JJ Irani of Tata Sons said that Steel industry is robust. The cost of raw materials are shooting up. It mainly consists of iron ore and coking coke. But he don't think that any sub prices rise is on the cards and there may be a marginal rise. Present prices are likley to continue till the end of the year.

He further said that Iron ore prices in India will follow the Chinese negotiations. Indian demand will outstrip the steel production and India may have to import steel. The steel capacities are seeing delay in commissioning due to this India may see increase in imports, causing prices to remain firm.

Andrew Goodwin of Steel Business Briefing said that China exports are declinging in long products and flat product prices are robust. He expects negotiations to take longer and expects a 30% increase in iron ore prices. He believes that steel prices will remain stable and likley to pick up later in the year. Flat products will remain strong on US markets picking up. Chinese exports are not drying up and the prices are robust. He is forecasting the prices in 12 months to be stable. He further said that Financial problems in US are not likely to affect the steel prices. China is seeing a dip in growth in production, but overall production is still strong, he said finally.

The commodity markets suffered along with other financial markets on account of the US sub prime mortgage concern. The Federal Reserve has made several moves to ease concerns about credit by pouring additional liquidity into the banking system and trimming its discount interest rate to banks. This has brought in stability in the equity markets and metal stocks are among the top gainers on the bourses.

The brokerage houses have lately turned positive towards metal stocks like Sterlite Industries, SAIL and Tata Steel. This comes on the back of a couple of reasons like the stocks had been beaten down too much and looking attractively valued. Also there has been positive news coming in from metal majors like BHP Billliton on recording good numbers lifting sentiment in the local markets and metal prices look stable going ahead.

The global economy remains robust, driven by solid activity in Asia and Europe. Economic fundamentals remain relatively strong. In 2007, real prices for all major commodities remained at or near their highest levels since the 1970s as Chinese demand for raw materials continued.

Over the last year the LME traded metals performed very well. According to a Morgan Stanley research report metals prices are now look firm from a medium-term perspective, although some short-term volatility is still possible.

Aluminium: “We think the Chinese dynamics that have driven aluminium prices in the past three to four years are set to turn favorable for the sector in the coming four to five quarters. In contrast to other metals like steel and copper, an aluminium surplus has been recorded in China for the past five years. The consequent threat – real on some occasions, exaggerated on others – of a surge in exports of the metal from China has caused the aluminum price to underperform peer metals on the LME in the past four years.”

Copper: “Copper Concentrate Seem Close to Bottom But Unlikely to Rebound Sharply. In the past 18 months, the spot copper concentrate market has tightened sufficiently to squeeze TC/RC down to close 9c/lb in May 2007 from almost 45c/lb prevalent at the beginning of CY2006. Uncertain supply of concentrate has been the prime driver of the tight situation, exacerbated by increased imports by Chinese smelters in the past year. We are therefore building in an average TC/RC for Sterlite of 13c/lb in F2008 ( from 31c/lb in F2007) and 16 c/lb for F2009.”

Zinc: “Zinc prices stabilizing, if not rising. While we do not expect significant upside in zinc prices from here, the market is likely to remain relatively tight in CY2008 on continuing strong demand growth. Even though we project a zinc surplus – albeit modest – in CY2008, we expect inventory levels of 2.3 days of consumption to continue, too low to cause the market concern. Even in CY09, we project only 2.6 days of inventory, which should keep prices above US$2,500 /ton.”

Steel: Although steel prices were cut by 2%-5% in July, but the brokeage house is of the view that the monsoon driven seasonal demand slow down is shallower and shorter this year due to strong underlying steel demand in India keeping inventories low and likelihood of of plateauing, or even reduced steel exports from China.

According to Merril Lynch steel prices have done slightly better than its expectations in the current year and we forecast a 4% rise next year in benchmark steel prices versus flat earlier.

