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Material Matters: Titanium Dioxide, Base Metals, Precious Metals And Coal

Commodities | May 26 2015

This story features EVOLUTION MINING LIMITED, and other companies. For more info SHARE ANALYSIS: EVN

-Zinc deficit to emerge later this year?
– Copper surplus not flowing to China
-UBS rates small cap gold sector Buy
-Puzzle over low platinum price
-Inefficiencies in thermal coal

 

By Eva Brocklehurst

Titanium Dioxide

Citi hosted a conference call with an expert in this key product for the paint industry and found a generally constructive outlook. This is driven by expectations that utilisation rates will increase in China as the industry closes inefficient capacity. Capacity utilisation should increase for the remainder of 2015 and into 2016. Higher volumes are expected to be followed by price increases. Moreover, a number of mergers have been announced which should benefit the industry structure, such as the merger of Henan Billions and Sichuan Lomon, which will create China's largest titanium dioxide producer and the world's fourth largest.

Zinc

Inflows into London Metal Exchange zinc stocks have surged, given the tightening in the front end of the forward curve amid Macquarie's understanding that sizeable volumes are stationed off-warrant in both the US and Asia. A soft physical market has undercut price support and the rally earlier in the month was never going to be supported by the underlying fundamentals, in the broker's view. Macquarie still likes zinc, with mine closures leading to a raw material deficit set to emerge later in the second half. At this stage, however, the fundamentals are reasserting control and, with such a rapid correction, the broker envisages little downside from here, with the trough around US$2,100-2150/t.

Copper

After a visit to China, Citi notes credit conditions are of most concern as the government has cracked down on the shadow banking that was a primary source of capital. Copper financing deals have become more difficult and with domestic banks wary of issuing credit against copper, there has been a shift towards nickel. Sentiment on copper remains largely bearish and, as major Chinese funds have lost money on the price rebound since January, they are looking to re-engage on the short side. Fabricators and traders, meanwhile, have witnessed some improvement in activity but this has been modest. Bonded warehouse premiums are depressed and inventories well supplied. 

Citi observes that while the world's copper surplus previously flowed to China, it is now being dispersed amongst other countries and this is contributing to the weakness in LME spreads. Also, Citi expects Chinese copper cathode imports will fall in 2015, with lower volumes in term contracts creating a lower floor for the price, in addition to lower financing activity and rising domestic refined production.

Nickel

Nickel demand has been poor and the stainless steel sector particularly weak, Citi maintains. Much of the weakness was attributed to China's real estate sector, which not only affects direct demand, but also influences the purchases of household goods. Chinese stainless steel production also faces headwinds from anti-dumping tariffs imposed by the European Union, India and Vietnam. Citi expects Chinese stainless steel exports to fall year on year. Also, nickel demand is likely to be negatively affected by rising stainless steel scrap supply. Goods from 10-15 years ago are now being recycled and this was a period when Chinese nickel consumption expanded sharply.

Meanwhile, nickel pig iron production has declined because of poor profitability and environmental pressure and Citi expects it to continue to trend lower. The first shipments from new plants in Indonesia have begun to arrive in China .Total volumes are likely to be small this year but will create uncertainty over the gap between diminished Chinese production and the rise of Indonesia's supply, in the broker's view. Chinese ferronickel and refined nickel imports have risen this year and Citi expects these imports to remain strong moving forward.

Gold Equities

UBS recently initiated coverage of Evolution Mining ((EVN)) which takes the broker's Aussie gold coverage to ten stocks. The broker likes Evolution because it offers operational diversity and growth in free cash flow. The stock is expected re-rate higher as the market gains comfort with the recent transactions. The broker also considers Alacer Gold ((AQG)) trades on an undemanding implied price, given strong free cash flow and a quality sulphide expansion project.

With the exception of Independence Group ((IGO)) and Newcrest Mining ((NCM)), the broker has Buy ratings for the entire gold coverage, because of the general lack of engagement by investors in the small cap gold sector. Newcrest may be one of the best performing resource stocks this year but UBS attributes this to investors looking for the most liquid name. With significant doubt over the operating performance of Lihir the broker does not find the valuation reflects the market pricing of the stock and retains a Sell rating. UBS also acknowledges investors find Independence Group appealing for its asset diversification and free cash flow but prefers a Neutral rating.

Platinum

Macquarie observes the mood at the annual platinum industry gathering was bearish. There is no devastating industrial action this year but the sharp rebound in production has signalled an oversupply. Going forward, Macquarie suspects either the platinum price will have to rise or miners cut production. Hardly new, but the broker suspects the longer the price is low the more pertinent the need to act. Moreover, the broker highlights a fall-off in Chinese platinum imports, although these have picked up a little in the last two months. The broker expects China's platinum imports will follow 2014, weak by 2013 standards but meaning large year-on-year falls are unlikely.

Market estimates show a smaller deficit than in 2014 but there is disagreement as to the size. Macquarie acknowledges the quandary as to a market in deficit producing such a weak price performance but, along with participants at the conference, attributes this to large above-ground stocks. Macquarie believes sequential shifts in supply and demand are more likely to drive price moves.

Palladium

Most of the discussion on palladium at the conference centred on the threat from new automotive technologies. Fuel cell vehicles remain a favourite of the platinum market, as they tend to have a need for the metal, but the broker estimates these cells will not be important players any time soon. Macquarie believes a more concrete short-term threat to palladium is the slowing in global car sales. Specifically, Chinese car sales growth has slowed and palladium imports have been weak this year.

Thermal Coal

Market expectations have finally adjusted to the view that pricing for thermal coal is unlikely to improve soon. Macquarie suspects that this may also reflect the fact that alongside end-users, which benefit from weak prices, non-US suppliers have had their margins supported by FX depreciation. The broker concludes that, barring a large reversal in the oil and FX market, there is probably around US$10/t of downside to current spot prices.

Most of this year has witnessed a battle between weak underlying fundamentals and trader/producer efforts to squeeze the Newcastle market, in Macquarie's view. The net result is the Newcastle spot price is down 8.0% and European delivered prices are down a more significant 15.0%. Thermal coal is no longer sustaining large seaborne supply growth but cuts to supply are small in terms of the broader market and thermal coal remains oversupplied. Macquarie observes two other problems for the commodity as well.

The first is cost deflation, driven by US dollar strength and the slump in the oil price feeding through to lower diesel seaborne freight prices. Hence the seaborne cost curve for thermal coal is down 20% on average compared with mid 2014. Macquarie estimates that only 15% of the industry is losing money on a cash basis. The second problem is that China is no longer clearing surplus tonnage. A number of policies have been introduced which mean import volumes are a function of policy rather than seaborne coal availability. China's restructuring will be a lengthy process, Macquarie observes, and there is a risk that further restrictions are put in place.

The broker believes India is the main demand growth story for thermal coal and remains cautiously optimistic on Indian imports. Nevertheless, there does not appear to be a viable adjustment mechanism for the market to re-balance any time soon.
 

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