Material Matters: Base Metals, Gold & Lithium

This story features SANDFIRE RESOURCES LIMITED. For more info SHARE ANALYSIS: SFR

A glance through the latest expert views and predictions about commodities. Sentiment on base metals; upbeat zinc miners; US dollar impact on metals; gold outlook; lithium demand.

-Ord Minnett upgrades forecasts for base metals amid strong data and production curtailments
-Zinc prices likely able to take another leg higher in the short term
-US dollar rally to continue but unlikely to appreciate strongly
-Persistent doubt about the outlook for global growth underpinning gold
-Global lithium demand to lift strongly and new projects will provide incremental supply
 

By Eva Brocklehurst

Base Metals

Ord Minnett's commodities analysts have raised near-term price forecasts for base metals on the back of positive settlement, supply disruption and strong demand. The largest changes include increases of 15% and 26% for copper price estimates in 2017 and 2018 respectively, and increases in estimates for aluminium of 21% and 15% in the same respective periods.

As a result, Ord Minnett raises its recommendation for Sandfire Resources ((SFR)) to Speculative Buy from Hold and Western Areas ((WSA)) to Hold from Lighten.

Ongoing strength in Chinese economic data, the curtailment of inefficient production across a range of sectors and ongoing strength in global purchasing manager indices, leads the broker to be bullish on the mining sector from a top-down perspective. Balance sheets are also rapidly de-gearing, suggesting there is significant capacity to increase shareholder returns via dividends and/or buy-backs at the August results.

The broker's preference is for bulk commodity exposure over base metal names, given more favourable valuation metrics, higher near-term free cash flow yields and greater capacity for expectations to change. Gold is the broker's least preferred exposure, with valuations continuing to screen expensively and the commodity view essentially flat in the medium term.

Zinc

Zinc miners are upbeat, Macquarie observes, given the shortage of concentrate in the market which has sent spot treatment charges falling to multi-year lows. At the annual conference in California, demand was considered to be reasonable in most areas, if slow for this time of year. In Asia, premiums have begun to rise slightly, although the broker is not sure whether this reflects anticipation of tightness in China or actual shortages.

The shortfall in raw material suggests to Macquarie that zinc prices can take another leg higher as refined tightness kicks in. Despite new mines, China's is expected to be short the metal and come to the international market for feed for its smelters. This means more zinc will need to be imported and Macquarie understands traders have been positioning material over the last few weeks towards Asia.

One spanner in the works is the industrial action at the Valleyfield smelter in Quebec. At present the smelter is being operated by management at 25-30% of capability. This smelter is the second largest in the region and regional premiums have climbed.

For the next 18 months or so Macquarie remains bullish, but beyond this period believes zinc's tenure at an elevated spread to aluminium will drive a reduction in demand for low-and die-cast alloys and other zinc-majority products, thus allowing prices to retrace later in the decade.

Metals And US Dollar

The US dollar is pushing higher and Macquarie expects further gains. This could pressure metal prices, although the impact should be mitigated by greater economic optimism. The broker does not envisage a major shift higher in the currency, although US trade and tax reforms remain a wild card. The main gains for the US dollar post the US election were against the Japanese yen but this has been reversed since mid January.

The broker notes the US dollar has now been strong for over two years and has recently rallied as investors become relatively more positive about the US economy. The rally is expected to continue for some time further, given a more hawkish stance from the US Federal Reserve, and this should pressure metals prices, particularly gold and silver.

Nevertheless, Macquarie does not envisage another large appreciation in the US dollar without some major structural shift, and does not expect a major acceleration in the US economy.

Mathematically, when the US dollar is rising against other currencies it means the US dollar price of metal is falling relative to the price of the metal in those other currencies. The converse is also true. Gold typically shows the most sensitivity to this dynamic, yet the broker acknowledges this does not explain gold's rally in February.

Gold

Despite the talk of material-intensive growth in the US, Morgan Stanley observes demand for gold has held up. Since the US election, gold has bounced 10% to a peak of US$1257/oz by February, tracking a similar lift in US yields and the US dollar. The broker observes the last time all these signals moved together was in the confusing months of the global financial crisis.

Some factors behind the robust demand for gold include persistent doubt about US plans for infrastructure building and uncertainty about the US Fed's resolve to curb inflation, as well as the risks posed to global growth and the US implementation of new trade/immigration policies. Fed chair Janet Yellen, in signalling a March rate hike, not only boosted the US dollar but also capped the gold price rally and restored the gold-US dollar/yield inverse relationship, for now, the broker notes.

Morgan Stanley expects the Fed to lift its funds rate by 25 basis points in March and raise rates in another two instances in 2017, to take the rate to above 1.25%. While a long-term bear on the gold price the broker suspects there is more short-term support to come as gold, offering little return beyond the preservation of wealth, provides an excellent reason for those investors who are unsure about the global economic outlook.

Lithium

Deutsche Bank calculates global lithium demand rose 15% to 212,000 tonnes in 2016. In 2016 electric vehicles totalled around 800,000, slightly below the broker's previous estimates. Battery costs continue to fall, supported by the improving economics of electric vehicles. Incremental supply from Australia and Argentina and stricter Chinese subsidies for electric vehicles has meant Chinese lithium prices have fallen 31% since mid-2016.

The broker expects global lithium demand will increase 24% in 2017, driven by electric vehicle sales. New projects such as Mt Marion, Mt Cattlin and La Negra II will provide incremental supply, lifting global production by 30% year-on-year. The broker expects lithium pricing will remain elevated relative to historical averages, but retrace 15% on average versus 2016 levels.

The broker believes the medium-term outlook is improving and lifts 2019 demand forecast by around 20% to 380,000t. The medium term outlook is strengthening, as global automotive companies set ambitious sales target for electric vehicles from 2020 onwards.

Deutsche Bank also estimates US$4.5m of capital needs to flow into upstream lithium markets to meet 2025 demand. Hard rock projects and downstream refinancing capacity have responded the fastest and the broker estimates 75% of incremental lithium supply over the next three years will be from hard rock projects.
 

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