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Material Matters: Outlook Commentary, Gold, Oil, Bulks And Aluminium

Commodities | Sep 25 2012

 – Outlook for commodities constructive heading into 2013
 – Deutsche particularly bullish on precious metals
 – ANZ expects high oil prices will continue
 – Goldman Sachs updates preferred energy exposures
 – Further gains in iron ore prices likely
 – Fundamentals suggest aluminium looks toppy

By Chris Shaw

Given the assumption world economic growth will accelerate to 3.4% next year, the US dollar will remain weak and the S&P 500 moves higher, Deutsche Bank suggests the macro environment is constructive for commodities heading into 2013.

Adding to the positive outlook in Deutsche's view is European Central Bank (ECB) action has reduced downside tail event risk for the eurozone, while further liquidity injections from the US Federal Reserve are likely to support investor appetite for risk assets such as commodities.

To reflect this, Deutsche remains bullish on the outlook for precious metals, forecasting gold prices will rise to US$2,200 per ounce over the course of 2013. Pushing prices will be negative real interest rates, ongoing central bank buying, the potential for further QE by the Fed and a weaker US dollar.

In energy Deutsche expects geopolitical risk will sustain price spike risk across the complex, but the US Presidential election and high gasoline prices will keep speculation of a release of strategic reserves alive. 

Key issues for industrial metals include the US fiscal cliff, as Deutsche notes this has negative implications for growth in the US economy. As noted, when US Treasury debt was last downgraded in August of last year oil and industrial metal prices suffered the most.

The strong gains in food prices seen over the northern summer months are now fading, but Deutsche notes fundamentals in some markets such as corn remain tight. A developing El Nino is a threat to Australian crops, especially as it may mean a downgrade to expected wheat production. 

Deutsche suggests industrial metal prices may struggle to sustain recent strength given ongoing concerns with respect to the growth outlook for China. A more sustained rally in the base metals appears to depend more on reflationary measures in China, which Deutsche expects will only become more apparent in the early stages of 2013.

In oil, ANZ Banking Group expects higher prices will remain through 2013 due to a combination of ongoing supply issues and stronger demand. The demand side will be helped by further stimulus measures in the US, as well as a seasonal pick-up as the market enters the fourth quarter northern winter heating oil period.

On ANZ's numbers, demand growth will strengthen to 1.8% in 2013, implying growth of an average of 91.1 million barrels per day. Stronger growth in the US at 2.5% and in China at 5.9% should offset stale growth in Europe in the bank's view. 

One trend expected by ANZ in 2013 is for the Brent/West Texas Intermediate (WTI) spread to narrow, this as European crude loses market share in the Gulf of Mexico to growing domestic supplies in the US and stronger unconventional liquids production from Canada.

On the supply side, Deutsche Bank expects Saudi crude availability will improve from this month given the end of peak summer demand for crude for power generation. This is significant, as Saudi Arabia is estimated to source nearly 60% of its power generation from crude oil well above the average of about 35% for the Middle East as a whole.

On the other side of the equation, Deutsche notes Saudi spare capacity remains constrained holding below two million barrels per day since February. This suggests the cushion for dealing with any supply shortfalls remains thin in Deutsche's view.

ANZ's forecasts call for Brent to rise 6% to an average of US$119 per barrel in 2013, while WTI is forecast to increase 14% to US$110 per barrel. Goldman Sachs is more bullish, continuing to forecast an average price for Brent for 2013 of US$130 per barrel on the view a tightening market will force prices higher.

In terms of preferred stocks among Australian-listed energy plays based on oil price expectations, Goldman Sachs prefers Santos ((STO)) and Oil Search ((OSH)) among the large caps and Beach Energy ((BPT)) and ROC Oil ((ROC)) among the smaller cap plays.

Given recent strong relative outperformance, Goldman Sachs has removed Oil Search from its conviction list and replaced it with Santos. Despite the switch the broker continues to rate Oil Search as a Buy, attracted to a number of drilling and resource-related catalysts. Oil Search's price target stands at $9.25, while the consensus price target according to the FNArena database is $8.77.

For Santos, Goldman Sachs notes the stock continues to trade at a solid discount to valuation of more than 30%, this despite strong momentum and a good free cash flow growth outlook. This should be better recognised by investors as capex eases in 2013. Goldman Sachs has a price target on Santos of $14.85, which compares to a consensus target in the database of $15.89.

At the same time Goldman Sachs has downgraded Drillsearch ((DLS)) to Neutral from Buy, this following relative outperformance thanks to successful drilling results from the company. The good results meant Goldman Sachs increased its price target on the stock to $1.80 from $1.75, still broadly in line with the consensus price target in the database of $1.74.

Buy ratings on both Beach and ROC are accompanied by respective price targets of $1.65 and $0.45, which compare to consensus targets according to the database of $1.34 for Beach and $0.54 for Roc.

In the bulks, UBS expects the recent pick-up in iron ore prices is likely to continue, partly for seasonal reasons and partly given an improved metal spread for Chinese steel producers. This has been reflected in a pickup in China's daily steel run rate.

UBS is forecasting iron ore prices of US$130 per tonne for the final quarter of 2012. Signals the rally will continue include any decline in trader steel inventory at China's major cities and ports, as further declines could generate a pick-up in restocking.

A further potential positive in UBS's view is government policy in China is likely to provide some steel demand support, as infrastructure projects being announced are boosting sentiment in the sector and causing traders to add to inventory levels.

To play an improving iron ore price outlook UBS suggests Fortescue Metals ((FMG)) offers the most leverage, rating the stock as a Buy. The FNArena database shows a Sentiment Indicator reading for Fortescue of 0.8.

Macquarie suggests slowing industrial output is continuing to impact on global iron and steel production, as overall crude steel production was down 1% in year-on-year terms in August. This has brought global capacity utilisation back to a level around 75%, which Macquarie notes continues to weigh on margins in the sector.

While Chinese steel output is being cut the cuts are not sharp enough in Macquarie's view, as inventories held by mills continue to build up. Further cuts in output are therefore expected to clear the current backlog of inventories.

In the industrial metals, aluminium exchange prices have rallied almost 20% over the past month and Macquarie sees some implications for the market as a result. From a longer-term perspective Macquarie suggests with a net aluminum price of around US$2,440 per tonne almost all of global production is cash positive. This significantly limits the potential for further cuts to capacity.

Given China has scope to export more aluminium products, Macquarie expects Chinese trade in aluminium will continue to act as a significant stabiliser for prices ex-China. Short-term, as consumers have run down stocks recently and consumption in markets such as Europe has been weak, Macquarie sees scope for prices to overshoot in the short-run. Having said that, the broker's view is LME prices for aluminium appear toppy when assessed from a fundamental perspective.

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