Material Matters: Base, Bulk And Precious Metals

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 – Commodity price forecasts revised
 – Bulk material expectations updates
 – Industrial metal markets analysed
 – PGM outlook reviewed

By Chris Shaw

With the September quarter drawing to a close BA Merrill Lynch has marked-to-market commodity price assumptions, with changes reflecting a revised outlook for stronger gold prices and weakness in the bulks sector given a soft steel output.

An open-ended Quantitative Easing environment should be supportive for gold in BA-ML's view, leading to the introduction of a two-year price target for the metal of US$2,400 per ounce. A short-term target of US$2,000 per ounce for the June quarter of next year is retained. Gold is BA-ML's preferred commodity exposure, with preferred stocks being Regis Resources ((RRL)), Evolution Mining ((EVN)) and Newcrest ((NCM)).

For the bulks, BA-ML has cut hard coking coal price forecasts by 16% in 2013 and 5% in 2014 to US$185 per tonne and US$190 per tonne respectively. The changes are based on revised global steel demand growth of 4.6% and 3.9% respectively in year-on-year terms in 2013 and 2014, down from 4.8% and 4.4% previously.

Iron ore price forecasts have also been lowered, BA-ML dropping estimates by 15% in 2013 and 8% in 2014 to US$110 per tonne. The changes are based on revised expectations for the ramp up of new supply and high cost Chinese production. 

For the base metals BA-ML cautions recent strength in prices may not last, as the US fiscal cliff and potential for weaker Chinese growth in the first quarter of next year presents some reasons for caution. Any resulting weakness in prices stemming from these factors could present an opportunity in the broker's view, with copper BA-ML's preferred metal exposure given a lack of new projects. 

The changes to commodity price forecasts by BA-ML have translated to earnings and price target adjustments across stocks under coverage. There have also been some resulting changes in ratings, with BA-ML downgrading Ampella ((AMX)) and Gindalbie ((GBG)) to Underperform from Buy, OZ Minerals ((OZL)) to Underperform from Neutral and upgrading PanAust ((PNA)) and Perseus ((PRU)) to Neutral from Underperform.

PanAust is BA-ML's preferred copper exposure ahead of OZ Minerals, while Western Areas ((WSA)) is preferred to Independence Group ((IGO)) in the nickel sector. 

The FNArena database shows Sentiment Indicator readings for the above stocks of 0.9 for Perseus, 0.8 for PanAust and Evolution, 0.7 for Western Areas and Regis Resources, 0.6 for Independence Group, 0.3 for Ampella, 0.2 for Gindalbie, 0.1 for Newcrest and 0.0 for OZ Minerals.

Commonwealth Bank notes coking coal prices have fallen to 2012 lows, with spot premium coking coal now trading at US$140 per tonne. In the market CBA notes producers now appear less desperate to move cargo, as inventory pressures are easing and Chinese domestic prices increase.

Traders have indicated to CBA that if buying was to occur before China's National Day Holiday beginning on October 1, a big discount to coking coal prices would be required.

Further on the bulks, Macquarie points out August global steel output figures highlight the knock-on effect of slowing industrial output. Overall crude steel production for the month was down 1% in year-on-year terms.

While august is seasonally a weak month Macquarie suggests the data is unlikely to inspire much in the way of confidence in the sector, especially as the recent falls in global capacity utilisation means steel margins remain under pressure.

Chinese data has offered some evidence of a fall in output but Macquarie argues production cuts have been both too late and not severe enough. Further output cuts in China are expected into October in an attempt to clear current inventories.

Turning to the industrial metals, in aluminium CBA notes the spot arbitrage, which is the difference between SHFE land LME prices, averaged US20-25c per pound in mid-August but dropped to a low of around US4c per pound in the middle of this month before rising to around US11c now.

LME prices remain attractive for Chinese aluminium importers but CBA notes arbitrage profits have declined significantly. With Chinese aluminium imports barely moving from June to August even with a favourable arbitrage, it suggests to CBA a subdued Chinese demand environment. This is consistent with slowing steel demand.

Given aluminium prices have become less favourable for imports, CBA sees little scope for China's aluminium imports to improve in the near-term.

