Forget Metal Stocks, Run These Stocks For Better Returns

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

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

However, you might be surprised to know that legendary investor Warren Buffett wrote in his 2011 letter to shareholders for an asset we all love: Sleep,

Anyone who has read Buffett knows that he never invests in gold because of this reason.

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

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

It meets the underlying criteria of owning any productive (dividend or interest) asset. Barrick Gold had a high dividend payout.

As an auto analyst, I know it can be a tempting game. auto accessories stock instead of OEM.

In addition, some auto subsidiaries enjoy higher or similar valuation multiples than their underlying OEMs.

This was quite counter-intuitive as I had always learned that consumer-facing companies and brands always command higher valuations.

When you buy a Maruti Suzuki car, no one knows who supplies the brakes or the airbags or the windshield or which company’s paint is used.

So why do some auto accessories command the same or even higher valuations than their original OEMs?

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

It also hedges the risk if there is a downturn in a particular segment.

When rural growth slows, tractors and motorcycles are affected, and when the urban market slows, the passenger car market is affected. Rarely do you get a time when all the sub segments slow down at once.

Also auto ancillary companies have good export exposure.

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

Like auto ancillaries, why not find companies in sectors that are proxy for a sector that is growing.

One sector that comes to my mind is the metals sector, particularly the steel sector.

The steel sector was the darling of investors in 2021 and the early part of 2022 when it peaked.

The main reason was improving supply conditions, which led to a fall in HRC (steel) prices, as well as lower demand from China, a major consumer, starting to slow down.

The final nail in the coffin came after the zero covid policy by the Chinese government, which led to a lockdown in late 2022.

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

In addition, the Chinese New Year begins in February where the Chinese travel to their hometowns and go on holidays.

What I am trying to indicate 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 consumer of metals especially steel.

The steel sector was the darling of investors in 2021 and peaked during the latter half of the previous year into the early part of calendar year 2022.

Many people do not make money in the metals sector because they follow a buy and hold strategy.

Metal is a speed sport.

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

As the Chinese reopen their economy and post Covid is behind it, the base metal prices are now rising due to higher demand from China.

When I was tracking the metal sector again, I noticed that most of the stocks are at 52 weeks high. Whatever I have written, the market has given it a lot of discount.

So why not look into the stealth game of metals?

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

The two proxies that come to my mind are:

1) Graphite Companies

2) Refractory Companies

Cast steel is manufactured through two processes: blast furnace and electric arc furnace.

Blast furnaces emit four times more carbon than an electric arc furnace and are relatively more expensive. Many steel producers are adopting electric arc furnace method.

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

massive capex The shift to Electric Arc Furnace is coming.

Graphite electrodes are now required for every ten hours of electric arc furnace run time.

Demand is directly linked to steel production and run time.

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

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

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

• 10-15 kg of refractories are required for 1 ton of steel.
• 1 ton of aluminum requires 6 kg of refractories
• 1 ton of copper requires 3 kg of refractories

Please note that the stocks mentioned are not recommended. Plus, it’s a trend that you can cash in on as an investor. This is not a long term thesis.

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

This article is syndicated equitymaster.com