Commodities | Mar 16 2017
A glance through the latest expert views and predictions about commodities. Mining outlook; price and equity upgrades; coal and lithium.
-Signs of an aggressive supply response, yet upside for miners if prices retrace at a slower-than-expected rates
-First phase of increased capex usually favours explosives, contractors and services companies
-Mining companies moving away from emphasis on debt reduction
By Eva Brocklehurst
2017 started strongly for material commodities, with a maturing industrial recovery, rising inflation expectations and a degree of economic confidence that surprised Macquarie. Nevertheless, some cracks are emerging in the bullishness, notably in China as the government continues to tighten monetary policy at the edges.
The broker believes current indicators are not showing the aggressive improvement in demand that was expected. Also, there are signs of a supply response and inventory is already elevated. That said, the broker raises 2017 forecasts across the majority of metals and bulk commodities.
Ord Minnett has lifted its mining sector coverage to an Overweight position. The broker believes the recent pull-back, particularly in European-listed names, has opened up an opportunity. The broker's global commodities team is confident that the hawkish comments by US Federal Reserve officials probably only triggered a temporary correction in metals prices during the recent sell-off.
As a US interest rate hike appeared a certainty, the broker also upgrades its emerging markets rating to Overweight, with the preferred country exposures being China and Brazil.
On the subject of mining capital expenditure, Goldman Sachs believes global reductions are over after four years of declines. Strong prices have driven a rise in cash flow that it is signalling rising expenditure. The broker has raised forecasts for capital expenditure in 2017 by US$5bn, or 8%, and now expects this year will show the first year-on-year expenditure increase since 2012.
The first phase of an increased capital expenditure budget is usually put to rectifying the liabilities that have been generated in recent years. This includes normalisation of strip ratios, maintenance expenditure and exploration. The broker believes this is a positive phase for explosives, contractors and services companies.
Goldman Sachs observes miners are now spending almost as much on dividends as they are on capital expenditure. This may signal a period of improved returns for shareholders but the sustainability of only limited investment in medium-term growth is questionable. New greenfield project growth, whilst not yet on the mining radar, is expected to return over the next two years, reducing the potential for additional capital returns from miners in coming years, in the broker's view.
Upside For Miners?
While commodities may be moving lower, many are still priced above Morgan Stanley's forecasts. The broker believes there is still upside for miners if prices retrace at a slower-than-projected rate. Mark-to-market upside is intact for most of the key commodities versus the broker's price deck. Morgan Stanley believes the industry is now giving up some of its gains, which reflects momentum-style investment re-positioning.
The sector has also moved towards utilising excess cash and away from the debt reduction emphasis witnessed 12 months ago. The broker does not believe that cash accumulation or potential re-investment is being factored into many equities at this point.
In view of the revisions, Morgan Stanley upgrades Fortescue Metals ((FMG)) to Equal-weight and Resolute Mining ((RSG)) to Overweight. Morgan Stanley has contrarian views to consensus on BHP Billiton ((BHP)), Newcrest Mining ((NCM)), Sandfire Resources ((SFR)) and Syrah Resources ((SYR)).
Key Commodity Upgrades
Macquarie's updates feature upgrades of 29% to cobalt estimates, 21% for alumina and, the only material downgrade, a -9% cut to coking coal. The broker's upgrades and downgrades to relevant stocks are driven by supply-side fundamentals, amid concerns over cobalt sourced in the Democratic Republic Congo and the proposed winter curtailment for alumina, along with a lack of favourable Chinese intervention on coking coal supply.
The broker observes downside risk continues for nickel, although upgrades have been made to estimates, while the spot price upside risk has largely been removed for all commodities with the exception of iron ore and cobalt.
The broker believes upside risk remains in place for iron ore, and this is significant for BHP Billiton, Rio Tinto ((RIO)) and, particularly, Fortescue Metals. Emerging supply constraints for both aluminium and alumina drive material upside risk for the earnings outlook for South32 ((S32)) and Alumina Ltd ((AWC)).
Macquarie also believes the price decline in manganese is close to a bottom, given the supply-side response to soaring prices late last year was significant, and lower-grade prices are now below break-even for many higher-cost South African producers.
Macquarie upgrades Oz Minerals ((OZL)) and Western Areas ((WSA)) to Outperform after incorporating commodity price changes. The broker prefers Western Areas over Independence Group ((IGO)) for nickel exposure and expects the supply outlook to become clearer in coming months.
Nickel prices have been volatile, falling on the back of the partial lifting of the nickel ore export ban in Indonesia. Macquarie believes the risk of large closures from the Philippines mine audit is rising, and upgrades nickel price forecasts for 2017 by 12% and 2018 and 2019 by 6% and 4% respectively. Other base metals are relatively unchanged.
Meanwhile CleanTeQ Holdings ((CLQ)) offers a unique exposure to the improving outlook for cobalt. The broker observes cobalt pricing has been strong in 2017, rising to US$25/lb.
In the gold segment, volatility in equities continues, as expected. Macquarie upgrades St Barbara ((SBM)) and Alacer Gold ((AQG)) to Outperform on valuation grounds and downgrades Beadell Resources ((BDR)) and Troy Resources ((TRY)) to Neutral because of emerging operating risks.
The decline in spot coking coal prices has been more aggressive than Macquarie was anticipating. The quarterly contract price for the June quarter is expected to come in around US$175/t, -24% lower than previously forecast. Macquarie re-bases forecasts for the remainder of the year and for next year as a result.
The broker believes that with Chinese thermal coal prices around RMB630/t, an immediate resumption of the 276-day policy is less likely, although this is still expected to occur should thermal coal prices fall back towards RMB500/t.
The broker is also upgrading its near-term outlook for lithium, reflecting recent moves in the spot price. The broker highlights that most of the hard rock lithium producers have fixed-price agreements. Hence, they are not overly affected by price upgrades.
Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.