Material Matters: Outlook, Bulks, Oz Miners, And Gold

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Pricing outlook for mining commodities; demand increases for bulks; positive trends for Oz coal and iron ore miners;  Ord Minnett's gold picks.

-Lift in Chinese imports of bulk commodities sets tone for higher prices
-Macquarie substantially upgrades forecasts for diversified miners
-Coal joins iron ore in Credit Suisse's upward revisions to prices
-Ord Minnett underweight on gold but recommends mid caps 

By Eva Brocklehurst

Commodities Outlook

Commonwealth Bank analysts have upgraded price forecasts for the next year or so, given China's stimulus measures continue to support commodity prices. The manufacturing and property sectors are leading demand while the analysts note upstream sectors are experiencing a deterioration in their financial conditions.

Sectors such as China's coal, iron ore and oil are experiencing a large lift in imports as the government appears to be replacing high-cost domestic capacity with lower-cost imports.

The analysts upgrade their price deck for most mining commodities but still expect the prices will fall next year as the effects of the stimulus fade. Producer margins also point to a price correction. Cash margins have expanded as prices lift and cost reduce but this raises the potential for more supply investment.

Zinc and coal markets are tighter because supply is reduced and this should mean milder price falls compared with other commodities. The analysts expect prices to bottom at the end of 2017 and bring margins back to sustainable levels. The degree of price declines has been moderated nonetheless and the analysts now believe a 20% decline in spot metal prices is more reasonable.

Bulks And Oz Miners

Stronger demand and the impact of supply-side reforms in China have enhanced the outlook for most bulk commodities and Macquarie has materially upgraded its forecasts for coking & thermal coal and manganese.

The latest data from China suggest construction activity is still in a positive trend and global industrial production is recovering. Macquarie continues to increase its 12-month forward demand outlook across the industrial metals as the Chinese government prolongs its commodity-intensive phase of growth.

The broker makes it clear that the fundamentals do not point to any sustained inflationary bottlenecks outside of raw material constraints, such as with zinc, and the long-term challenges of over capacity and lower industrial demand growth remain in place. Moreover, the usual seasonal weakness in demand is expected into the end of the year.

Coking coal price forecasts are lifted by 42% and 28% for FY17 and FY18 respectively, thermal coal by 21% and manganese by around 25% over the same period. The surge in coal prices combined with strength in iron ore, drives an earnings upgrade for the diversified major miners and coal producers.

Macquarie upgrades earnings estimates for BHP Billiton ((BHP)) and Rio Tinto ((RIO)), driving 20% and 10% increases in the price targets respectively. BHP is upgraded to Outperform from Neutral. As the three commodities being upgraded are dominant for South32 ((S32)), Macquarie upgrades to Outperform from Underperform. The rating on coal stock New Hope Corp ((NHC)) is also lifted to Outperform from Underperform.

Macquarie retains a preference for bulk commodities, nickel and gold stocks. In terms of the latter Northern Star Resources ((NST)) and St Barbara ((SBM)) are upgraded to Outperform from Neutral. The broker expects steel and bulks will underperform over the December quarter and the potential for a US rate rise will hamper precious metals. Upside is envisaged for nickel and, despite its structural pressures, alumina.

Coal has also joined iron ore in Credit Suisse's upward revisions to commodity prices. The broker expects China's steel production will surpass 800m tonnes in 2016 and iron ore prices should average US$54/t in 2016. Yet with new supply on board the broker's US$45/t forecast for 2017 is unchanged. A price around US$160/t appears likely for prime hard coking coal, given reduced supply in China and the broker looks for hard coking coal prices to average US$119/t in 2017.

For thermal coal, China is targeting a domestic price equivalent to US$60/t and the broker looks for prices to come under pressure in the medium term as China's and India's imports resume their down trend. Credit Suisse does not believe this is the time to be underweight the miners and upgrades Fortescue Metals ((FMG)), Alumina ((AWC)) and Iluka Resources ((ILU)) to Neutral, having previously rated them Underperform.

Gold

Mid cap gold stocks appear the most attractive to Ord Minnett at spot prices. The broker recommends investors be underweight on precious metals but for those that want gold exposure a basket of mid caps is suggested.

Ord Minnett retains a Lighten rating on Newcrest Mining ((NCM)), given the stock appears expensive on a relative and absolute basis. The broker suspects gold sector multiples are likely to de-rate as the gold price momentum stalls. Currently, valuations are implying a much higher gold price forecast versus spot and the broker believes precious metals are at risk of a consensus downgrade cycle.

Deutsche Bank recently hosted its gold sector conference in Sydney and notes a focus on organic value creation from the companies presenting. The companies remain cautious about premiums in deals being done and are hesitant to consider M&A outside of Australia.

What impressed the broker was how quickly the gold stocks have re-directed their focus to strategies that create value and not relying on the current Australian dollar gold price. Those that stood out with their growth stories were Northern Star, St Barbara and Evolution Mining ((EVN)).
 

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