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Material Matters: Platinum, Palladium, Gold And Iron Ore

Commodities | Sep 15 2014

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-ETF liquidations key to PGM rebound
-Gold stocks enhance credibility
-Gold M&A could heat up
-Iron ore prices discouraging start-up
-But low-cost Chinese producers remain

 

By Eva Brocklehurst

Platinum supply is unlikely to rise much. Macquarie's analysis of shipments from South Africa indicates the state of play, despite a return to normal after a five-month strike, will remain weak for the rest of the year. July was the first full strike-free month of platinum production since December 2013. The fact that refined output remains low indicates how difficult it is for miners to get production back to normal. Sales of the metal have been in excess of refined production and largely the shortfall has been furnished from supplier inventories. Despite the use of these inventories, exports from South Africa have fallen.

ANZ Bank analysts expect near term downside risk to both platinum and palladium prices as investors take profits, despite the recent declines, followed by a rebound to higher ranges. More downside to palladium pricing is expected, in particular, as the build up of speculative interest recedes. Low stocks, having been run down significantly in South Africa in the wake of the strike, mean the market is more sensitive to further supply shocks. The analysts note the industry was sufficiently well stocked to absorb production losses – more so for platinum – but the supply deficit makes it is hard to envisage that prices will fall too far.

In terms of palladium, there is more downside potential because of stretched long positions. Above ground stocks of palladium were significantly lower than platinum stocks when the South African strikes started. Palladium is underpinned by the fact that Russian stocks are also low. Moreover, South Africa imported a significant amount of palladium for the first time in two years in April 2014. With the world's largest producers running low this should keep palladium prices in a higher range over the next 12 months. Nevertheless, the analysts suspect, absent any sanctions that may affect Russia's Norilsk Nickel – the world's largest palladium producer – a significant rally will not eventuate.

Why? The analysts draw attention to the exchange traded fund (ETF) holdings of palladium, which declined by 4% in late August – the largest percentage decline since 2008. ETF holdings of platinum also declined by a similar percentage and were the precursor to the latest bout of profit taking. Continued redemptions of ETF holdings, which add to supply in the marketplace, should be watched closely, in the analysts' view. The experience of the gold market in 2013 shows that, when the floodgates are opened, the consequences can be significant.

Gold companies are concentrating on profitable ounces and predictability of resources to shore up balance sheets and support higher exploration spending. These are the themes emanating from Deutsche Bank's recent gold conference in Sydney. Mergers and acquisitions were also mentioned by four of the eight participants – Independence Group ((IGO)), Evolution Mining ((EVN)), OceanaGold ((OGC)) and Regis Resources ((RRL)) – as a consideration over the next 1-2 years. Deutsche Bank observes companies are very attentive to further enhancing their credibility. Where necessary, they are preparing to scale back production to ensure the delivery of higher margin ounces. Cost cutting initiatives are resulting in the mining of only quality deposits in order to sustain sufficient margin and protect cash flow.

Deutsche Bank believes the most important drivers in the gold market are US long-term real rates, the US equity risk premium and the US dollar. The gold price for the past six months has had no direction, which the analysts put down to opposing fundamental forces. US economic growth and Federal Reserve policy will therefore play a crucial role in the next move in the gold price. If growth surprises to the upside the broker expects this to push US rates, equities and the US dollar higher, in turn pressuring the gold price. Conversely, negative growth shocks would result in a higher gold price.

A similar view is in place at Van Eck Global, which believes gold stocks could rise from undervalued levels and merger and acquisition activity heat up with any rise in the gold price towards US$1400/oz. The strategist at Van Eck, Joe Foster, observes gold stocks have been out of favour for a few years and it will take some time to regain fair value. Gold has established an important base around US$1200/oz, in Mr Foster's view. Fundamentals driving the bullish outlook are expectations of improved Chinese demand and lower costs of production, heightened geopolitical risk and absence of persistent bullion exchange-traded product sales. Mr Foster considers gold is a hedge against irresponsible policies from Washington DC and possible asset bubbles or inflationary pressure. 

The shake out for iron ore juniors continues and BA-Merrill Lynch observes increased risks for the majors as well. Increasing production at lower prices and the stubbornness of non-traditional supply means prices are likely to remain under pressure. Already the broker envisages limited upside to earnings, and significant risk to the downside should the clearing price re-base. The questions the broker asks is as to whether long-term market fundamentals will improve through sector consolidation and/or could new entrants appear. Also, does higher supply/lower costs win versus lower prices?

Merrills believes, after high-cost miners in China exit the market the remainder will be hard to displace despite an increasingly oversupplied seaborne market. A reminder: Chinese companies are also gaining footholds in global projects, further exacerbating oversupply. Chinese investment in foreign projects may yield questionable returns but as these investments are invariably carried out by state-owned entities that have easier access to funding, they may be sticky. After the first quarter of 2015, significant volumes ex China will need to be displaced in order to balance the market, in the broker's opinion. Iron ore prices over US$120/t for extended periods could encourage new entrants. Below US$90/t there is potential for cancellations or postponements.

The broker emphasises pricing in the range of US$90-100/t provides incentives for incumbents but does not encourage new entrants. Major miners continue to expand significantly and remain committed to delivering new "lower cost" tonnes. Merrills considers this behaviour is consistent with a maturing market and the majors will aim for higher volume and lower cost in the long term. The market will remain oligopolistic, as miners facing lower prices will seek to pressure suppliers with their stronger pricing power. The broker expects attractive projects undertaken by BHP Billiton ((BHP)) and Rio Tinto ((RIO)) will continue to be developed, despite lower prices, but overall returns will remain flat over the forecast period.
 

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