So metal stocks can be considered in ones portfolio especially stocks like Sterlite Industries, Tata Steel and SAIL. Morgan Stanley report has given Sterlite Industries a price target of Rs 742 and says it is the most diversified mining company it has well chalked-out growth plans and captive sources of raw materials. Sterlite has exercised the option to purchase the government’s 49% stake in Balco and is in the process of doing so for its 25% stake in HZL.

Morgan Stanley report has given Tata Steel a price target of Rs 796 on firmer steel prices and strength in Corus earnings supported by robust steel pricing in Europe.

But the opinion is divided in this case as Kotak Institutional Equitues report says that it has raised its rating to In-Line as risk-reward now appears to be balanced but they haven’t turned buyers as yet and are awaiting lead-indicators to point towards improving steel prices.

The report further says, “Steel-prices in US are sharply-down while stable in EU. However, the weakness otherwise continues. We believe Chinese exports will continue and we shall see a sluggish US/EU quarter ahead. We look forward to Tata Steel-Corus consolidated-earnings announcement over the next month. We raise our target price to Rs600/share and revise our rating to In- Line (under perform previously)."

Similarly SAIL was given a buy rating by Merril Lynch with a price target of Rs 182. The report says,” SAIL offers ownership of iron ore, strong volume growth, high free cash flow despite capex and is more than 25% undervalued versus global peers on FY08E and FY09E P/E multiples.”

Traders remained divided on the outlook of base metals last week. A section of the traders was of the view that copper would drive all base metals on the LME, while others doubted if the last week’s recovery might sustain for long amid the growing use of substitution. Plastic and other substitutes have been fast restricting use of metals in infrastructure and heavy engineering.

Bulls anticipate that the workers’ strike in Xstrata, the world’s third-largest copper producer, would continue and the company’s output would decline heavily in the days ahead.

The strike that began on August 7 resulted in a sharp fall in output, a company executive said.

In an another development, First Quantum Minerals, another large copper producer, reported a drop in output in the second quarter because of heavy rainfall at its Bwanaonshi project in Africa.

However, an another school of thought argued that the base metals had already dropped heavily last week and would now go up.

Meanwhile, copper and other base metals in London fell on continuing speculative liquidation on further steep falls in global equities due to signs of widening sub-prime problems, said analysts. Technical momentum accelerated the selling.

Last week on the LME, copper lost 7 per cent to $7455 on 8.5 per cent inventory additions. Copper stocks on the LME-registered warehouses recorded additions of 8.5 per cent or 8850 tonnes to settle the week at 1,14,500 tonnes.

Aluminium closed 5 per cent lower at $2518 while tin, zinc, lead and nickel declined 3 per cent, 6 per cent, 15 per cent and 14 per cent to end the week at $15830, $3320, $2873 and $25405 respectively.

Meanwhile, aluminium inventories slumped marginally to 8,33,325 tonnes from 8,37,925 tonnes.

Lead and zinc stocks also witnessed a heavy fall of 8.36 per cent and 4 per cent to 32,575 tonnes and 63,175 tonnes from 35,550 tonnes and 65,825 tonnes respectively in the beginning of the week. In contrast, nickel and tin inventories surged to 18,804 tonnes and 14,330 tonnes from 15,138 tonnes and 14,150 tonnes respectively.

Domestic base metals traders, however, stayed away from the market because of high volatility in the benchmark LME. “We know the price is going to stabilise over a period of time. Hence, we prefer to wait and watch till the price normalises,” said Surendra Mardia, a local trader.

Indian metal markets remained calm throughout the week with nickel cooling down 11 per cent to Rs 1325 a kg and copper wire bar slipping 3.61 per cent to Rs 374.

Copper cable scrap, heavy scrap and utensil scrap in Mumbai non-ferrous metals market slumped 4.17 per cent to Rs 345 a kg, 4.23 per cent to Rs 340 and 2.52 per cent to Rs 309 respectively.

