Market whispers!

It’s 2007, the world is in a multi year commodity bull run led by China’s insatiable demand to construct now what we know as Highways to nowhere. Fuelled by higher share prices and soaring profits, Tata Steel acquires Corus, the UK Steel major. Hindalco acquires Novelis, another major global alumina giant.

It was anticipated that China’s rise at the breakneck speed of almost 10% per annum is the new normal. All major commodities, ferrous and non ferrous traded at lifetime highs. The music was getting louder and the party seemed unstoppable.

Come the 2010s, the world is still reeling under the aftermath of the global financial Crisis and the China story is shaky. People are beginning to whisper of a hard landing in China, metal stocks are down and both the deals which were touted as arrival of India on the world stage are now being found wanting!

It took Tata Steel almost a decade plus to cross its highs made at the top of 2007 bull run and for the entire period, most metal stocks were shunned altogether by investors. This is typical of all deals done at the top of the metal cycle. What I believe and sense is that the end of the current bull run in metals might not be too far away..

Recently, Holcim announced its intention to dispose of it’s stake in Ambuja and ACC at the tentative deal valuation north of $10B. This was followed by media reports claiming interests from JSW group and Adani group to bring the cement companies under their fold. What is interesting is that JSW plans to fund part of the deal by mortgaging some of it’s stake in JSW Steel and JSW Enegery, both shares trading at decadal highs, fuelled by this post Covid commodity dream run.

History rhymes, if not repeats itself. The stocks of old economy stocks such as Steel, cement etc were shunned by investors for almost a decade before making a splendid comeback in the latter half of 2020. Experts are lining up to urge the public to allot major parts of their portfolios to metal stocks as they promise rising profits and higher dividends.

Once the cycle turns sour, the profitability of metal and all commodity stocks goes down sharply as most of them have very high fixed operating costs and margins vary wildly based on current market prices of the underlying commodity. Like it or not, the deals are done mostly at the top of the cycle because that’s when balance sheets look strong, it’s de-leveraged and analysts are more likely to assign a higher EV-EBITDA valuation.

Howard Marks has highlighted this in his fantastic book Mastering the Market Cycle. It’s illuminating to see how investors are extremely greedy at the top of the cycle and horrified at the bottom. The key in investing is to be the opposite – be fearful when others are greedy and be extremely greedy when others are running for cover.

It’s going to be very interesting to see how this story unfolds!