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Brokers Look To Easing Metal Prices

Commodities | Dec 11 2006

By Greg Peel

Merrill Lynch, Macquarie and JP Morgan all provided resource sector updates today with a common thread. While forecast prices have been lifted closer to spot, expectations are for an easing of prices over 2007.

In lifting price forecasts, brokers had also made some significant earnings forecast changes for various metal stocks. However, forecast prices are still well below spot.

The most significant changes for 2007 made by Merrill Lynch are in nickel (US$10.50/lb to US$10.75/lb) and zinc (US$1.15/lb to US$1.60/lb). These flow to earnings forecast increases for Zinifex (ZFX) of 33% and Oxiana (OXR) 26%. However, it must be noted that current spot prices are US$15.78/lb for nickel and US$2.00 for zinc.

Merrills expects 2007 to be a year of price pullbacks as the global economy slows. The analysts see copper as being hardest hit, dragging the others along. Given this view, Merrills has pulled its resource sector rating back to Neutral, with an Underweight on base metals and Overweight on precious metals and steel.

This results in downgrades to BHP Billiton (BHP) and Rio Tinto (RIO) from Buy to Neutral, while Minara Resources (MRE) has been dropped to Sell. Oxiana and Alumina (AWC) were already rated Neutral and the analysts have rated Zinifex a Sell for most of eternity, believing the current share price reflects 3.5 years of zinc at its current spot price.

A slower US economy, lower US dollar, US housing slump, an easing of Chinese consumption and an increase in substitution are all reasons given for Merrills’ outlook. In downgrading BHP and Rio however, the analysts suggest the diversifieds should not be hit as hard as the pure-plays.

Macquarie has echoed Merrills’ sentiments and suggests it’s time “to be more selective”. The analysts continue to be long term bulls but they see the first half of 2007 as ushering in metal price weakness.

Macquarie maintains a bullish view on iron ore, thermal coal and zinc, but is predicting weakness in copper, nickel and aluminium. The analysts note:

“Miners with superior volume growth and a preferred commodity mix (ie thermal and PCI coal and nickel, zinc and gold) continue to offer potential for outperformance while those companies that trade at a discount to deep value metrics are hard to ignore”.

But on the other hand, “we would continue to avoid leveraged, high cost, low quality exposure despite the speculative appeal for some investors”. Macquarie further warns of a falling US dollar with respect to those companies with significant dollar earnings.

Macquarie’s preferred sector exposures remain as BHP and Rio, with Alumina, Jubilee Mines (JBM), Iluka (ILU) and Macarthur Coal (MCC). However, the two diversifieds only score Neutral while the remainder rate Outperform.

JP Morgan is sticking with Overweight for BHP and Rio, Overweight for Alumina, and Underweight for Zinifex and Oxiana, the prices of which are well above net present value.

Morgans has also made a raft of metal price forecast upgrades, the most significant of which are aluminium (12%) and nickel (23%). But like Merrills, Morgans forecast prices remain a good deal below spot levels. The analysts are more keen on precious metals than base metals at present, and positive on iron ore and coal. They see the supply side beginning to catch up in 2007 while demand begins to ease for base metals.

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