The net profit of China Alcoa International surged 33 times year on year in the first quarter, which clearly aroused the desire to explore the non-ferrous metals sector.

On April 19, China Alcoa International (02068,601608.SH) released its performance report for the first quarter of 2024. According to financial data, the company achieved operating income of 49.853 billion yuan during the period, up 15.77% year on year; net profit attributable to shareholders of listed companies was 104 million yuan, up 3343.56% year on year.

The reason for the sharp increase in performance is mainly due to “internal factors” — during the period, as the company focused on new productivity, strengthened technological innovation, and accelerated reform and transformation, and the gross profit and profit contribution of the engineering survey, design and consulting business sector further increased, the company's net profit attributable to shareholders of listed companies increased dramatically.

As we all know, the non-ferrous metals industry is a typical cyclical industry. The performance of the industry mainly depends on the performance of commodity prices. That is, the strength and weakness of such industries is commodity prices. When commodity prices are rising, the revenue and profits of industry companies increase; conversely, when commodity prices fall, the revenue and profits of industry companies decrease.

Therefore, with the sharp rise in China Alcoa International's performance, does it mean that the non-ferrous metals sector will usher in a sixth upward cycle? Will individual stocks in the industry seize the “Davis Double Hit” opportunity with rapid increases in performance and stock prices?

Two major factors trigger the “up button”

According to the Zhitong Finance App, non-ferrous metals can be mainly divided into four categories, namely precious metals, industrial metals, energy metals, and rare metals. Among them, precious metals are also the metals we are familiar with, such as gold and silver, while industrial metals are metals commonly used in industrial production. Typical industrial metals are copper and aluminum, energy metals refer to lithium, cobalt, nickel, etc. used to make lithium batteries, and rare metals refer to rare earths.

Looking back at the recent rise in non-ferrous metals, it is easy to see that it is mainly due to the rise in precious metals represented by gold and industrial metals represented by copper and aluminum catalyzed by the rise. For example, since this year, the price of spot gold has risen from 482.74 yuan/gram at the beginning of the year to 561.60 yuan/gram on April 22, and the price of non-ferrous copper rose from 69,130.00 yuan/ton at the beginning of the year to 80,320.00 yuan/ton on April 22.

Looking closely at the reasons for the rise in precious metals and industrial metals, it is easy to find that it is mainly due to two reasons. One is the expectation that the Federal Reserve will cut interest rates, and the other is a decrease in supply.

On January 31 of this year, the Federal Reserve announced that it will keep the federal funds rate target range unchanged at 5.25% to 5.5%. This is the fourth time since September 2023 that the Federal Reserve has kept this interest rate range unchanged. As of March, the Federal Reserve is still expecting to cut interest rates 3 times, and is expected to start cutting interest rates as early as May.

Generally speaking, the price of gold usually has an inverse relationship with interest rates on US bonds. When interest rates fall, the returns provided by traditional fixed income investments (such as bonds) are relatively weak, and investors look for unconventional means of storing wealth, such as precious metals, thus driving up their prices. At the same time, lower interest rates will weaken the dollar and make gold cheaper for international buyers, thereby boosting buyers' demand for gold. Therefore, the Federal Reserve's easing policy and the weakening dollar are the main driving forces behind the rise in gold prices.

Let's look at another supporting factor — reduced supply. In the case of non-ferrous copper supply, since 2014, the lower capital expenses of copper mining companies have determined that future copper production growth will be limited. On the one hand, the taste of copper ore is declining rapidly, that is, less and less copper can be extracted from the same excavated copper ore. Moreover, the world's copper mines are aging very seriously. About half of the copper mines have been mined for more than 50 years, which means that less and less copper metal can be extracted from copper mines of the same weight.

Factors such as the aging of mines and declining grades have apparently also limited the increase in the supply of copper concentrate. According to ICSG, CRU, and Woodmac statistics, the average grade of open pit mines in the world has declined from 0.81% in 1993 to about 0.6%, and the average grade of underground mines has declined from 1.36% in 1993 to 1.12%.

In addition to copper, global industrial metals such as aluminum and zinc are also facing a decline in supply. For example, industrial zinc, production cuts and increased production in overseas mines due to high costs, strikes, and production accidents. It is expected to affect zinc concentrate production by about 220,000 tons in 2023, accounting for about 1.5% of total output, and supply contraction is transmitted downward from the mine end.

