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Material Matters: Copper, Aluminium, Australian Resources And Steel & Scrap

Commodities | Apr 05 2016

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-Demand growth still missing for copper
-Re-firing of aluminium capacity possible
-Macquarie: commodity backdrop improving
-Turnaround in steel & scrap looms

 

By Eva Brocklehurst

Copper

Morgan Stanley suggests an opportunistic transfer of copper metal to China has occurred and as a result copper is delivering mixed signals to the market. Ex China the market is increasingly bullish but inside China it is bearish.

Ultimately, the broker believes demand growth is still missing. Global copper has responded strongly to the change in China's credit conditions by delivering metal into the local market. For price stability to occur in 2016, stockpiles in China need to be drawn down along with sustained construction activity.

China is sitting on at least 3m tonnes, Morgan Stanley contends, which means there is a surplus. So, in order for prices to find support, demand needs to grow.

Morgan Stanley is in Chile next week for the copper conference. The issues are how much new projects can deliver and the source of future supply growth, as well as production cuts and mine costs. Overall, the broker envisages a balanced market for copper this year.

The inventory build-up in China is cause for concern but the broker suspects a seasonal pick-up in demand over April-May may prompt a draw on stocks. Moreover, copper's global inventories are far from excessive and any stalling on the supply side would tighten the market quickly, the broker contends. The biggest downside risk is another year of weaker-than-anticipated growth in China.

Aluminium

Supply-side discipline has stabilised the aluminium price, Morgan Stanley observes, a rare occurrence. Now weakening demand growth and China's credit surge are threatening price support. The broker observes almost 5.5mtpa of capacity was removed since 2014 while smelting costs have fallen 20-25% since 2011, versus a 30% price decline.

China's monthly aluminium exports have fallen in 2016, partly from reduced production and stabilising demand. However, while China's production rate fell from its mid 2015 highs, it was still up 10% year on year in January. Aluminium prices have also rallied 10% since the November 2015 low. This is boosting the appeal of re-firing capacity that is offline and threatens prices for the short term, the broker contends.

Australian Resources

Macquarie assesses the potential of a weaker US dollar on earnings forecasts. Mining equities have made inroads into costs over the past four years, aided by currency movements. Since mid 2011 when the Australian dollar peaked at US110c the currency has declined 30%. With currency tailwinds easing, the broker expects specific commodity exposure and operational performance to become more critical.

Marking to market, Macquarie reduces earnings forecasts, downgrading FY16 estimates for BHP Billiton ((BHP)), Rio Tinto ((RIO)), Fortescue Metals ((FMG)) and Newcrest Mining ((NCM)) by 14%, 1%, 3% and 5% respectively. Forecasts for South32 ((S32)) are upgraded 8%.

Macquarie maintains a mixed outlook for commodities for the next two years, expecting a decline in iron ore, thermal coal, manganese and aluminium. Material rises for oil, US gas, nickel, silver, zinc and lead are factored in which combine with expectations for a stronger US dollar.

In the first quarter of 2016 the best performer of the London Metal Exchange was tin, which made a gain of 16%, Macquarie observes, followed by zinc, up 12%. Copper added 3%. All three were down more than 5% in early January but made sharp recoveries in February/March.

Three metals were either flat – aluminium – or weaker – nickel down 3% and lead down 4%. These three acted in reverse, up early in the quarter and then fading by the end.

Macquarie observes iron ore was the strongest performer in the March quarter, gaining 24% and gold was not far behind, up 17%. Crude recovered after hitting a new low in mid February, ending the quarter up 6% for Brent and 3% for West Texas Intermediate. The broker considers this a remarkable turnaround and one that clearly helped the metals complex.

All up, the broker considers the strong performance of metals over the quarter as a sign that demand conditions and the economic backdrop are improving. A more mixed second quarter is expected.

Steel

A rally in steel and scrap prices in the past month has helped drive a recovery in equities, Credit Suisse notes. Australian names such as BlueScope Steel ((BSL)), Sims Metal Management ((SGM)) and Arrium ((ARI)) are up 7.7%, 23.6% and 32.4% respectively.

The broker highlights the potential for BlueScope's shares to rally further if recent spread improvements are maintained. An additional $150m in earnings could be generated at a $220/t spread assumption for 2m tonnes of sales, on the broker's modelling.

Sims' peer Schnitzer's second quarter results indicated significantly weaker export demand and non ferrous and ferrous sale prices falling to multi-year lows. The silver lining, in Credit Suisse's view, is that it appears to mark a turning point in the cycle for scrap merchants.

Price increases over March have led to a 1-% increase in volumes. Guidance from Sims in February was based on there being recovery in volumes or price, both of which have now occurred. This infers for Credit Suisse possible outperformance against guidance, or at least a materially improved FY17 for Sims.
 

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