Commodities | Apr 11 2016
This story features ILUKA RESOURCES LIMITED, and other companies. For more info SHARE ANALYSIS: ILU
-Rebound or re-stocking in China?
-Over the worst for some metals?
-Gold sustainable above US$1,150/oz
-Stubborn copper surplus continues
-Steel disconnect with iron ore
By Eva Brocklehurst
UBS wonders whether Chinese growth is starting to rebound, or whether the evidence so far is merely of re-stocking after the winter. The broker's economists expect the upcoming March economic data will show the start of a sequential rebound in activity but analysts' channel checks with companies suggest re-stocking is the driver so far.
The most notable change to the broker's commodity price deck so far for 2016 is a 20% reduction in zircon and titanium dioxide feedstock prices, as a result of a breakdown in producer discipline. Iluka Resources ((ILU)) has followed from Rio Tinto ((RIO)) and Tronox and announced a US$100/t reduction to zircon prices.
Credit Suisse believes the worst of the downturn has passed for aluminium, metallurgical coal, zinc, lead and gold. The broker also believe the ferrous sector has improved after China pulled forward infrastructure plans.
The broker increases forecasts for China's steel output, improving its view of iron ore demand as well. Iron ore supply appears tighter this year but large surpluses are still expected from 2017 as supply expansions take place.
The speed at which a positive gold scenario has played out has surprised Credit Suisse, with the yellow metal briefly cutting through US$1,300/oz amidst exchange traded fund (EFT) purchases and declining mine supply. The broker raises forecasts for gold to average US$1,270/oz in 2016 and US$1,313/oz in 2017.
Support has come through declining real interest rates, a weaker US dollar and safe haven demand. Prices have pulled back from their highs but, nevertheless, Credit Suisse suspects a three-year down trend has reversed. The broker does not believe a return to sub US$1,150/oz is likely or sustainable.
Meanwhile, silver is tracking gold higher, and the broker expects the gold/silver ratio to re-test highs above one standard deviation, given stronger gold fundamentals and a lack of major drivers for silver. International capital flows and a heightened geopolitical risk premium are factors which the broker suspects favour gold over silver.
UBS agrees the same criteria makes holding gold versus other assets a more attractive proposition this year. The broker maintains a gold price forecast of US$1,225/oz for 2016 believing a re-allocation into gold is warranted, although not forecasting a bull run. Australia's gold miners, on average, are generating strong cash flow and have improving balance sheets.
The broker believes gold equities will continue to perform well but investors should still be selective. UBS has a preference in the large cap segment for Evolution Mining ((EVN)) and Regis Resources ((RRL)) over Newcrest Mining ((NCM)) and OceanaGold ((OGC)). In smaller cap stocks the broker is drawn to Beadell Resources ((BDR)) and Alacer Gold ((AQG)).
UBS believes the copper price is vulnerable to some downside, estimating demand growth would need to run at over 5.0% in China to absorb the market surplus. Supply could be tweaked to re-balance the trade, but in this instance the broker observes most operations are still generating cash and cost curves are falling.
Credit Suisse has become more bearish on copper, believing copper demand growth in China will fade rather than rebound and copper is likely to remain in surplus this decade unless there are cuts to production.
Nickel is one base metal where much of the industry is loss making and shut-downs are the most obvious potential catalyst. Another 100-150,000 tonnes per annum needs to be cut away, which UBS expects is more likely in the later stages of 2016 and into 2017.
The broker downgrades Western Areas ((WSA)) to Sell from Neutral, incorporating a recent placement and lower Australian dollar nickel price forecasts. The broker remains drawn to Independence Group ((IGO)) with development risks expected to fade once Nova commences production in 2017.
UBS downgrades Alumina Ltd ((AWC)) to Neutral from Buy, primarily to reflect a reduced valuation and recent share price movements. The broker believes the spot alumina price has recently shifted to reflect downside risk, as refinery re-starts occur in China.
Zinc and lead are Credit Suisse's top picks in the base metals segment, with supply shortfalls looming as mines close. Aluminium and alumina have recovered with the curtailment of supply in China but the broker suspects capacity is available to re-start which will limit the price rebound.
Declining Australian shipments and improving steel producer fundamental underpin Macquarie's preference for iron ore exposure. Port data suggests that both Rio Tinto and BHP Billiton ((BHP)) will report a significant drop in shipments in the first quarter of 2016.
The broker notes evidence that iron ore supply has responded quickly to higher prices, with material volumes from Sierra Leone and India. Nevertheless, the broker is comfortable with its 2016 average US$50/t forecast, given improving steel mill fundamentals.
Moreover, the news that Arrium ((ARI)) has entered voluntary administration puts at risk 8.5-9.0mtpa of loss-making production. Macquarie maintains a preference for Fortescue Metals ((FMG)) and Rio Tinto.
Margins have expanded substantially in China, Macquarie observes, as the steel mills benefit from a recovery in demand, assisted by seasonality, low steel inventory and slower rises in production. The broker also suspects the upside risk to Chinese growth forecasts is increasing.
Macquarie observes steel prices have disconnected from iron ore in recent weeks with steel rising 6.0% and iron ore falling 4.0%. The broker expects the margin improvement should be sustainable in the weeks ahead, but ultimately there is no reason for a sustainable, structural improvement in Chinese steel markets.
Mills will lift production beyond the pick up in demand by the middle of the year and margins will prove attractive which will enable more re-starts, a similar situation to what is occurring in aluminium, the broker maintains.
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