Commodities | Mar 15 2007
By Rudi Filapek-Vandyck
One could easily argue that Merrill Lynch’s research reports on natural resources this morning are the perfect illustration of investors’ attitude towards stocks of resources producers these days. Let’s have a look at the various title choices first:
BHP Billiton (BHP) – Earnings up, BUT near term share price risks from nickel
Rio Tinto (RIO) – Bulks look good BUT metals could be a short term drag
Alumina (AWC) -Earnings upgrade, BUT aluminium price has peaked
In short there are various positives, but they come with various negatives, dangers and uncertainties and thus stocking up aggressively with shares of resources companies may not necessarily be the wisest thing to do, even though some of them have started to look really cheap.
Merrill Lynch is positive on bulk commodities such as iron ore, not so on base metals which the broker suggests bear the burden of having become a toy for short term speculators and hedge funds. In addition the future should continue to look bright for precious metals (gold and the so-called PGM family).
Having said all this, the broker’s resources team has just updated product price forecasts throughout the resources spectrum and the result has been for some serious upward adjustments. How else would you describe an increase for the 2007 average price forecast of lead by 40% to US$0.70/lb? Or try nickel: plus 29% to US$13.88/lb in 2007; or aluminium – up16% to $1.10/lb for 2007.
Future increases for the likes of coking coal and soft-coking coal, as well as for iron ore look less impressive but most experts would have assumed previously that prices would actually decline from hereon and Merrill Lynch was not an exception.
The result, as could be expected, is for further earnings forecast increases for the likes of BHP Billiton (BHP), Rio Tinto (RIO), Alumina Ltd (AWC) and Newcrest (NCM).
Yet, the overall atmosphere inside today’s reports is probably best described as “cautious” – this despite the broker repeating its firm belief in the Commodities Super Cycle.
Inside a special framed, highlighted piece of text Merrill Lynch resources specialist try to explain the gap between being a Super Cyclist but also cautious about the outlook for resources stocks: long term price averages will remain higher but this is not to be confused with spot prices.
“We believe there is still too much hype and speculation in the traded base metals”, the statement reads. Hence the analysts’ preference for the “longer duration contracted commodities such as iron ore and coal, as well as uranium, platinum and gold”.
The biggest danger, according to analyst Vicky Binns and colleagues, is for a sharp reversal in the fortunes of nickel. Merrill Lynch has put nickel at the bottom of its preferences on a 3-6 months horizon, although a positive view is upheld on a 1-3 year horizon.
Merrill Lynch believes impending stainless steel de-stock could see the nickel price correct by as much as 30-40% in the next six months. Price corrections for copper, zinc and aluminium are also seen likely.
So what should investors look for? Quality stocks that can keep costs under control and that are leveraged to aforementioned longer duration contracted commodities, Merrill Lynch believes. As the slowdown in US housing is believed to have further to go still, this is likely to have an impact on demand (and thus prices) of metals such as copper and this is likely to further drag down share prices of resources companies.
This will open up value opportunities. The broker believes it is time to get aggressive again when BHP shares dive below $25 and Rio Tinto shares fall below $70. Currently, Rio Tinto is preferred above BHP because of a larger leverage to iron ore and because Rio Tinto is expected to surprise the market with some capital management initiative in the near term.
BHP already had its moment of glory during the recent interim results season.
Resources specialists at Morgan Stanley, however, don’t share the somewhat cautious inclination of Vicki Binns and Co. In a sector report published this week Morgan Stanley firmly reiterates its support for the mining sector, arguing renewed fears for an end to global abundant liquidity or for less Chinese growth will prove to be –once again- unfounded.
It goes without saying that Morgan Stanley sees opportunities galore among mining stocks. The broker’s preference is for pure metal stocks and diversified giants.
Morgan Stanley too prefers Rio over BHP. Apart from iron ore, Rio also has a larger leverage to copper and the analysts believe the odds remain in favour of the price of copper surprising in the second half of 2007.
Oxiana (OXR), Newcrest (NCM) and Zinifex (ZFX) represent the highest potential return in the broker’s research portfolio, followed by the two large diversifieds BHP and Rio Tinto.
An update by Macquarie, a long standing member of the Super Cyclists Club, combines elements of the two previously mentioned brokers. Macquarie believes investors have again taken lead from scepsis and fear and this has once again created a buying opportunity for others. But Macquarie also agrees with Merrill Lynch that bulk commodities such as coal and iron ore will be the standout performer among natural resources, and the analysts are not just talking 2007 and 2008, but many more years to come.
Macquarie believes time will come for resources companies to once again land on the radar of investors again. Not only is the current pricing of their shares considered “nonsensical” but as time goes by investors will be forced to think about the logic of chasing higher operationally leveraged companies of lesser quality at a relatively lesser attractive market valuation, the report states.
Macquarie is positive on gold as well.
The analysts have increased their iron ore forecasts to another price rise of 10% for next year (JPY2008). This is the highest forecast we’ve spotted so far at FNArena. What’s more, the analysts suggest prices may well roll over still in JPY2009, extending the positive momentum for the sector.
The largest increase in forecast product prices is for nickel with today’s update lifting the estimated spot price average by 45.7% to US$1474/t for the current calendar year. Nickel price forecasts for the next few years have been lifted significantly as well.
Interestingly the analysts note: “Inherent in our [nickel price] forecasts is a major price correction as the market comes into balance, although off an extraordinary high base.”
