article 3 months old

Material Matters: Gold, Lead, Zinc And Alumina

Commodities | Sep 23 2014

This story features REGIS RESOURCES LIMITED, and other companies. For more info SHARE ANALYSIS: RRL

-Gold price at mercy of US policy
-Gold explorers remain busy
-No mention of gold hedging
-Reduced lead demand in China
-Large Pacific Basin bauxite deficit

 

By Eva Brocklehurst

With the gold market back in balance, the price of the yellow metal is now at the whim of US monetary policy, in the view of research consultancy GFMS. In the second half of 2014 forecasts are for bar and coin investment to be lower year on year while an increase in jewellery demand is expected, taking the estimate for overall gold demand to up 3%. On the supply side, mine output is expected to fall marginally. 2014 is expected to be the peak of gold mine production with scrap supply expected to decline as a consequence of lower gold prices, a lack of source material that is readily available and, in some countries, more onerous regulation. This means GFMS forecasts gold supply to fall 2% in the second half, year on year.

What does this supply/demand dynamic mean for the gold price? Not much, in Macquarie's opinion. The biggest impact on the price in the short term, if it eventuates, will most probably stem from investor reactions to changes in US monetary policy. Macquarie's US economists expect an earlier rise in US official interest rates than the market is factoring in, but also believes long-term rates will peak at lower levels. This is a reason for the broker's forecast that gold prices will weaken in the short term but recover in 2015.

So, what views did brokers develop after the recent Denver Gold Forum? To Goldman Sachs there were few material developments emanating from the conference. Companies still seemed keen to grow while cost cutting remained a high priority. Exploration also does not appear to be slowing as much as the broker expected, with producers flagging considerable exploration spending in the coming year. Despite the sharp fall in the gold price over the past 18 months, the small-mid cap equities are pushing forward with growth projects, intent on diversifying operational risk.

To Goldman, it seems many believe a bottom has formed in the gold price and, with some value in the market, this could drive an increase in acquisitions in the sector over the next year. Both Regis Resources ((RRL)) and Beadell Resources ((BDR)) have signalled they would like to pay dividends over the next 12 months, but Goldman believes this will only be the case if the gold price remains relatively stable.

UBS differs in its interpretation, suspecting the bottom of the gold exploration cycle is nigh and citing one CEO who stated that 2014 global gold production levels were unsustainable. UBS noted no presenter mentioned hedging at the conference. The broker is surprised as given recent weakness in the gold price, it would be unusual if some producers were not considering hedging as an option. Still, in the same way the de-hedging probably helped the price on its way up, a return to hedging could accelerate the downward trajectory. Another area where UBS considers improvement is still being made is productivity, with companies targeting better balance sheets without spending significant capex. The broker also observes most of procuers' major debt facilities have been termed out with significant repayments not required until 2017-2019.

Most of the larger cap gold names continue to carry significant debt loads and Deutsche Bank finds few demonstrate a cash flow profile that will cover future debt obligations at current or lower gold prices. The broker believes there is another 10-15% improvement that can come from structural cost cutting opportunities over a longer period. At the conference the broker noted several small producers reported they were still generating cash, among them are Independence Group ((IGO)), Alacer Gold ((AGQ)) and OceanaGold ((OGC)).

To another heavy metal, lead. Macquarie observes lead has a lot of ground to make up to its sister metal, zinc. Prior to 2014, lead was at a premium to zinc for most of the time since 2007. Recent ILZSG data shows lead was in surplus by 11,000 tonnes in the first seven months of this year compared with a zinc deficit of 248,000 tonnes. Macquarie suspects the zinc deficit could be exaggerated, as Chinese bonded zinc stocks have risen by around 90,000 tonnes since the beginning of the year. Nevertheless, it is still a considerable deficit and the broker suspects it will be hard for lead prices to make up the pricing gap.

One interesting observation Macquarie makes on the history of the lead/zinc relationship is that growth in electric motor scooter (e-bike) output is levelling off in China. A surge in e-bike output over the last decade meant an increase in demand for lead-acid batteries and this was instrumental in elevating the lead price premium. Now, as the e-bike market matures and lithium-ion batteries encroach, growth in lead-acid batteries is restrained. Outside of China fewer than 10% of global e-bikes are produced and these use either lithium-ion or nickel hydride batteries. So they have minimal impact on the lead market.

Weighing up Indonesia's restrictions on the export of bauxite, Commonwealth Bank analysts suspect prices will increase over time and, combined with higher steam costs at refineries, will drive up alumina prices. The analysts note Chinese alumina refineries have responded by investing in domestic bauxite and new Indonesian refineries, as well as sourcing more bauxite from newer areas and stockpiling bauxite last year. Nevertheless, the scale of Indonesia's market supply means the Pacific Basin market will sustain a large deficit.

Given bauxite and alumina price forecasts will be subject to the variability of Chinese and Indonesian supply, the analysts have modelled a bull and bear case scenario. In the bull case, in which the market is tighter, prices for alumina head towards US$380/t FOB Australia this year and average US$365-380/t for 2015-2017. If the market experiences faster construction of Chinese bauxite mines or new Indonesian alumina capacity, and the cost push assumptions are less severe than currently estimated, the analysts expect alumina prices could drop to US$310/t this year and transition to US$345/t by 2017.
 

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.

Share on FacebookTweet about this on TwitterShare on LinkedIn

Click to view our Glossary of Financial Terms

CHARTS

IGO RRL

For more info SHARE ANALYSIS: IGO - IGO LIMITED

For more info SHARE ANALYSIS: RRL - REGIS RESOURCES LIMITED