Cyclicals should be bought when the Price to Earnings (PE) is at its maximum and sold when the PE is at its minimum. In 2001 Tata Steel traded at a PE of 50 times. After having gone up 10 times and well into the top of the steel cycle it trades at a PE of 5 times.

 

The problem with steel, aluminum, cement and other Cyclicals is thatas the price of their end product rises a number of projects that were closed down earlier become viable. This releases a gush of new supply.  Rising commodity prices encourage entrepreneurs to start green field projects Banks and Financial Institutions that were earlier not disbursing loans become eager to advance as project viability increases

 

When these companies start hitting their lows they should be evaluated on market cap and the replacement cost basis. In 2001 Tata Steel traded at a PE multiple of 50 times with a Market cap of Rs 2000 crores (US $ 500 million) and is presently valued at (US $ 5 billion)

 

In times of higher profitability (increasing operating margins) rising RoE's and  lower PE's cyclicals are most probably nearing their top.

 

If one were to invest in cyclical commodities it is better to keep track of the London metal Exchange ( LME) prices. A crash at the LME metal prices precedes a fall at the domestic bourses.

 

For commodities one has to keep an eye on the Govt.'s import / export policies. A rise in import duties never gets a stock a higher multiple. This is because the market is never sure whether this import duty would not be reduced during the next budget.

Over a period of 10 years cyclicals have not delivered more then the market rate of return. See Market Cap Chart.