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Material Matters: Coal, Gold And Base Metals

Commodities | Apr 13 2017

A glance through the latest expert views and predictions about commodities. China's aluminium exports; Coal price estimates upgraded; Caution prevails for gold; iron ore rally slowing; US oil producers; lead & zinc deficits.

-Morgans advocates trimming profits in Whitehaven Coal and South32 when prices exceed 10% of fair value
-Convincing break of US$1250-1260/oz for gold needed to encourage stronger participation
-Brokers suspect market may be valuing risks in base metals stocks more appropriately
-Rapid response of US shale oil sector to OPEC cuts explains price retreat
-Deficit conditions expected to persist in lead and zinc

 

By Eva Brocklehurst

Aluminium

Aluminium has outperformed after China outlined plans to restrict production to ensure cleaner air, and Commonwealth Bank analysts expect prices to continue outperforming in 2017. The analysts observe higher trade barriers are also further segmenting the market. China's aluminium exports are facing increasing scrutiny from international trade regulators. The analysts suspect that the end result may leave deficit conditions to fester outside China.

Coal

Just as the analysts believe supply was normalising for the coking (metallurgical) coal market along comes Cyclone Debbie to show that supply is never safe. The analysts suggest 13-17m tonnes of seaborne coking coal may be lost this year. Premium coking coal prices are likely to lift to US$250-300/t in coming weeks, they suggest.

Morgans upgrades FY17-19 prices primarily because of the disruptive influence of Cyclone Debbie. Exporters outside of the affected Queensland region, such as Whitehaven Coal ((WHC)), South32 ((S32)), and New Hope Corp ((NHC)) are short-term beneficiaries of a price hike. The broker suspects higher prices will be netted out by lower volumes for BHP Billiton (BHP)).

The broker advocates traders trim profits in Whitehaven and South 32 when prices exceed 10% of fair value and at the first sight of the topping out in metallurgical coal prices.

Chinese policy makers are expected to determine the future price direction of thermal coal. The CBA analysts upgrade thermal coal price estimates to US$74/t based on the price range indicated by the China National Coal Association as well as recent price action.

Gold

UBS is cautious about the direction of gold, emphasising the downside. Gold price forecasts are reduced by around -5% and the sector is considered expensive. Sentiment towards gold has been positive but the broker notes participation has been limited and market expectations appear to be over a broad range, with an upside bias.

The broker suspects a relatively orderly up-trend has thus far helped to strengthen underlying sentiment. Nevertheless, a more convincing break beyond US$1250-1260/oz is probably needed to encourage stronger participation. UBS believes the Australian gold sector, which has an average all-in sustaining cost (AISC) of US$833/oz in FY16 is occupying the front-end of the global cost curve.

Separating out where the cost reductions are, as well as the long-term sustainability, remains a problem and the broker believes this is prompting some investors to be cautious. Even with the reductions, the broker's gold price deck remains on average 10% above consensus.

In 2017 UBS expects prices around US$1301/oz, lifting to US$1325/oz in 2018. The broker is focused on company-specific events as the drivers of gold stocks. UBS remains drawn to Evolution Mining ((EVN)) and Alacer Gold ((AQG)), as these two stocks are the only ones under coverage not trading at a premium or dependent on short-term operational or political developments.

Regis Resources ((RRL)) is reduced to Sell from Neutral, following its strong share price performance. The broker believes the balance sheet, growth and low-cost position of the stock is more than priced in.

Copper And Nickel

UBS remains positive on copper and nickel, being 15% above consensus for copper and 23% above consensus for nickel in its estimates over the next six years. In 2017 the broker looks for US$3/lb copper prices and US$5.25/lb nickel prices. Robust momentum in Chinese property is also translating into demand for consumer items to fit out houses.

The broker's analysis suggests that if present run rates continue this implies upside risk. In the copper space the broker is drawn to OZ Minerals ((OZL)) over Sandfire Resources ((SFR)), downgrading SFR to Neutral from Buy because the risk/reward outlook is weakening. UBS is attracted to the longer life story at OZ Minerals versus Sandfire's simple organic growth opportunities.

In the nickel market, stainless steel production outside China is also showing signs of strength. The broker upgrades its estimates for stainless production in China to 7.7% growth in 2017, which equates to over 5,000 tonnes of primary nickel demand growth. The broker retains a Neutral rating for Independence Group ((IGO)) and Western Areas ((WSA)).

Morgans has also analysed the outlook for the base metals market, upgrading OZ Minerals to Hold and downgrading Sandfire Resources to Hold. The broker believes the market is now valuing the inherent risks more appropriately, particularly around OZ Minerals' Carrapateena development. In terms of Sandfire Resources, attention turns to the ability to add incremental mine life from exploration where success is required to justify the upside, in the broker's opinion.

Iron Ore

The iron ore rally experienced throughout 2016 and into the early part of 2017 appears to be showing signs of slowing and Morgans observes some fundamental drivers are cooling down such as re-stocking, construction activity, steel exports and steel prices. The broker is closely monitoring declining Chinese steel prices, as it was the rebound in profitability across the sector that drove strong demand for raw materials.

Morgans suspects the fall-out from Cyclone Debbie, which has resulted in higher coking coal prices, will affect already-declining margins for the steel mills. The broker expects mills to switch to using a larger proportion of high-grade iron ore to minimise the amount of coke required in the furnaces. This trend could mean discounts for lower-grade iron ore increases in coming weeks.

The broker's long-term iron ore price forecast of US$65/t reinforces the view that iron ore prices do not need to sustain current levels in order to justify investment in preferred exposures.

Morgans envisages short-term downside potential in the higher leveraged miners such as Fortescue Metals ((FMG)) while remaining comfortable with an Add recommendation on BHP Billiton and Rio Tinto ((RIO)) on a 12-month basis. Any seasonally related weakness may create an accumulation opportunity, in the broker's opinion.

Oil

Commonwealth Bank analysts believe it is inevitable that the market share and influence of US oil producers will grow. The rapid response of the shale sector to the OPEC production reductions explains why prices have now retreated. The analyst observed OPEC and other oil producers are now in a difficult position. Extending their output cut in order to keep markets balanced potentially cedes more market share to the US shale oil sector.

On the other side of the equation demand is unlikely to move the dial. OPEC expects demand to grow around 1.3% this year, slightly below the 1.4% growth recorded last year. Non-OECD countries are expected to drive consumption again, accounting for around 80% of the anticipated increase in demand. The analysts expect Brent crude oil prices to move between US$50-60/bbl this year.

Lead And Zinc

The CBA analysts upgrade zinc and lead prices materially for the next 12-18 months as deficit conditions are likely to persist in both markets. Nevertheless, a supply response is coming. Zinc mines are expected to increase output by around 8% this year. China has several projects that are due to come on line this year and Australia will also contribute, as Glencore resumes output for both zinc and lead at MacArthur River and Mount Isa mines.

Lead supply is less constructive for the CBA analysts, as concentrate is only expected to lift 2-2.5% this year. A modest pick up in supply is expected in North America, Asia and Latin America. Lead acid batteries will continue to be the primary driver of demand and substitution risk is low, the analysts observe, despite the emergence of lithium ion technology.
 

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AQG EVN FMG IGO NHC OZL RIO RRL S32 SFR WHC WSA