In view of the above, it is easy to see that the Fed's interest rate cut expectations+reduced supply are the main “trigger buttons” for the current rise in non-ferrous metals.

Is the “wind” of a strong cycle blowing towards the non-ferrous metals sector?

As can be seen from the 5 strong cycle market reviews of non-ferrous metals, the underlying logic of the cyclical stock market explosion is actually due to the catalytic relationship between supply and demand.

The first round of the strong cycle was mainly in the period from 2006 to 2007. At that time, thanks to the expansion of global demand, the Chinese economy also entered a boom period. Strong demand for real estate and infrastructure in China drove the price of raw materials to soar. The increase in coal, non-ferrous metals, and steel basically doubled 3-4 times. However, the financial turmoil in 2008 then prompted an economic recession, and the cyclical market peaked and declined in March 2008.

The second round of strong cycles began at the end of 2008. In order to cope with the financial turmoil, at the end of 2008, the Chinese government introduced a “4 trillion” super stimulus policy, which prompted a rapid recovery in domestic demand in the short term. At the same time, the introduction of policies to stimulate consumption, such as automobiles and appliances going to the countryside, has further strengthened demand for upstream resource products, thus catalyzing a strong cycle of non-ferrous metals.

The third strong cycle occurred from July 2010 to the beginning of 2011, mainly due to supply-side restrictions, which drove industry valuations to rise. The fourth cycle occurred in 2016-2017, and the upward catalyst was “supply-side reform”; while the fifth round of the cycle was in the 2020-2022 period, when the cycle between China and the US picked up resonance, and production recovery prompted strong demand for upstream resources, which also drove the non-ferrous metals industry to rise.

As can be seen from above, the rise in non-ferrous metals is mainly driven by the relationship between supply and demand. In other words, short supply is a strong cycle, while oversupply is a weak cycle.

However, it should be noted that the upward trend catalyzed by demand-side increases is generally more sustainable, and the increase is often larger. However, the upward trend catalyzed by supply-side restrictions is often pulse-like and less sustainable, usually depending on how long the catalytic factors can last.

Therefore, as can be seen from the strong cycle performance described above, the fifth round of the strong cycle did not continue until 2023. In 2023, China's economy showed a weak recovery. The growth rate of some economic indicators slowed, and non-ferrous metal prices generally weakened. Among them, copper prices and aluminum prices remained strong, and prices of lithium carbonate, industrial silicon, and nickel fell sharply. Due to its strong investment properties, gold maintained a volatile upward trend, and rare earth metal prices showed a downward trend.

This can also be seen from the 2023 results of major nonferrous metals companies. Judging from the performance of non-ferrous metal concept stocks in the Hong Kong stock market, 2023 was also a “mixed year of sorrow and joy” for them.

For example, Shandong Gold (01787), represented by the production of gold and silver mines, showed the same upward trend as the gold trend. Revenue increased 17.83% year over year to 59.275 billion yuan, and net profit increased 114.66% year on year to 1,804 billion yuan; Ganfeng Lithium (01772) showed the same decline as lithium carbonate, with revenue falling 20.69% year on year to 32,812 billion yuan. Net profit fell 75.70% year on year to 4.983 billion yuan. Meanwhile, Jiangxi Copper (00358), which is mainly a copper mine, showed steady growth in revenue and net profit, at 520.339 billion yuan (up 8.77% year on year) and 6.746 billion yuan (up 12.4% year on year), respectively.

From the above various data, it is easy to see that the rise in the non-ferrous metals sector brought about by the Federal Reserve's interest rate cut and reduced production volume is not very sustainable. As mentioned earlier, if the upward trend in a strong cycle is to be sustainable, it is mainly stimulated by the demand side. However, the non-ferrous metals sector this time is mainly due to limited supply, and at the same time, Chinese demand has not actually recovered. I'm afraid the continuation of this round of upward market growth is not easy to say. In the future, with a clear recovery in domestic demand, this may be the real starting time for a strong cycle. Therefore, for investors, although the short-term rise in the non-ferrous metals sector is remarkable, the risk of catching up is also increasing, and they may need to be treated with caution.