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Metals Lose Their Luster

By Sam Stovall After shining for much of 2004, the metals group may be losing its luster. The S&P Diversified Metals & Mining subindustry index was dropped from the Industry Momentum List, indicating that its 12-month price performance was no longer among the top 10% of subindustries in the S&P Composite 1500.

There can be no denying that the group has had a good run in 2004. Year to date through Oct. 29, the S&P Diversified Metals & Mining Index (where copper companies dominate) rose 8.4%, vs. a 2.2% advance for the S&P 1500 (see chart below). But should investors attempt to take profits before the gap between the subindex's performance and that of the overall market begins to narrow? Yes, according to Leo Larkin, S&P's Equity Metals & Mining analyst. Based on S&P's expectation that the price of copper in 2005 will likely trail 2004 levels, Larkin has a negative investment outlook for this group.

CYCLICAL UPTURN. Larkin notes that after peaking in 1995 at $1.35 per pound, the average price of copper dropped steadily, albeit irregularly, through 2002, mostly as a result of excess global production relative to demand. However, S&P believes a more favorable supply-and-demand balance has begun to take hold. From 1994 through 2003, production exceeded consumption, with production rising at a compound annual rate of 3.5%, while consumption rose at a compound annual rate of 3.2%. More recently, from 1999 through 2003, total production increased at a 1.3% rate, while demand increased at a 2.5% pace.

Larkin believes this rise in demand relative to supply set the stage for a cyclical upturn in copper prices. In 2003, the average price of the metal was 81 cents per pound, up from 2002's average of 73 cents. S&P believes the increase in the price in 2003 reflected more favorable supply-and-demand fundamentals. Through October 29, 2004, the price of copper averaged $1.27, year to date.

A look at the supply and demand numbers is revealing. After reaching a 10-year high of 1,004,000 metric tons in 2001, the surplus of copper supply over demand declined to 345,000 metric tons in 2002, according to data from the World Bureau of Metal Statistics. In 2003, there was a deficit of 196,000 metric tons, reflecting the combination of a 1% decline in total global production and a 2.8% rise in global consumption. In 2004, Larkin anticipates that the deficit will increase, prompted by higher demand relative to production, leading to an increase in the average price for 2004 to $1.25 -- a more than 50% increase over the 2003 figure.

DOWNHILL FROM HERE? But 2005 will tell a different story, according to Larkin. S&P believes that the price of copper will decline for the year as more formerly idle production capacity comes on stream as a result of 2004's higher prices. Consequently, Larkin thinks the copper-market deficit will shrink in 2005, which would likely result in a lower copper price relative to 2004. On that basis, he believes 2004 could represent the peak, or near-peak, of earnings for the current cycle.

So there you have it. The relative performance is weakening for this group, which S&P believes is supported by the fundamentals. As a result, S&P does not assign buy rankings to any of the stocks in the group, but recommends putting assets to work elsewhere.

Industry Momentum List Update

For regular readers of the Sector Watch column, here is this week's list of the industries in the S&P 1500 with Relative Strength Rankings of "5" (price performances in the past 12 months that were among the top 10% of the industries in the S&P 1500) and their proxies (the highest STARS-ranked companies in the subindustry index; tie goes to the largest market value) as of October 29, 2004:






Commodity Chemicals

Lyondell Chemical




Consumer Electronics

Harman International




Fertilizers & Agricultural Chemicals

Scott's Co.




Internet Retail





Internet Software & Services





Multi-Sector Holdings

Leucadia National




Office Electronics





Oil & Gas Equipment & Services

BJ Services




Oil & Gas Exploration & Production





Oil & Gas Refining & Marketing & Transportation










Wireless Telecommunication Services

Nextel Partners




Required Disclosures

Standard & Poor's Stock Appreciation Ranking System (STARS)

5-STARS (Buy): Total return is expected to outperform the total return of the S&P 500 Index by a wide margin, with shares rising in price on an absolute basis.

4-STARS (Accumulate): Total return is expected to outperform the total return of the S&P 500 Index, with shares rising in price on an absolute basis.

3-STARS (Hold): Total return is expected to closely approximate that of the total return of the S&P 500 Index, with shares generally rising in price on an absolute basis.

2-STARS (Avoid): Total return is expected to underperform the total return of the S&P 500 Index, and share price is not anticipated to show a gain.

1-STARS (Sell): Total return is expected to underperform the total return of the S&P 500 Index by a wide margin, with shares falling in price on an absolute basis.

As of September 30, 2004, SPIAS and their U.S. research analysts have recommended 29.2% of issuers with buy recommendations, 58.5% with hold recommendations and 12.3% with sell recommendations.

All of the views expressed in this research report accurately reflect the research analysts' personal views regarding any and all of the subject securities or issuers. No part of the analysts' compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this research report.

Additional information is available upon request to Standard & Poor's.

Other Disclosures

This research report was prepared by Standard & Poor's Investment Advisory Services LLC ("SPIAS"), and may have been provided to you either by: (i) Standard & Poor's under a license agreement with The McGraw-Hill Companies, Inc., which holds the copyright to this report; or (ii) a Standard & Poor's client who is granted a sub-license by Standard & Poor's. This equity research report and recommendations are performed separately from any other analytic activity of Standard & Poor's. Standard & Poor's equity research analysts have no access to non-public information received by other units of Standard & Poor's.

Standard & Poor's does not trade in its own account. SPIAS is affiliated with various entities, which may perform services for companies covered by the recommendations in this report. Each such affiliate is operationally independent from SPIAS.


This material is based upon information that we consider to be reliable, but neither SPIAS nor its affiliates warrant its completeness or accuracy, and it should not be relied upon as such. Assumptions, opinions and estimates constitute our judgment as of the date of this material and are subject to change without notice.

Past performance is not indicative of future results.

This material is not intended as an offer or solicitation for the purchase or sale so any security or other financial instrument. Securities, financial instruments or strategies mentioned herein may not be suitable for all investors. This material does not take into account your particular investment objectives, financial situations or needs and is not intended as a recommendation of particular securities, financial instruments or strategies to you. Before acting on any recommendation in this material, you should consider whether it is suitable for your particular circumstances and, if necessary, seek professional advice. Stovall is chief investment strategist for Standard & Poor's

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