An Economics 101 Lesson From Corporate America

Supply. Demand.

Any basic economics class will start with these two words on the blackboard. They are the yin and yang of the market. Whenever one of these two items falls out of balance, it can take a major toll on companies that do business in that space. In recent years, certain sectors have been ravaged by an imbalance in supply and demand. Let's look at these sectors and see what will be needed to get back.

Metals: I sense a great disturbance in the (supply) force
Predicting global demand for metals can almost be answered with one question: How much will China and India need? Demand outside these countries is much more steady and predictable, but the growth in China and India has the ability to swing global supplies more so than anywhere else in the world. 

Back in 2011, aluminum prices hit their post financial-collapse peak, and there was a mad dash to increase supply to keep pace with Chinese demand. Since then, Chinese demand has waned and stockpiles for both aluminum and iron ore have grown, while spot prices for both materials dropped by at least 23%.

Iron Ore Spot Price (Any Origin) Chart

Iron Ore Spot Price (Any Origin) data by YCharts

Of course, when a company deals exclusively with these kinds of materials, a major slump in demand and prices will deal a major blow to share prices. Alcoa (NYSE: AA  ) , U.S. Steel (NYSE: X  ) , and Cliffs Natural Resoures (NYSE: CLF  ) , all of which deal exclusively with either aluminum- or steel-related materials, have seen their share prices drop since the metal-price peak back in 2011.

AA Chart

AA data by YCharts

Today, aluminum, iron ore, and metalurgical coal companies have started to slow down production to let demand catch up with excess stockpiles of these materials. Alcoa has idled almost 500,000 tons of aluminum smelting capacity, and Cliffs Natural Resources shut down two of its facilities in Michigan and Minnesota late last year. Both of these moves are part of a larger concentrated effort by several metal companies to bring prices back up.

In a way, these moves are starting to pay off. Alcoa recently reported better-than-expected earnings this past quarter, and although U.S. Steel still saw a sizable loss this past quarter, it was just 33% of the loss the company suffered on a year-over-year basis for the period. The outlook for the rest of 2013 and into 2014 looks much stronger, as stockpiles for these basic metals are rather low, Chinese demand is growing again, and prices for these materials are starting to inch their way back up. 

Solar panels
Commodities such as metals and other basic materials have always made for a rather cyclical industry, always reacting to the recent moves in demand. It's less rare for a manufactured product such as solar panels to experience an oversupply as it has recently, but moves by certain companies have brought on that very problem.

Like the metals market, the market for solar panels has been dominated by China, but in a completely different way. Rather than being the largest demand source, it's been the largest supply source of cheap solar panels around the world. Over the past several years, the Chinese government heavily subsidized major solar-panel manufacturers such as Trina Solar, Yingli Green Energy, and the recently bankrupt Suntech Power Holdings. China was thus able to capture 80% of the worlds solar panel market by being a low-cost provider. 

The problem with that approach is that solar-panel companies' manufacturing cpacity far outpaced worldwide demand. Global manufacturing capacity for solar panels stands at about 60 gigawatts per year. In 2012, though, demand for solar power was only about 35 gigawatts, according to Dr. Harry A. Atwater, director of the Resnick Sustainability Institute at the California Institute of Technology. With so much extra capacity on the market, almost every company struggled to sell panels at a profit. First Solar (NASDAQ: FSLR  ) , which developed a cost-effective panel that didn't use silicon, saw its price advantage erode, and with it much of the company's share price over the past couple of years. 

Now it appears that the solar-panel industry is in the middle of a correction. No longer propped up by Chinese government subsidies and facing U.S. and European import tariffs, Chinese solar companies have been folding rapidly, most recently highlighted by the Suntech bankruptcy. According to a GTM Research report, 88 solar companies will shut down factories or completely close up shop within the next three years, 54 of those being Chinese companies.  

Some companies are starting to show life as the stronger companies emerge from this massive correction. Both First Solar and SunPower are anticipating higher profits throughout 2013 and beyond. The next couple of years will be the proving ground for these solar companies as the wheat separates itself from the chaff. 

What a Fool believes
Markets are like nature, always in flux and striving for equilibrium. Just as when too many predators exist in a habitat with too few prey, supply levels will dwindle until sufficient demand catches up. As complex as nature and the global markets may be, they will always eventually revert back to this basic principle.

Long-term investors need to understand this equilibrium. In sectors such as commodities, ups and downs are expected to happen. Rather than trying to time the market, though, have the temperament to weather these rougher patches, and your portfolio will thank you in the long run.

Materials industries are traditionally known for their high barriers to entry, and the aluminum industry is no exception. Controlling about 15% of global production in this highly consolidated industry, Alcoa is in prime position to take advantage of growth that some expect will lead to total industry revenue approaching $160 billion by 2017. Based on this prospect and several other company-specific factors, Alcoa is certainly worth a closer look. For a Foolish investment perspective on this global giant, simply click here now to get started.


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