Forget Metal Stocks And Play These Shares For Better Returns

China is the largest producer as well as the consumer of metals. (Representational)

“Assets that will never produce anything, but that are purchased in the buyer’s hope that someone else – who also knows that these assets will be forever unproductive – will pay more for them in the future.”

On reading this long academic statement, the only asset class which came to my mind was cryptocurrency.

However, you will be surprised to know this was written by legendary investor Warren Buffett in his 2011 letter to shareholders for an asset which we all love: Gold.

For people who have read about Buffett, would know that he never invests in gold for this reason.

However, it was August 2020 where Buffett pivoted from his anti-gold stance where he picked up a small stake in a gold mining company Barrick Gold.

If you think logically, when Buffett bought a stake in Barrick Gold, his proxy investment was the yellow metal, gold.

It did meet the underlying criteria of owning any asset which is productive (dividends or interest). Barrick Gold had a high dividend pay-out.

As an auto analyst, I know it can be lucrative playing auto ancillary stocks rather than OEMs.

Also, some auto ancillaries enjoyed a higher or equal valuation multiple than their underlying OEMs.

That was quite counter intuitive as I had always learnt that consumer facing companies and brands always command higher valuations.

When you buy a Maruti Suzuki car, nobody knows who supplies the brakes or the airbags or the windshield or which company’s paint is used.

So why do some auto ancillaries command the same or higher valuations than their underlying OEMs.

One reason is that many auto ancillaries cater to all the sub segments such as passenger cars, two wheelers, three wheelers, commercial vehicles, and tractors.

This minimises risk when there is a slowdown in a particular segment.

When rural growth slows down, tractors and motorcycles are hit and when urban market slows down passenger car market is hit. Seldom do you get a time when all the sub segments slow down together.

Also auto ancillaries have a decent export exposure too.

It is said that there is always a bull market in some part of the world at any given point in time.

Just like auto ancillaries, why not find out companies in sectors which are proxy to a sector that is growing.

One sector which comes to my mind is the metals sector, specifically the steel sector.

The steel sector was the darling of investors in 2021 and the initial part of 2022 when it topped out.

The prime reasons were the improving supply situation, leading to a decline in HRC (steel) prices, along with lower demand as China, a major consumer, started to slow down.

The final nail in the coffin came from Chinese government following a zero covid policy which led to lockdowns in the latter part of 2022.

But look at the scenario now. While we read about record number of covid cases in China due to reopening of the country, I believe China has passed its covid peak.

Also, the Chinese New Year starts in February where the Chinese travel to their hometowns and go for holidays.

What I am trying to hint at is that demand is likely to come back with a bang as China abandons its zero covid policy.

The best way to play this is the metals sector as China is the largest producer as well as the consumer of metals especially steel.

The steel sector was the darling of investors in 2021 and the early part of calendar year 2022 only to top out during the latter part of the previous year.

A lot of people don’t make money in the metals sector as they follow the buy and hold strategy.

Metals are a momentum play.

The strategy is to sell when the HRC (steel) prices are falling, and demand is faltering as it happened in 2022 leading to a 30% correction in stock prices from the peak.

As the Chinese reopen their economy and peak covid behind it, the base metal prices are on the rise now due to higher demand from China.

While I was looking at the metal sector again, I saw most of the stocks are sitting at 52-week highs. The markets have discounted a lot of what I’ve written about.

So why not focus on the proxy play to metals?

Just like Buffett played gold with an investment in Barrick Gold, you can play the steel and the metal sector with proxies.

Two proxies which come to my mind are:

1) Graphite companies

2) Refractory companies

Crude steel is manufactured via two processes: Blast Furnace and Electric Arc Furnace.

Blast furnaces emit four times the carbon which an electric arc furnace does and is relatively more expensive. Many steel producers are shifting to electric arc furnace method.

USA has already reached 70% while the global average is 45% electric and 55% blast furnace.

Massive capex is coming to shift to electric arc furnaces.

Now for every ten hours of electric arc furnace run time, a graphite electrode is required.

The demand is directly linked to steel production and run time.

So, if you want to play steel, why not play proxies like graphite manufacturing companies?

The best part is that companies like HEG and Graphite India which make graphite electrodes are available at cheap valuations. In fact, they are trading at book value.

Another proxy would be the refractory companies like RHI Magnate and Orient Refractories which make refractory material used to manufacture almost every metal.

  • 1 tonne of steel requires 10-15 kg of refractories
  • 1 tonne of aluminium requires 6 kg of refractories
  • 1 tonne of copper requires 3 kg of refractories

Please note the mentioned stocks are not recommendations. Also, this is a trend which you as an investor can capitalise on. It’s not a long-term thesis.

Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such.

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