Metals - The sheen is showing

Higher product prices to prop up June quarter numbers.

Integrated steel companies such as Tata Steel and Steel Authority of India (SAIL) are expected to report an improved performance in the June 2007 quarter as steel product prices are about 8-10 per cent higher on a y-o-y basis, point out analysts.

For instance, in the June 2006 quarter, Tata Steel’s realisations were at Rs 35,117 a tonne levels. No doubt, prices of key inputs like coking coal are lower on a y-o-y basis in Q1 FY08, but the near 7 per cent appreciation of the rupee in the last quarter q-o-q, could put pressure on export realisations for these large players.

Nevertheless, Tata Steel on a standalone basis (excluding Corus) is expected to grow its net sales by 16 per cent y-o-y in the last quarter, while operating profit could grow by over 20 per cent. SAIL is also expected to grow its operating profit margin by 150-200 basis points y-o-y in Q1 FY08.

However, the operating environment for non-ferrous players has been difficult in the last quarter — spot alumina price realisations had dipped 38 per cent y-o-y in the last quarter, while average aluminium prices rose merely 4 per cent to $2,804 a tonne in the last quarter, point out analysts.

As a result, Nalco is expected to see its operating profit decline by 15-17 per cent y-o-y along with a 9-10 per cent fall in net sales in the June 2007 quarter, say analysts.

In addition, non-ferrous players such as Hindalco (excluding Novelis) are also expected to be hit by weak treatment and refining charges in their copper divisions on a y-o-y basis in the last quarter.

As a result, Hindalco is expected to see its operating margin decline by 100 basis points y-o-y in the last quarter. SAIL trades at 8 times estimated FY08 earnings, while Nalco gets a discounting of 9.5 times.

Base metals, led by copper, are likely to ease in the coming week in anticipation that supply would resume from strike-torn miners and smelters, who have resolved the disputes with their workers.

Last week, as many as three leading mining companies successfully negotiated with their workers to end the disputes which, according to analysts, have changed the market sentiment from bullish to bearish. “After all, the metals trade is a sentiment game,” they said.

Chile’s Collahuasi mine, the producer of 440,000 tonnes of copper – 380,000 tonnes in concentrates and around 60,000 tonnes in cathodes each year and equivalent to 8 per cent of the country’s mining capacity – ended the strike and workers resumed duty after the company management accepted the wage hike offer.

In Zambia, Konkola Copper Mines (KCM), the largest copper producer in the country, has signed a new labour deal that will give its 10,000 unionised workers a 20 per cent salary increase. The company, majority owned by London-listed Vedanta Resources, has raised its wage offer by 16 per cent with a retrospective effect from July 1, 2007, to June 2008.

In another development, miners at First Quantum Minerals’ Kansanshi copper mine in Solwezi ended a two-day strike on Friday morning and returned to work after the intervention of the Zambian president. In its second year of operation, the company is planning to produce about 145,000 tonnes of A grade copper cathode in 2007.

But, operations at Codelco’s Andina are still suspended, costing 700 tonnes a day of lost output, after a worker was injured, coupled with a heavy snowfall. In Canada, the strike at Xstrata’s Canadian Copper Refinery (CCR) continues and in Peru, the dispute at Southern Copper Corp is still not resolved.

Copper on the London Metal Exchange (LME) jumped $38 to settle at $7,940.5 a tonne last week on uncertainty over the talks between striking workers and miners, which resulted into an inventory decline of 7,925 tonnes to 97,550 tonnes.

In the domestic market, however, traders preferred to abstain from the current volatile market.

“We are waiting for the base metals prices to settle down to utilise our 100 per cent (35-40 per cent currently) capacity,” said a brass equipment manufacturer. The final price of products made of brass, an alloy of copper, aluminium and zinc is determined by the price movement of the raw materials.

The outlook for aluminium also looks bearish because of a huge way-in of inventories in the LME-registered warehouses that ended the week at 838,275 tonnes from 824,700 tonnes last week.

