. Once that growth came to an end, a rebalancing wasn’t accomplished by an acceleration in consumption and a deceleration in investment. In each and every case, consumption decelerated sharply as well.”

Divestment as a Strategy

Morningstar expects Chinese household consumption growth to decelerate from the trailing 10-year average. Rohr said companies are responding to tectonic shifts in the macroeconomic environment by reorganizing their portfolios.

ATI can still pay off for investors, according to Morningstar, once it settles its lockout and uses its new stainless production facility. Source: Adobe Stock/Jovanning.

ATI can still pay off for investors, according to Morningstar, once it settles its lockout and uses its new stainless production facility. Source: Adobe Stock/Jovanning.

Miners coping with poor Chinese demand and weak commodity prices are looking to sell assets and shrink. Agricultural chemical companies have taken a different approach. Faltering crop prices have prompted many to seek mergers in a bid to cut overhead and grab synergies.

“That’s what we’re seeing right now in China. As it pertains to commodities, it’s a negative environment for ALL commodities, just somewhat less negative for the consumer-oriented ones,” Rohr said.

Gold and The Fed

With gold, Rohr said Morningstar does not believe the recent Federal Reserve interest rate hikes are going to engender outflows from Gold exchange-traded funds.

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“To the extent that gold does offer an alternative to stocks we don’t see that changing much, but, looking further out, we do see consumer demand for gold going up, meaning, mostly jewelry,” Rohr said.

ATI is a Top Pick

Morningstar also backed Allegheny Technologies, Inc. as a top basic materials pick. In a note, Morningstar said; “For Allegheny, near-term headwinds are significant. Its flat-rolled products segment has become unprofitable on an EBITDA basis, as the company is dealing with low stainless steel prices, weak demand from the energy end market, and an ongoing lockout of union employees. However, with the ramp-up of the new hot-rolling and processing facility, the eventual signing of a new contract with the United Steelworkers union that is likely to save costs for Allegheny relative to the expired agreement, and operational rightsizing, we expect the flat-rolled products segment to restore profitability in 2016.”

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