Commodities | Jun 16 2016
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-Real US rates key to gold
-Global zinc deficit continues
-TGS offering leverage to copper
-Oil, LNG driving thermal coal
-Few positives seen for copper, aluminium
By Eva Brocklehurst
Prices for gold are surging, as a patch of bad economic data in the US is seen hampering the Federal Reserve's ability to tighten monetary policy. Macquarie envisages the near-term gains for gold are temporary as it does not believe the US is heading into recession.
The timing of a weak jobs report could not have been worse for the Fed, Macquarie contends. The broker believes the Fed was moving in the direction of raising rates again.
While gold does gain ground amidst Fed inaction, Macquarie notes it has not re-rated against US metrics such as interest rates and the currency. This is because the latest employment report, while poor, does not mean much more than a slightly longer wait for the Fed to hike. The broker's US economist does not find the jobs data indicative of overall trends and still envisages a high probability of a Fed funds hike at the next meeting in July or, if not then, September.
Still, Macquarie remains bullish in the medium term on gold, arguing for higher gold prices in 2017 and 2018, based on increasing inflationary pressures, and the fact the Fed may be reluctant to react compared with previous cycles because of its fear of causing another recession.
The appearance of weak economic data now and then is expected to embolden the Fed's doves and ensure real interest rates in the US remain low, and it is real interest rates that typically determine longer-run gold prices.
The top performer among commodities in 2016 is zinc, given mine shortfalls and China-led demand growth, Morgan Stanley observes. The spot price is up 30% in the year to date and above US$2,000/t for the first time since July 2015 and the broker suggests it is close to a peak.
More than half of all zinc supply ends up on steel, as galvanising. So, as steel production rates lifted so did demand for zinc. Softer prices for steel in May reflect a slowing in local demand in China amid emerging anti-dumping constraints on its exports, the broker contends. Still, the growth outlook remains solid for 2016 and the broker continues to forecast a deficit for zinc in the global market in 2016-17.
Macquarie continues to be bearish on copper, decreasing its FY16 and FY17 copper price forecast by 4% and 9% to US$2.13/lb and US$2.17/lb respectively. Mid tier copper producers in the broker's coverage suffer downgrades to earnings estimates as a result.
Sandfire Resources ((SFR)) remains the preferred copper play, trading on a 2017 price/earnings ratio of 6 versus 11 and 12 for OZ Minerals ((OZL)) and Tiger Resources ((TGS)) respectively. The broker concludes that all three are currently fully valued. The broker also prefers Sandfire's exploration potential in the Doolgunna province over Oz Minerals' Gawler Craton tenements.
In an absolute sense, Tiger Resources offers the most leverage to a near-term improvement in copper prices. The stock is the only primary copper producer under coverage with material geographical risk, which the broker suggests may be discounting the current valuation.
Morgan Stanley observes it is over five years since the market was surprised by the seaborne thermal coal market, with prices down 50-60% since the 2010 peak. Since late April prices are up 2-10%, with the biggest moves in the top grades.
The reason the broker finds this rally surprising is the season. A lift might occur in November or December in the pre-northern winter re-stock but not in the middle of the year when the trade is well supplied.
The broker also suggests China's import regime is not the culprit, as it is not a driver of the thermal coal price now. Rather, ongoing strength in crude oil and gas prices are behind the latest rally. China faces a looming shortfall in supply to its coal-fired power grid and in the longer term Morgan Stanley suspects conditions are improving for seaborne thermal coal.
Steel & Iron Ore
The re-start of blast furnaces under higher steel prices seems muted to Credit Suisse. Lower output may reflect a decline in steel prices in mid May but also seasonality, as China's output typically peaks early in the second quarter of the year.
Meanwhile, as the northern slowdown of steel demand approaches, this is likely to keep iron ore demand subdued until mid August and the price appears to be in a holding pattern for the near term.
Credit Suisse expects steel demand will step up again in the December quarter as the infrastructure stimulus that China initiated early in the year comes into play. The broker also notes no building up of iron ore at ports, with China's domestic supply seen declining to balance the market.
Macquarie observes after a trip to China that a more cautious approach to demand is increasing. Most contacts suggested to Macquarie that a peak has already occurred in sequential economic growth for this mini-cycle. Yet none expect a imminent sharp decline. Concerns over structural problems have also started to re-emerge.
The broker's views were reinforced, with a belief that iron ore is well supported around current prices and the recovery in coal is likely to be limited. On the subject of base metals, besides zinc standing out in a tight market, there was little to make Macquarie more positive about copper or aluminium. Industry participants were more cautious about a recovery in nickel than the broker is currently.
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