In copper, Deutsche Bank remains of the view supply side challenges remain and could re-emerge from the final quarter of this year. International Copper Study Group (ICSG) data implies refined copper supply is failing to keep pace with global demand, this due to falling grades, ongoing labour disputes, technical issues and temporary production shutdowns.

Further disruptions to output could come in coming months as current labour contracts expire, which is expected to see labour unions attempt to negotiate better terms. Power shortages in Chile could also impact on supply in coming months.

Macquarie also notes global copper mine supply growth continues to underperform, meaning any surplus copper produced is likely to be absorbed by the market as low inventory levels are rebuilt. On the demand side Macquarie expects Chinese infrastructure will continue to drive the market into 2013. The expectation is for continued tight copper market fundamentals through the start of 2013, which is a positive for prices for the metal.

From an investment perspective, Macquarie's view on the outlook for copper translates into a preference for PanAust among Australian producers. PanAust offers a combination of both production growth and exploration potential from its assets in Laos.

Expansions at the Phu Kham project will add around 17% to production by 2014, while the Nam San underground and Phonsavan project both offer potential to boost output in later years. Macquarie rates PanAust as Outperform with a price target of $3.60.

Also rated as Outperform are OZ Minerals and Discovery Metals ((DML)), the former on valuation grounds and the potential for production to be expanded beyond the current resource base at Prominent Hill and the latter as production at Boseto is ramped-up and a recent capital raising has strengthened Discovery's balance sheet.

Macquarie also rates smaller play Blackthorn Resources ((BTR)) as Outperform as the Kitumba project in Zambia continues to deliver promising results and the potential for further exploration at the Mumbwa project to add significantly to resources. Sandfire ((SFR)) is rated as Neutral, Macquarie seeing the stock as fair value at current levels as the company transitions from developer to producer.

The FNArena database shows Sentiment Indicator readings for the above copper plays of 1.0 for Blackthorn, 0.1 for Sandfire and 0.0 for Oz Minerals and Discovery Metals. 

In the nickel market, UBS disagrees with the market's perception Chinese high-cost nickel pig iron (NPI) capacity offers marginal support for global nickel prices. UBS's view is NPI only supports prices when lower cost supply options either underperform or fail, but is short-term nickel demand weakens there is no price support from marginal cost supply.

For nickel in general UBS suggests there remain a number of fundamentally bearish factors, including huge project overhang, substantial inventories and a lack of demand growth in traditional markets. This leads UBS to forecast a subdued outlook for nickel prices in 2013 of levels around US$17,000 per tonne.

Once de-stocking has been completed UBS suggests nickel prices can then better reflect fundamentals, where a concern is new, lower cost supply such as Barro Alto and Onca Puma will bring down the level of fundamental price support, as supply growth remains greater than demand growth. As higher cost NPI becomes redundant, the cost curve for nickel moves lower. 

To exit the current downward spiral in nickel UBS suggests there needs to be a stabilisation in market prices. The broker suggests this is likely to be preceded by some stability in stainless steel prices. 

In the precious metals, Standard Bank suggests investor interest in platinum has cooled, as short-covering appears to be a major driver of changes in positions at present. As well, the easing of some labour tensions in South Africa have prompted some investors to sell out of long positions.

Such unease on the part of investors is understandable in Standard Bank's view, as net speculative length remaining above five-year average levels indicates an overstretched market that is more vulnerable to a correction.

While investor interest is slowing, Standard Bank continues to see platinum as a second-tier pick in the precious metals space behind gold and silver.

Citi has upgraded price forecasts for the platinum group metals, lifting estimates out to 2016 by 1.5-7.6% for palladium and by 6.3-15.6% for platinum. The changes to forecasts reflect ongoing strikes in South Africa and related supply cuts to both metals.

Revisions to expectations mean Citi now expects a balanced market outlook for platinum through 2014 and deficits thereafter, while deficits in the palladium market are forecast to continue growing. 

While price forecasts have been increased Citi continues to suggest caution with respect to the outlook for PGM prices, as the recent price rally may provide enough incentive to companies to re-start mothballed production and reinstate capex programs.

Higher prices may also increase supply from recycling, which in combination with production restarts could add as much as 400,000 ounces to platinum market supply in 2013 than is currently built into Citi's forecasts.

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