Commodities | Feb 29 2012
– 2Q rebound in metals demand growth expected
– Chinese demand remains a risk to metals prices
– Continued strength in AUD may impact on resource sector earnings
– NAB updates commodity price expectations
By Chris Shaw
Given recent Chinese PMI data surprised to the upside and the US ISM new orders index continues to post improvements, Barclays Capital expects a rebound in metals demand growth towards the end of the current quarter and into the second quarter.
As Barclays points out, macroeconomic news flow has helped stabilise the market and the recent improvements should encourage market participants to look beyond the current downturn. Such a scenario bodes well for metals demand in coming months.
Supportive of expectations for a pick-up is Barclays's leading indicator which has experienced a sharp month-on-month increase, the sharpest such gain since 2005. This pick-up was broad-based and supports the view of an improving trend for metals demand in recent months.
Other measures such as increasing manufacturing order books in the US, China and Europe over the past two months and a stabilisation of expected purchases of raw materials also supports the view of Barclays a pick up in metals demand momentum is likely in coming months.
Citi in contrast continues to see some risks for metal markets, suggesting there remains downside risk to metal prices if Chinese demand was to stagnate. Citi's view is markets at present are already factoring in a rebound in Chinese demand, so if this doesn't eventuate there is scope for disappointment.
At present, macro indicators are suggesting of further weakness in metals demand according to Citi, as Chinese crude steel production was down 13% in year-on-year terms in January and production of aluminium semis has also declined since early last year.
In terms of the various commodity sectors, Citi suggests copper has the most downside from current spot prices but iron ore and coal have the biggest downside relative to current price forecasts.
In the bulks, Citi notes if Chinese steel production was to remain at an equivalent rate of 650 million tonnes this year there would be an implied iron ore market surplus of 35 million tonnes. This would likely be enough to push prices for iron ore down to around US$100-$110 per tonne.
Taking a less bearish view, if the iron ore market remained in deficit but prices fell below US$120 per tonne a significant volume of Chinese iron ore would be forced off the market. In such a scenario, Citi suggests prices would be unlikely to stay below that level for long. More likely would be prices stagnating at a level of US$120-$130 per tonne.
In the thermal coal market, Citi sees potential for Chinese imports to halve to around 50 million tonnes. As the market is currently oversupplied this would likely see prices weaken. Price support is not likely until levels around US$80-$90 per tonne.
For copper, assuming there was no restocking this year the current barely positive growth rate in Chinese copper semi's production would push the market into a significant surplus on Citi's numbers. This would open up the possibility of price falls of as much as 25%.
In the aluminium market, Citi estimates the current rate of semi's production would see a much larger market surplus than currently forecast. This would require a 5% cut in Chinese capacity to bring the market back into balance, something Citi suggests would likely occur if prices dipped below US$2,000 per tonne.
Citi has also looked at the impact on commodity markets of the strengthening Australian dollar, which has occurred despite a backdrop of soft-ish commodity prices meaning the natural hedge for Australian producers has diminished.
Assuming a strong Australian dollar continues to be the case, and given the backdrop of soft commodity prices, Citi cautions there may be significant profit implications for Australian miners.
The most likely big losers from a higher currency according to Citi are Alumina Ltd ((AWC)), Iluka ((ILU)), Gindalbie ((GBG)), Whitehaven Coal ((WHC)), Newcrest ((NCM)) and Atlas Iron ((AGO)). All could see potential earnings downgrades of 20% and valuation downgrades of 8% if the AUDUSD stayed above US$1.10.
In contrast, the earnings impact on the majors such as BHP Billiton ((BHP)) and Rio Tinto ((RIO)) would be minimal. Big winners from a stronger Australian dollar according to Citi wold be the non-Australian miners, with the best picks here being PanAust ((PNA)), Medusa Mining ((MML)) and Perseus Mining ((PRU).
At present, Citi doesn't expect the AUDUSD rate will push above US$1.10 for any extended period, the broker's forecasts for the pair standing at an average of US$1.03 this year and US$0.96 in 2013.
The Chinese New Year has meant there has been little economic news of significance for bulk commodities in recent weeks, which National Australia Bank notes has contributed to some sideways trading.
But while sentiment towards the global economic outlook has improved so far in 2012, the fact the Eurozone appears to have entered a recession and some of the big emerging economies are showing signs of slowing means bulk commodity prices will continue to face headwinds.
This leads NAB to suggest bulk prices have probably settled around an equilibrium level for now, with risks to prices relatively finely balanced. Medium-term, the bank expects improvements in global growth will be offset by improved supply conditions, leading prices little changed from current levels.
For the minerals and energy sectors NAB has taken a similar view, suggesting while some data have improved of late, the global economic outlook continues to be uncertain. This implies little upside risk to commodity prices over the near to medium-term.
In the oil market, NAB's view is price direction will largely be dictated by how the current tensions in relation to Iran play out. One possible consequence of currently higher prices is the EU releasing some emergency stocks of oil. If this were to occur, or if Iran was to capitulate to the extent sanctions against it were lifted, NAB sees a reasonable amount of downside risk to oil prices from current levels.
In terms of an actual price forecast, NAB expects the oil price will generally remain above US$100 per barrel through 2012, with generally weak stocks of middle distillate likely to offer some price support through the year.
For the base metals, NAB sees generally favourable fundamental conditions as helping to sustain prices close to or a little above current, historically elevated levels. While there are downside risks, a repeat of the price falls experienced during the GFC is unlikely in the bank's view.
As the economic outlook improves and there is a corresponding unwinding of global economic uncertainty, NAB expects gold prices will ease from current levels. In quarterly average price terms the bank is forecasting a level around US$1,700 per ounce for the March quarter of this year, falling to US$1,620 per ounce by the middle of the year and US$1,500 per ounce by the end of 2012. Prices are then expected to continue to ease, to an average price forecast for the December quarter of US$1,340 per ounce.
In US dollar terms, the NAB non-rural commodity price index is forecast to fall by about 3.5% this year and an additional 3.25% in 2013. In relation to forecasts for the Australian dollar over the same period, the bank expects Australian dollar non-rural commodity prices to fall 2.5% this year, followed by an increase of 2.0% in 2013.
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