India's Approaching Age of Basic Materials

Thus far, India has passed through the secular age of Information Technology.  This was an important first step as the tools to enhance productivity were a must.  She did this not just for herself, but for the globe too.  In doing so she created a trickle of wealth. She next proceeded to the secular age of Consumer Discretionary spending; everyone from the fruit vendor to the CEO carries a mobile today; and the number is still growing. Bicycles have been upgraded for scooters and motor cycles, scooters and motor cycles have been upgraded for cars, retail malls and leisure have grown in importance, people bought houses; all this in the secular age of Consumer Discretionary which now draws to a close.

Now, she strives to enter the secular age of Basic Materials in anticipation of the secular age of Industrials.  Within that secular trend, she now enters a strong cyclical upturn in Basic Materials.  This, in anticipation of a cyclical upturn in Industrials, with the Commonwealth Games as a catalyst.  Yes, roads are needed, as are trains and public transportation, hospitals, power stations (even nuclear power is needed), potable water, proper sewage, residential accommodation, office space, and retail malls. So far India is still at the need recognition stage; real demand exists because the need & the ability to pay are both in place.  Yet, so far much has been promised and little delivered.

Today, India is at the door-step of a secular age of Basic Materials.  Before entering the secular age of Industrials (which we call Capital Goods in India), India first must past through the age of Basic Materials.  She needs iron ore, steel, copper, cement, and much more to build the nation's infrastructure.  Similarly, she needs chemical, fertilizer, seed, and much more before she builds her tractors.  She is also entering a strong cyclical upturn in Industrials, which will be led by a cyclical upturn in Basic Materials.

So what holds India back?

Firstly, Basic Material prices have been greatly elevated.  China passed through its secular age of Basic Materials a long time ago.  It passed through its secular age of Industrials and entered the secular age of Energy in 2003.  In the run up to 2008, in the midst of its secular age of Energy, China passed through a cyclical upturn in Basic Materials & Industrials, aided by the Olympic Games as a catalyst.  For India, it is always a disadvantage being second in line; demand is the desire backed with the ability to pay and the ability to pay is impacted by price levels.  Nevertheless, prices have pulled back, with expected reduction in China demand following conclusion of its cyclical Industrials cycle, and so India should be ready to recommence the Basic Materials cycle from a lower base than recently; the demand side of the equation is thus in place.

Secondly, capacity & supply was an issue.  Cement capacity has been increased, as has steel and iron ore, fertilizer and chemicals amongst other Basic Materials.  The corporates (Sesa Goa, Sterlite (SLT), Hindalco, Tata Steel, Essar Steel etc.) have done well to create the required capacity expansion and they continue to do so; for this is the secular age of Basic Materials.  Of course the global miners and producers are ready and willing to supply at the equilibrium price.  So supply is in place too.

Thirdly, is the capital goods industry ready to run the cyclical up-turn?  Yes, not only ready, but raring to go.  So far the Commonwealth Games infrastructure needs are woefully behind, perhaps with the exception of the airports and metro which are on target.  Amongst the capital goods sector my favorites are L&T, Punj Loyd, GMR and Mundra - all ready to build airports, special economic zones, ports and other infrastructure.  So this is no impediment.

Finally, it's the government.  This is the greatest impediment to progress in India.  It has changed a lot over the years, but controls still slow the pace of progress.  Efficient price discovery is hindered because of interventionist government policies, be they in mining, sugar, steel, iron ore, cement, chemicals or fertilizer; no matter how noble the intentions, they are always bad.  Intervention can be legislative, it can be a dictatorial policy note, it can be an import or export tax, it can be a simple suggestion.  Upcoming elections will cause problems short term; but perhaps once that is done, better sense shall prevail - the risk of an international embarrassment during the Commonwealth Games might prove a change catalyst.

Now what confuses me is that the analyst community in India remains negative on materials but positive on capital goods.  Is it not obvious that for capital goods to succeed, first materials must prosper?

Gentlemen and ladies, India's entry into a secular age of Basic Materials is not merely a trend within an economic cycle; it is a powerful secular trend with the ability to influence the global Basic Materials sector.  Together with a cyclical upturn in anticipation of the Commonwealth Games, we have a very powerful catalyst in place for sector out-performance on an India and Global level.

Disclosure: Author is long Sesa Goa, Tata Steel in India.

Comments

[stockezy:]

The age of the Basic Material is surely knocking on India's door, no doubts there, but I think unlike China the 'secular age of Energy' in India has to coincide with Basic Materials and Capital Goods. We cannot afford the luxury of taking it one step at a time. Fingers crossed we do not have a hung parliament and some coalition works out to provide a stable government. Then it is a battle only India alone can loose. If I have to name stocks my favorites include Jaiprakash Associates and Jindal Saw Ltd. One each in Capital Goods and Basic Materials space.

2008 Sep 23 04:08 PM

[LCACM:]

When free markets are crumbling in the US due to a lack of proper government oversight, it is strange that the author is advocating less deregulation in India.

2008 Sep 23 10:53 PM

[captainjohann:]

What about OIl/gas which it imports and stands at 120 dollars.How will it service this demand?As the election has approached it has printed rupees driving up the prices locally.Except mobile rates everything is skyhigh.
You see a fall in crude prices when DOW burst but rebounded strongly with 700 billion payoutplan.I think India will benefit only when the texan oil lobby doesnot succeed in USA

2008 Sep 24 09:08 AM

[yank:]

Shiv:
I agree that it is absolute nonsense for analysts to be bullish on capital goods and industrials while ignoring basic materials. It is quite clear that basic materials demand PRECEDES the growth of the other two. It was no accident that the CEO of BHP/BIlliton, one of the largest commodity producers in the world, recently commented that India had every potential of becoming the "next China" in terms of commodity demand. With the latest Govt bailout in the USA, you can be sure that economies in emerging markets like India and China will go along and "reflate" their way out of this contraction. As someone pointed out, the wild card for India is the crippling reliance on oil imports with oil at $100 or above. That's a considerable drain on GDP and growth.

2008 Sep 24 01:31 PM

[hownow:]

Well Shiv, analysts all over are finally being seen in new light for their "special" visionary skills.. but it is worrying you manage to miss even their simple maths..

materials - global supply /demand.
Cap goods - domestic supply /demand.

2008 Sep 26 02:25 AM

[Shiv Kapoor:]

hownow - capital goods in India is domestic led. They are supplied first by domestic material suppliers and next by international material suppliers. The domestic suppliers are somewhat dis-advantaged at present because they cannot compete internationally. However, in the long run, the Indian demand from capital goods is of such significance that it can move the global material markets. In that sense, materials becomes a domestic story and in this situation, Indian material suppliers are in an advantaged positions. We do see India as being significantly influenced by global credit markets. If global financial services starts the healing process we will change our sector weightage.

At present, FMCG & Staples are over-weight positions; these will go to under-weight with an over-weight in financials as soon as the chances of success of the bail out package are estimable. We will shift into early cyclicals like technology and discretionary as once financial services outperforms. Once IT & discretionary commence out performance we will switch over weight to materials and capital goods. We are always 100% invested and we rotate sectors based on Sam Stovall's economic cycle.

2008 Sep 26 10:19 AM