Sector fairly priced; removing Chalco and JXC from Conviction Buy
Key stance: A more balanced risk/reward
We are now incrementally cautious after our mid-Feb selective upgrades. We
break down the sector drivers into structural and cyclical components. We
believe current valuations, after an average 30% rally since March lows to
above mid-cycle levels now, potentially already reflect structural resilience on
the supply side, but not the mounting inflationary pressure or cyclical risks.
Recent sector strength reflecting structural supply tightness
With earnings season wrapped up, the market has been very efficient at
reflecting fundamental differences across sub-sectors.
–We see above-market performance in coal, cement, soda ash, and copper
equities, as supply tightness drives upside earnings surprises.
–Aluminum and zinc shares are lagging as smelting margins are squeezed.
–Upstream supply “bottleneck” is likely to be structural and long-lasting
due to the difficulty in raising supply for global commodities and Chinese
government’s crackdown on small players on safety issues (for coal) and
pollution/energy-intensive issues (for cement/steel/soda ash).
Further upside potentially capped by mounting cyclical risk
What is not priced in is the increasing demand risk, in our opinion. With
the upstream supply “bottleneck” structural, we believe growth will likely
slow down in the battle with inflation. Our analysis of previous episodes of
high inflation indicates a margin squeeze through the value chain, with a
time lag feeding through to even upstream sub-sectors such as coal.
Five themes for stock screening
(1) Valuation ceiling and floor matrix, tighter control on entry and exit
points: floor close to trough, ceiling at above mid-cycle.
(2) Upstream preferred, in this case coal and soda ash.
(3) Supply tightness key – good for coal/soda ash/cement/steel/copper.
(4) National champions – Angang, Shenhua, Chalco, Zijin, and Conch.
(5) Strong company-specific catalysts – Angang and Shenhua.
Top pick: Angang; taking Chalco and JXC off Conviction Buy List
We think Angang (0347.HK, Buy) fits most of the above five criteria. We
retain our Buy on Jiangxi Copper (0358.HK, JXC) and Chalco (2600.HK)
despite Conviction List removal on either lack of catalysts (Chalco) or strong
recent performance (JXC). Risks include sharp China macro slowdown.

Table of contents
Key stance: A more balanced risk/reward 2
Recent sector strength reflects structural supply tightness 3
Further upside potential capped by mounting cyclical risk 9
Five themes for stock screening; top pick Angang Steel 12
Disclosures 27