The metal slumped towards the weekend to $2,726 a tonne after touching a high of $2,775.5 a tonne in the middle of the week. Aluminium was ruling at $2,743.5 in the beginning of the week.

Meanwhile, China is all set to play a major role in the metal’s price movement as demand is expected to surge by 33.6 per cent to 11.7 billion tonnes this year.

The bulls are likely to remain active at the zinc counter on the intermittently falling inventories, which settled the weekend at 68,950 tonnes from 71,450 tonnes earlier. Zinc prices, meanwhile, gained $115 last week to settle at $3,540 a tonne.

Steel companies have reduced flat product prices by Rs 500-1,000 a tonne across categories in keeping with market conditions.

Steel Authority of India (SAIL) has reduced prices by Rs 500-1,000 a tonne for flat steel. Prices of galvanised plain (GP) and galvanised corrugated (GC) sheets – the demand for which is normally high during the season – have also been reduced by the steel PSU.

Essar Steel has cut prices by Rs 700-800, while Ispat Industries has dropped prices by Rs 500-800, according to industry sources. A Tata Steel spokesperson said the company was yet to decide on price revision.

Seshagiri Rao, director-finance, JSW Steel, said the company would take a decision on that regard on Tuesday. SAIL has kept prices of long products such as TMT bars, unchanged.

The industry is, however, optimistic that the market would remain stable and rangebound for the rest of the year. “Globally, prices have dropped by ¤30, so prices may increase to the same extent. After the third quarter, there can be an increase,” said industry sources.

The expectation is in line with global forecast. ArcelorMittal, the world’s largest steelmaker, recently announced that it would maintain its current pricing structure for flat products in Europe for the third quarter.

The company also announced that its production volume in the European market would be lower by 3-4 per cent in the third quarter compared with the second quarter, as a result of mill outages.

The steel behemoth expects the move to reduce the level of inventory in the market, which was slightly inflated due to the recent surge in imports.

While soft global prices is one of the reasons behind the drop, rupee appreciation against the dollar has also added to the pressure on pricing. Imports of hot rolled coils (HRC) are priced at around Rs 26,000 a tonne, much lower than the domestic HRC prices, which are at Rs 35,000-37,000 a tonne.

Imports have been on the rise due to the appreciation of the rupee against the dollar. As the consumption has also increased, imports, which were at 2.1 million tonne in 2005-06, increased to 3.9 million tonnes in 2006-07 and is expected to cross the 4-million tonne mark this year.

BHP Billiton has recently negotiated with smelters at lower TC/RC of 5-5.5 cents a pound. Processing of deal between BHP and Japanese smelters is often seen as the benchmark. Mid-year fees represent a sharp decline from those for calender 2007, which were mostly set at $ 60/6.0 cents. No price participation was included, which resulted in the TC/RC of smelters falling substantially over the last few months.

Why are TC/RC so important for copper companies? Smelters and refiners generally buy copper concentrate at a slight discount to the London Metal Exchange price. This discount is towards the costs incurred in treating and refining the concentrate to obtain pure metal. For the smelter operators this is the source of their income. Tc/Rc charges are determined as a function of the relative scarcity of copper concentrate. If there is an abundance of concentrate available, the Tc/Rc rates are high. Tc/Rc charges are depressed due to lowered availability of copper concentrate in the market.

Spot TC/RC was estimated at 12-13 cents a pound compared with 20-22 cents a pound at the end of the March 2007 quarter. Global deficit of copper concentrate in CY06 was estimated at 290,000 tonnes. Deficit of copper concentrate of 500,000 tonnes in calendar year 2007.

