Commodities | Mar 13 2017
A glance through the latest expert views and predictions about commodities. Asian investor briefing; iron ore prices; aluminium outlook; nickel uncertainty; subdued oil.
-Asian investors appear more constructive on the Australian mining sector
-As most iron ore miners make cash, swing supply is returning
-China appearing oversupplied with aluminium
-Growth in nickel use likely to be soft while uncertainty reigns
-Should OPEC-Russia deal hold, gradual up-trend in oil price expected
By Eva Brocklehurst
Ord Minnett has reviewed Australian mining from an Asian perspective following meetings with a number of investors and notes they appear more constructive at current levels in the market. With probable pent-up buying interest, attractive valuations and a positive macro-economic backdrop, the broker has become more bullish on the sector.
Most investors who are still selling have been doing this as a tactical trade rather than because of any structural concerns. The most interest, the broker found, is in Fortescue Metals ((FMG)), followed by Rio Tinto ((RIO)) and BHP Billiton ((BHP)).
There was broad agreement that the sector is cheap on net present value measures, earnings multiples and free cash flow yields. The main concern appears to be that miner stocks will fall with any correction in commodities. This is particularly the case with iron ore, as a price above US$90 tonne is considered a headwind for marginal buyers.
The majority of investors Ord Minnett met believe that iron ore will struggle to trade much higher over the near term. On the other hand, there is no strong conviction as to why iron ore should trade materially lower in the near term, as Chinese steel margins are at multi-year highs and cuts to capacity are supporting steel prices. Expectations centre on iron ore finishing 2017 in a range of US$60-90/t.
At current prices, Deutsche Bank calculates that only a handful of small miners are losing cash. With the bounce in FX and oil in the second half of 2016, 14% of supply is now estimated to lose cash at US$60/t.
Nevertheless, swing supply is returning at US$90/t, with the broker observing Chinese domestic production is now operating at a 280mtpa run rate, up from an average of 220mtpa in the first half of 2016. Although Chinese steel demand is robust, the broker suspects more low-cost supply in 2017 will result in a retracement in the price to US$60-70/t by mid year.
Macquarie observes China's preliminary commodity data in February revealed both iron ore and coal imports were strong. While this side of the Chinese commodity business model appears normal, with plenty of appetite to soak up raw materials, the other side, exporting finished products, was very weak in February.
Macquarie notes annualised steel and aluminium export volumes were the lowest since early 2014. Often such anomalies can be put down to Chinese holidays but the broker observes, in most cases, February was just an extension of a trend seen over January. Macquarie reiterates its view that the peak of China's growth cycle is passing and headwinds are likely to arise over the second quarter.
Macquarie observes the London Metal Exchanges biggest metal market by volume, aluminium, is showing a gain in the year to date of 10.5% as the price continues to rebound. Nevertheless, other data suggest the production is rising strongly in China. In the first two months of the year production is an annualised 5mtpa above that of a year ago, at around 35mtpa.
China appears oversupplied and the physical metal premiums have fallen to a steep discount to spot prices, pointing to a softer ingot market. It is small wonder, in Macquarie's view, that China paints a much more bearish picture. The broker believes strong sentiment, coupled with confusion over the timing of the cuts to winter smelting, has been the main support for prices recently, but in the last few days prices have moved lower as speculator expectations begin to confront consumer reality.
Macquarie continues to believe prices will fade from this point on soft physical conditions before reductions as the Chinese winter comes to bear drive seasonally higher prices over the fourth quarter of this year and into the first quarter of next.
in 2017 the key to the global market for the supply of nickel ore is Indonesia and the Philippines. Based on Macquarie's assessment of the current situation those investors seeking clarity are likely to be disappointed.
There is little concrete information emerging from Indonesia since January, with unconfirmed speculation that exports may be capped at 5m wet tonnes, just below 50,000 tonnes of recoverable nickel. The broker notes at this point no export licenses have been issued and it is unclear how much can be exported.
In the Philippines some doubts have begun to emerge about whether the mines minister, Gina Lopez, will maintain her hard line through the appeals process. Apart from nickel ore, the Chinese nickel pig iron industry has also started using other feed sources.
Given the large range of potential outcomes for the nickel industry, Macquarie assumes, in its base case, that nickel use grows only 2% this year compared with 7.8% in 2016. A similar market deficit to 2016 is projected at 50,000t.
Bell Potter observes the mixed news has hit nickel miners, with Western Areas ((WSA)) and Independence Group ((IGO)) being sold off heavily since early January when a partial relaxation of Indonesia's nickel or export ban was heralded.
In the broker's view an opportunity has emerged to increase exposure and both stocks carry a Buy rating. This is because both have high-quality, low-cost production assets which make money at current prices.
Robust balance sheets also provide the ability to withstand lower nickel prices. While the immediate outlook for the nickel price is crimped by uncertainty, Bell Potter still envisages a supply deficit over 2017and maintains a view for a rising nickel price over 2017.
Oil And LNG
Steep falls in the oil price over the last couple of days amid a build up in US inventory suggests to analysts at National Australia Bank the market is concerned about the balance in supply/demand. Should data continue to confirm the OPEC-Russia deal to cut production is holding up, the analysts expect a gradual up-trend in the oil price over this year, although if inventory remains elevated a rally will be less likely.
The analysts' central case is for oil prices to average around the mid to high US$50/bbl range in the second quarter before reaching the low US$60/bbl range by the end of 2017, and stabilising at these levels in 2018.
Approaching 2020 there may be some upside, they contend, as lower investment flows through to lower production capacity, although this is far from clear at the present time. Another major consideration for Australia is the effect of oil market developments on LNG exports.
Australia is ramping up production to the extent that it should have the world's largest LNG production capacity, at over 20% of global capacity, the analysts calculate. As much of Australia's LNG is priced against Japan's crude import price, a recovery in the oil price represents upside for the value of Australian LNG exports.
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