The basic industries sector of the North American market is plagued by overcapacity but there may be...
The basic industries sector of the North American market is plagued by overcapacity but there may be some short-term opportunities due to rising demand for commodities.
Rupert Howard, US fund manager at Aberdeen Asset Management, is negative on the sector as a whole. He says basic industries are generally not attractive. "We have zero exposure to them. The sector has declined to under 2% of the S&P 500. Basic industries have been among the most consistent destroyers of value and the long-term picture is negative as they suffer from overcapacity and lack of pricing."
However, Stephen Caldwell, North American equity analyst at Schroders, says: "The underlying fundamentals of individual commodities are looking quite positive. Demand globally has been materially stronger than experienced at the beginning of the year and there is not enough supply to meet demand."
Caldwell believes that if demand holds up, barring any slowdown in economic growth, there could be quite tight commodity prices in the first half of 2001, especially in copper and nickel.
The stock market is not paying attention to the sector, he says. "It has historically been a poor sector to invest in as commodity suppliers work in a capital-intensive industry."
In addition, he points out that what capital spending there has been has tended to be undisciplined.
Howard says that in general, when things go well in the sector, companies tend to over-invest and create new capacity and in a sector which is already cyclical, this is a continual problem.
He adds: "There have been efforts at consolidation within industries by companies like Alcoa in aluminium and Georgia Pacific in paper.
"Alcoa, which is the number one aluminium producer, has acquired Reynolds Metals, the number three aluminium producer. Georgia Pacific is buying Fort James, a tissue producer. However, despite their best efforts at consolidation it has not helped. The issue of overcapacity will not go away."
Caldwell argues: "Valuations are pretty low. If you buy the argument that commodity prices will be strong next year, we see confirmation of that in the wave of consolidations."
Forestry has been affected by the poor price of lumber which has been weak since spring 2000, reflecting the slowdown in US housing stocks, he says. In addition, some export markets such as Japan, remain sluggish.
In the paper market, pulp prices have been very strong, reflecting strong shipments and little new capacity.
Newsprint remains strong, whereas writing paper is the laggard due to excess supply.
Caldwell says: "Tembec in Canada, which we have holdings in, is a very strong story. It has shown a knack of making timely acquisitions at low valuations."
Grain prices are still depressed reflecting the bumper harvest of the last three years. With over-supply the problem in agriculture, perversely what they need is a drought, Caldwell adds.
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