Impact on Hindalco:

Falling copper TC/RC is expected to hit large domestic smelters such as Hindalco and Sterlite Industries. Copper contributes 60% to revenues, but 15% to the EBIT. They recently closed a smelter due to shortage in the concentrate market. The recent sharp reduction in spot TC/RCs led to production closure at one smelter. Brokerage group Citi has factored in weakness in TC/RC margins for FY08 valuations. CLSA says Hindalco's FY08 average TC/RC is likely to be 20c/lb down from 34c/lb.

Impact on Sterlite:

Copper contributed 48% to the revenues, 16% to the EBIT. In the March 2007 quarter, they reported a 16.4% y-o-y decline in its copper division's profit despite the production of copper cathodes rising 18.7% y-o-y to 89,000 tonne during the same period.

Prices Surge as Growing Middle Class Drives Demand

Shares of India's steelmakers are proving buoyant.

Rising global steel prices, propelled by China's demand, have lifted the profit margins for many of India's steel companies. But beyond that, fund managers say it's not too late to look at certain Indian steel stocks, despite hefty gains in their share prices.

The reason: Steel is among the sectors that stand to benefit most from India's own continuing economic boom. Demand at home is surging as members of the widening middle class buy new cars, remodel apartments and replace appliances. In the year that ended March 31, India's domestic steel consumption grew 11%, almost twice the 6% annual growth it averaged over the past decade.

Although there are plenty of steel stocks listed on the Bombay Stock Exchange, the best bet for investors is to think big, say analysts. That, they add, means picking integrated steel companies that offer the potential for better returns.

Industry Goliaths such as top maker Tata Steel and the second-biggest, government-run Steel Authority of India, or SAIL, have their own raw materials readily available, including iron ore and coal. Analysts confirm the assertion by Tata Steel that it is the world's lowest-cost steelmaker.

Another company that some investors favor is JSW Steel, India's third-largest integrated steel-maker by output. It has ambitious plans to more than triple production in the next five years.

JSW produces 8.6 million metric tons a year and it plans to start a 10-million-ton facility in West Bengal by 2009. A similarly sized plant is to begin operations in Jharkhand in 2012. Overall, the company intends to have total capacity of 30 million tons by 2012, according to A. Shekhar, an assistant general manager.

These integrated steel companies have a built-in advantage because they are cushioned from potential supply shortages and price increases for pivotal raw materials. Huge Indian reserves of iron ore, which put the country among the top five in the world, remain largely untapped.

So even if iron-ore prices continue to rise, India's integrated steelmakers are better placed to maintain profit margins. If steel prices go up -- as they have globally for hot-rolled coils by about 10% between February and April -- the companies' profit margins typically widen.

Policy shifts are also boosting Indian steel stocks. In a break from the past, Indian officials, who are usually fearful of inflation, appear willing to allow steel prices to rise. Finance Minister P. Chidambaram said recently that the central government wouldn't move to contain prices of hot-rolled coils used for making such products as pipes and tubes.

Also, while India's Steel Secretary R.S. Pandey has said a monitoring committee will study a recent rise in domestic steel prices, he added that the government has no plans to cap prices.

"Companies that benefit from [price rises] would be the steel giants," says Hitesh Agarwal, senior research analyst with Angel Broking in Mumbai.

The big three have already benefited this year from upbeat views of the industry. Shares of JSW are up 58% since the end of 2006, and those of SAIL have gained 57%. The stock price of Tata Steel, which fell when the company made a $12.9 billion acquisition this year of Anglo-Dutch steelmaker Corus Group, has risen 22% -- still far more than the 30-share Sensitive Index, or Sensex, which has gained 2.4% so far in 2007.

Bhavesh Shah, an analyst at Asit C. Mehta Investment Intermediates in Mumbai, says steel stocks are popular with Indian retail investors, as "they are making new highs regularly."

But given the strong gains, some analysts caution that their share prices may be approaching peaks.

HDFC Securities thinks SAIL doesn't have room to move higher for now; it has a target price of 135 rupees to 140 rupees ($3.32 to $3.44) over the next six to 12 months. Yesterday, shares of SAIL gained 1.8% to 140.10 rupees.

