Material Matters: Pricing Outlook, Gold, Agriculture And Oz Copper Equities

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-Commodity price falls boost global GDP
-Few reasons to be a seller of gold
-Farmers expected to de-stock fertiliser
-OZ Minerals most resilient in copper
 

By Eva Brocklehurst

Commodity Prices

The world should not fear lower commodity prices – that is the advice of Commonwealth Bank analysts. They believe the market has taken too bearish a view on the sharp fall in commodity prices and reject the notion that the fall will cause the sort deflation in the US that plagued Japan for decades.

The recent fall in prices reflects surging supply rather than depressed demand, the analysts note. This increase in supply is the result of a long boom in mining investment that doubled  productive capacity. More commodity supply at a lower price, they argue, supports real incomes, aggregate demand and faster growth in spending. Okay, all is not so rosy for commodity-dependent economies such as Australia, Canada, Russia and Brazil, but the majority are net consumers.

The analysts also believe the reasons behind the lower commodity prices do not matter that much for the direction of most currencies. Falling commodity prices shift income, terms of trade and current account balances away form net producers to net commodity consumers. These influences will push down the likes of the Australian and Canadian dollars.

The analyst also believe there is a danger in conventional wisdom. This states that if Chinese domestic demand led to the mining boom in the first place, then, with the Chinese economy now slowing, the fall must be because of weak Chinese demand. The analysts dismiss this idea, arguing that the unexpected surge in demand a decade ago triggered a spike in commodity prices, which laid the foundation for sharply increased investment in extra supply. That has now brought prices down substantially.

Recent International Monetary Fund research shows increased supply accounts for up to 80% of the recent fall in the oil price. In addition to higher mining output world GDP will be stimulated by lower commodity prices via a reduction in direct costs, such as lower transport costs, and also indirect costs. For example: fertiliser manufacturers benefit from lower petroleum costs, farmers benefit from cheaper fertilisers, food manufacturers benefit from cheaper crops. This ripple through into lower prices frees up consumers and provides them with more purchasing power.

There must be losers. The obvious ones are those miners which suffer a steep cut to their income, particularly in the case of higher cost producers. This can be so large as to cause what is known in Australia as an “income recession” and can also be felt beyond the mine site, in the analysts view.

Gold

In the current environment, ANZ analysts believe there is little reason to sell gold. Volatility is elevated, economic growth is weak and the European Central Bank is about to embark on substantial bond buying. The usual correlation between gold and the euro has reversed, with gold showing notable resilience. The analysts observe the factors which are driving down the euro are underpinning gold, such as uncertainty over Greece, weak economic activity and expectations of increased euro liquidity.

The Swiss National Bank’s surprise move to remove the currency peg to the euro also gave gold the impetus to rally. The analysts observe this move has lowered the appeal of the Swiss franc as a safe haven, with a re-valuation of the potential for negative rates. Meanwhile, the biggest headwind for gold is a continued rally in the US dollar which the analysts expect will continue for at least six months. They remain constructive on the gold price in 2015, envisaging upside risks to existing forecasts.

Agricultural Commodities

The majority of agricultural commodities Macquarie covers have endured inventory increases over recent months and there is increasing pressure on the supply side. A stronger US dollar, lack of weather-related issues and wider commodity pull-back means the pricing backdrop is tough. The analysts expect farmers will be de-stocking fertilisers heavily over the coming year, over and above a reduction in application rates. Hence, demand is likely to be stagnant. The analysts expect a sustained period of downward pressure on prices for ammonia, urea and potash. Some recovery in corn, wheat and natural rubber prices is expected with soybeans under pressure. The analysts expect strength in cattle pricing will continue.

Copper

After a rocky year, copper prices have continued to weaken into 2015 and this has weighed on copper equities. UBS observes, of those miners under coverage, pure plays are down an average 7.0%. Worst off is Tiger Resources ((TGS)), which is down 15% year to date and currently facing refinancing concerns. OZ Minerals ((OZL)) remains more resilient, down just 1.0%. Heading into 2015, the UBS commodity analysts are forecasting an average copper price of US$2.85/lb and a long-term price of US$2.95/lb. The analysts consider the fundamental outlook is mixed, with curtailing of new supply being offset by a moderation in Chinese imports.

Companies with Australian dollar denominated cost bases continue to be in favour and, in this regard, the broker is drawn to Sandfire Resources ((SFR)) and OZ Minerals. Furthermore, improving gold sentiment will benefit PanAust ((PNA)), Oz Minerals and Sandfire. PanAust tops the broker’s list of copper plays because of stronger growth opportunities and it screens favourably against its peers in terms of the implied copper price.
 

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