Material Matters: Copper, Gold And Gold Equities

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-Goldman: reduce copper exposure
-Chile proposing tougher water laws
-Value emerging in gold sector?

By Eva Brocklehurst

Copper

Goldman Sachs remains bearish on the copper outlook overall, and has been for some time, but does become a little more positive about the medium-long term on the assumption that Chinese demand growth is around 4.0% per annum and there is a major slowing of supply growth around 2017-18.

The broker targets a copper price of US$4,500/t by the end of 2016 and expects a slow rise back above marginal cost by 2020, to US$5,500/t. Risks to the downside are expected during October-March 2015/16 and 2016/17, which are periods associated with seasonal visible inventory build-up.

Goldman Sachs strongly recommends producers increase hedging of copper exposure and investors either reduce long exposure or take out long-dated short exposures in copper.

The market has recently centred its attention on the intensity of use in China's grid, amid concerns that substituting aluminium for copper would curtail demand. UBS observes that the grid accounts for around 40% of copper demand in China but consumer appliances are also important, and account for 31% of demand.

Hence while copper demand this year is growing at a very sluggish pace, the broker believes the slowdown in property and slow pace of spending on the grid is largely responsible. The catalyst for change would be stimulus directed at the infrastructure sector or clearer guidelines on the relationships between grid companies and supplies to stem probity concerns.

Which brings up the subject of water. Water, Morgan Stanley notes, is critical to copper production and 78% of copper produced by the world's 20 largest mines is in areas which are challenged for water supply. Global demand growth for water is set to exceed supply by 40% in 2030.

As an indication of the serious nature of the water shortage, Chile is proposing a law directing all mines using more than 150 litres of water per second to incorporate seawater in their operations. 

Water constraints strengthen the case for medium-term supply side support for the copper price, Morgan Stanley maintains. Desalination adds US$2,000-2,800/ tonne to capital intensity and a US$92/t uplift to annual operating costs. Moreover, social unrest and environmental scrutiny over the use of scarce water is already seen constraining copper production rates.

Gold

A fall in the gold price recently has sent related equities plunging. UBS suspects there is good value in the sector emerging but it may be too early to go in. The fall in the price coincided with large volume contracts being sold in Asia and on Comex in a period when liquidity is limited. Gold has since settled around US$1,100/oz but the downdraft has rattled investors.

UBS observes investors are speculating about when US rates will rise this year as well as China's ambitions with the yellow metal, after the government announced for the first time since 2009 it has increased its gold holdings, by 57%.

UBS is drawn to Evolution Mining ((EVN)) for its diversity and strong free cash flow and expects debt, while elevated, will be re-paid quickly. Alacer Gold ((AQG)) is also appealing because of its growth prospects while Regis Resources ((RRL)) has re-positioned itself to better compete in the mid-tier gold segment.

On the other hand, UBS struggles with Newcrest Mining's ((NCM)) valuation because of poor guidance on Lihir.

Macquarie has reduced gold price forecasts by 8-14% over the next four years to reflect weakness in the spot price, anticipated rate rises from the US Federal Reserve and lacklustre demand.

Reduced forecasts for gold and silver prices over the next few years have had a material impact on earnings estimates for gold and diversified producers.

Despite much of the weakness being factored into the share prices of gold equities, the broker makes four downgrades to ratings. Northern Star Resources ((NST)), Regis Resources ((RRL)) and Beadell Resources ((BDR)) are all downgraded to Neutral from Outperform. Medusa Mining ((MML)) is downgraded to Underperform from Neutral.

Macquarie continues to prefer those gold stocks whose assets offer exposure to the more stable Australian dollar gold price. The list of preferred stocks has shortened to Saracen Minerals ((SAR)), Doray Minerals ((DRM)) and Gold Road Resources ((GOR)). Of the international gold producers the one with value is considered to be OceanaGold ((OGC)).

Macquarie retains a positive view on more diverse resources stocks South32 ((S32)), Sandfire Resources ((SFR)), OZ Minerals ((OZL)) and Independence Group ((IGO)) despite the reduced earnings outlook.
 

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