What is wrong with metals?

There is nothing wrong with metals. It is we who don't have a real perception of them. The regular investor who is so equity-focused, a bit fixed income-focused is a bit aware of gold and oil prices and that's where it stops. When it comes to commodities or say metals, one has to cross the bridge.

The equity investors stay on one side and the commodity specialists on the other. Why is that so? Why are commodities or metals across the bridge? Why is it so hard for a regular investor to look at copper or zinc as investible assets?

The first reason is that just like the investors even exchanges and regulators do not see the connection. “If something is traditionally considered different, it is". So if you need to invest, you need to look at another specialized exchange and instrument. Second, metals are an indirect consumption. We use electricity as a service and not consume copper needed for delivery.

We use the cars for their comfort rather than the metal that goes into it, and so on and so forth. Or even when it comes to an Apple iPhone we consume the service rather than the metal used in it. Names like Rio Tinto might ring a bell as fashion majors rather than as a metals and mining major.

Third, out of sight, out of mind. When metal majors do not sell to the final consumer directly, it is out of sight, out of mind. The information produced by the metal companies also spurns regular news. India too lacks the instruments along with wider knowledge regarding the sector and hence investors remain on the other side of the spectrum unaware of risks and rewards of owning metals.

Some markets like Toronto hence get an advantage because you get to study RIM (Blackberry) along with Barrick Gold, a Toronto based gold miner. Now, these are geographical advantages, but that does not mean that geographical disadvantages cannot be overcome. Contemporary times offer everyone an opportunity to understand and hedge any risk. And somewhere the lack of knowledge or comfort problem is psychological rather than real. Because even if one might feel lost when it comes to metals, we are not lost when it comes to Gold. 80% of our attention to gold, makes up for our 20% limited attention across the metals complex.

So what is the opportunity with metals which we should see? Before we dig in, let us look at some facts of metal underperformance. The India metal sector has underperformed the Nifty index since April 2012. Had we gone long on Nifty and short on CNX Metal Index in mid of February this year, we would have earned 30% annualized returns. The relative performance between metals and the benchmark had few positive bumps. The Indian metal sector has seen a secular one-way underperformance vs. benchmark Nifty.

What are the reasons for one way underperformance? Internationally, metals as a commodity component have seen depressed prices. Barring the recent uptick in prices, Zinc, aluminum, nickel are near 2009 lows. Copper, tin, and lead are at 2010 levels, while Gold and silver are sideways for 18 months. From an inter-market perspective we are also not in late economic sector cycle, the reason no one seems to be interested in the lackluster metals complex.

For India, specifically, there are a few pattern observations. When you juxtapose Nifty with CNX Metals, the price structure though diverging looks similar. But a closer observation and one can see that while CNX Metals are at January 2012 lows, Nifty is at a 12 month high. This means we are not speaking about two inter-market sectors diverging, we are speaking about a larger divergence.

According to our extreme reversion approach, metals are a brilliant and not an opportunity to be missed. For those who know what it is to miss Hindalco at Rs 40 would relate to this view a bit more. A similar compelling opportunity lies for Tata Steel, Sterlite, Steel Authority, Nalco, JSW Steel, Sesa Goa, etc.

There are a few other big-picture reasons which make a compelling case for metals. Keeping in view the long-term inflation outlook high-interest rate should persist. Inflation leads to the destruction of purchasing power of cash. This will lead to a society valuing tangible assets more than cash.