The pencil "lead" is made mostly of conductive graphite and can conduct the small amounts of electricity required to activate the capacitive sensors in the touch screen. When you place your finger in the groove you made, the electricity from your body is conducted through the exposed graphite and activates the touch screen.

If you’re still not convinced or if you’re having trouble getting it to work, take these points into consideration:

Make sure the pencil is free from oil. There may be a thin layer of glue on the lead that prevents contact, so just scribble on a piece of paper to get rid of that.

Make sure your pencil is made from graphite and not another composite or recycled material (green/eco pencils).

Make the groove closer to the tip to improve contact.