Commodities | Apr 23 2015
-Will copper deficit loom in 2016?
-Funds bearish on copper
-Nickel trade tightening
-M&A deal size increasing
-Potential oil consolidation
-Oil price to recover, eventually
By Eva Brocklehurst
Deutsche Bank found a mixed message from the copper conference in Santiago, Chile. Issues facing the mining industry in Chile are far greater than anticipated. For the near term the market appears well supplied with physical product and recent disruptions to mining will ensure this situation is not exacerbated. Still, demand remains weak and the broker expects this may affect expectations for a balanced market in 2015. All market participants expect higher prices with a tighter market in 2017 and growing deficits from 2018.
Producer sentiment is dominated by supply constraints. Citi notes Rio Tinto ((RIO)) expects a move to deficit from surplus by 2018-19 and increased price volatility. The broker believes short-term price fluctuations are largely based on speculative Chinese hedge funds and a muddy outlook for the global economy. The broker considers downside pressure on copper prices has been overdone and investor positioning oversold. The broker cites evidence of fewer copper projects in the pipeline globally while prices are around 10% below those of a year ago. This is of fundamental concern as there has already been significant curtailment to global production guidance. Citi, therefore, expects a deficit will arise in 2016.
Macquarie found the supply view at the conference was uncontested, with participants agreeing that disruptions are unusually high this year and mines are underperforming. The concentrates market appears tight but refined metal is soft. Macquarie believes a slump in collateral financing demand has increased availability on spot markets, but participants are concerned that a deeper slowdown is emerging in China.
Chinese representation was thin on the ground in Santiago, Macquarie observes, but those that were there expressed optimism about a turnaround in demand in coming weeks. Concerns around underlying consumption persist and the broker is awaiting better buying signals. While not agreeing with the perspective, Macquarie notes commodities funds appear universally bearish, taking recent physical softness as a cue that copper may be about to follow steel towards rising inventories, collapsing metal and raw materials prices and weakening demand.
Macquarie's surveys of the copper and steel markets have revealed an improvement in market conditions for the two commodities. Infrastructure orders are playing a part and, for steel, construction orders are also returning. Re-stocking demand at copper fabricators and further drawdown on stocks at steel traders point to a more supportive environment for prices in the second quarter.
The expected nickel supply crunch following Indonesia's export ban on nickel ore 15 months ago has not yet emerged. UBS puts this down to moderation in stainless steel demand in the second half of 2014 and an increase in ore exports from the Philippines. The broker has not abandoned the idea that China will soon turn to alternative nickel products and tighten the trade. Ore inventories are declining in terms of both size and grade. Moreover, nickel is also very exposed to surprise on the economic growth front in Europe. Nickel stocks are telling the broker that equity investors believe the nickel price is now close to its low for this cycle.
On this basis, UBS considers Western Areas ((WSA)), Buy rated by the broker, as the "go to" nickel producer because of its stability, low cash costs and net cash position, which provides leverage to the nickel price. Sirius Resources ((SIR)), Buy rated, is also a compelling investment in the broker's view, because of the long-term value and strategic position of its resources. Mincor Resources ((MCR)) – Buy – and Panoramic Resources ((PAN)) – Neutral – meanwhile, offer significant leverage to exploration success.
Mergers & Acquisitions
Evolution Mining's ((EVN)) intention to buy the Frog's Leg and White Foil assets from La Mancha, in a scrip deal worth around $290m, is the largest Morgans has witnessed in around 12 months. The company expects the acquisition to provide good long-term value for shareholders with significant exploration upside, but the broker suspects the company is aligning with La Mancha for improved cash flow and a funding partner to enable a larger acquisition down the track. Morgans observes the number of quality assets available are dwindling and the value of deals is increasing. Evolution Mining paid a higher multiple for in-ground resources compared with some recent deals, the broker observes.
Over-geared major producers are driving divestments of non-core assets, with Morgans flagging Newcrest Mining ((NCM)) and Barrick as players on this stage with the Cowal, Porgera and Telfer mines up for grabs. Media speculation has also alluded to companies such as Northern Star Resources ((NST)), Regis Resources ((RRL)) Western Areas and Independence Group ((IGO)) bidding for these large assets because of the necessity to reinvigorate their portfolios.
The broker suggests investors should target high quality but cheap assets such as Highlands Pacific's ((HIG)) PNG assets or Gold Road Resources ((GOR)) for its large resource base. Doray Minerals ((DRM)) is also appealing for its cheap assets, in the broker's view.
Morgan Stanley has lowered oil price forecasts and reduced earnings and valuation estimates. The broker does expect a cyclical recovery, but from a lower base and over a longer period than previously assumed. Lower Australian dollar exchange rates may temper the negative impact for Australian energy stocks. The broker expects low cost producers are likely to outperform high cost peers should the oil price recovery stall and prices stay below US$60/bbl for an extended period.
Themes circulating in the sector and providing a backdrop include domestic gas market shortfalls and price opportunities, which Morgan Stanley suggests are closing following re-contracting and demand destruction, while there is the potential for consolidation activity in the wake of global trends and depressed local equity prices. Also, expenditure trends are downwards and high debt levels are dictating the allocation of cash flow to debt reduction while dividend growth is lower priority.
Canaccord Genuity suspects the rate of growth in oil production is falling and supply could start to turn down sooner than many expect, especially if the rig count for the key US shale players continues to drop. The broker believes US storage concerns are overdone and refining runs are already rising, which should encourage utilisation. Global risks are more supportive of a higher oil price, despite the easing of tension with Iran. The broker accepts the near-term scope for a sharp rebound in crude prices is limited but, on the other hand, it is likely the trough has passed and there appears to be more investor optimism in the sector globally.
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