The firm's target for Tata Steel for the same period is 630 to 640 rupees. It closed yesterday at 588.45. For JSW shares, HDFC Securities projects 670 rupees; the stock rose 1.7% yesterday to 611.60 rupees.

Meanwhile, shares of Essar Steel, a slightly smaller steelmaker, have tended to suffer by comparison. The company's purchase last month of Algoma Steel of Canada for $1.63 billion didn't move the share price, mainly because of concerns of slower profit growth, says Mr. Shah of Asit C. Mehta Investment. Essar's stock has been flat since the deal and has risen 15% so far this year.

Still, few other sectors are as well placed as India's steel business to tap strong demand at home and overseas. So it's no surprise they have been shopping for overseas assets, in spite of the debt load that comes with financing new purchases.

Tata Steel's purchase of Corus, which extends its reach into Europe, offers an example of the upside available to those Indian companies that can combine low costs and global reach.

"The acquisition of Corus gives Tata Steel access to high-quality, developed markets, in addition to its existing low-cost, high-growth markets," Macquarie Research said in research note this month.

Investment Case

China not to take its foot off the pedal soon

The current backwardation situation indicates tight supply scenario
prevalent in the industry, which is due to huge demand from the Chinese
market. This demand will be driven by investments in the power and
construction sector, coupled with robust consumption. Double digit growth
rate in the power generation sector over the next five years will support
China’s copper demand for the year. Demand from construction and
consumer durables is expected to be robust during the year, rising at a
rate of 18% and 13% over CY2006 respectively. The State Reserve Bureau
(SRB) is expected to replenish its stock piles during the year, raising demand
forecast for CY2007 by 10.8% - 13.5% to 3.9 - 4.1mn tons.

Inventory levels not enough to cushion supply cuts
Inventory levels of copper are not enough to cushion any drop in supply.
The current inventory levels are approximately equal to 3.5 days of cover
as per the demand forecast for CY2007. The average inventory levels
maintained throughout the year for CY2005 was 1.2 days and that in CY2006
was equal to just 2.5 days of usage. Though the current levels are higher
than that of the last two years, it is much lower than the 21.5 days witnessed
in CY2002 and 12.8 days in CY2004. The rise in the demand from China
has led to a drastic reduction in the inventory levels in the past one month.
The decrease in the inventory levels will support the rally in copper prices.

Resurgence of Euro Zone led by Germany to consume more copper in
CY2007
For the last decade every, market player has been talking about the strong
demand from the emerging markets like India, Thailand, Brazil and many
more. People have agreed to these arguments and today everyone is
focusing on this. But in the shadow of the emerging markets the Euro
zone has been rising every quarter in the last 2 years. The Euro Zone
Gross Domestic Product (GDP) growth was 2.7% in 2006, the best
performance since 2000 and is expected to witness a growth of 2.3% in
2007. The GDP and the manufacturing sector in the Euro zone has been
rising quarter on quarter indicating to a rise in the demand for the industrial
metals. According to ICSG, the demand from Europe is expected to be
more than 5mn tons in the CY2007, a rise of 2% from that of CY2006.
U.S economy moderating, not headed for recession
The US economy has coped very well with the hit to GDP growth from the
housing recession. Forecasts that the housing slump would push the
broader economy into recession have been wide off the mark. But the
direct effect on economic growth is not the only transmission mechanism.
The next issue is whether cutbacks in the supply of housing loans could
trigger a financial crisis. If so, this would be a genuine threat to the health
of the US economy. We assume that the rate tightening cycle is over and
the Fed can cut its interest rates as we move into the second half of the
year. We assume that the slump in the housing sector has bottomed out
and the demand for the metal will remain around current levels.

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Sujana Metal Products Ltd.
(Rs 131, FY08E - P/E - 6x, BUY, Target Price Rs 215)