Weekly Reports | Aug 12 2016
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Supply surge in lithium; disruption from Amazon; more difficult period ahead for equities; RBA cash rate outlook.
-Supply expansion likely to meet the significant demand for lithium in China
-Potential for Amazon to make inroads in electronics and media sales in Oz
-More difficult period for equities ahead but can accommodate some rise in bond yields
-Case for further official rate cuts mounts as risks seen increasing going into 2018
By Eva Brocklehurst
A supply wave is building in lithium. The supply of lithium from existing brine producers is accelerating and Australia’s two new hard rock mines at Mt Marion and Mt Cattlin are about to begin production, targeting immediate expansions. Macquarie expects Australian production of spodumene will double over the next 12 months.
Yet, the broker suspects incumbent producers may become more motivated to keep new supply out of the market. Higher production from the two new mines means demand will be satisfied out to 2021, the broker suspects, but the turning point for lithium pricing could arrive earlier than previously expected. Even in the context of China’s rapid growth in electric vehicles it appears unlikely the required growth will materialise quickly enough to absorb the supply.
Significant conversion capacity is being built in China and this is expected to be the main driver of demand. Yet the low barriers to entry for hard rock mines and ability of existing producers to ramp up suggests to Macquarie that supply will always be able to meet demand or even outstrip it.
Orocobre ((ORE)) remains the broker’s preferred pick in the lithium sector as it is already in production and has been able to realise current off-contract pricing. The broker envisages the Mineral Resources ((MIN)) and Neometals ((NMT)) joint venture at Mt Marion is the largest and lowest risk addition to hard rock supply.
The broker is also positive about the Galaxy Resources ((GXY)) Mt Cattlin mine, but believes the stock is factoring in a premium to long-term price forecasts. In light of the expansion plans for Mt Cattlin and Mt Marion Macquarie finds the outlook for Pilbara Minerals ((PLS)) and Altura Mining ((AJM)) more challenging.
Amazon has disrupted a number of retail markets around the world and, given its product overlap, the Australian retailer most likely to be affected in Citi’s view is JB Hi-Fi ((JBH)), where earnings are estimated to potentially fall 23%.
Amazon already has a large digital presence in Australia with the only limiting factor in expansion being logistics, but Citi maintains that the recent investment in the US, with its regionally-based fulfilment centres, should provide solutions for the vast distances experienced in Australia.
The broker estimates Amazon could reach $3.5-4.0bn in sales in Australia. Its biggest categories are electronics and media. That said, the same penetration enjoyed in the US is not considered likely given the strong presence of eBay in Australia. Amazon Fresh could also find it more difficult in Australia because capital city population density is low.
Still, Amazon could capture up to 7% of the electronics market based on its success in the US and UK and Citi maintains retailers such as JB Hi-Fi and Harvey Norman ((HVN)) would have to deal with a loss of sales and risk to overall margins, given Amazon’s pricing.
Credit Suisse’s indicators suggest bond yields should start to rise and equity markets could enter a more difficult period in the second half of 2017. At that point investors could be confronted by sharply accelerating US wages growth and China unable to roll over loans without printing money, with the market having discounted by that stage much more in the way of fiscal easing.
The broker anticipates a sell-off in equity markets in the second half of 2017, noting equity risk premium is too high and while there may be a sell-off in credit, the broker struggles to envisage it being meaningful. Most of the fall so far in bond yields has been offset by a rise in the equity risk premium and cost of equity. This now ensures an environment where many fixed income assets and parts of real estate appear expensive.
The broker believes central banks will err on the side of caution and risk an overshooting of inflation rather than risk a recession. This in turn remains supportive for equities.
The broker notes US equity mutual fund selling has been extreme with the corporate sector the only buyer, resulting in low equity weightings by institutions. Of note too, Credit Suisse observes, most bull markets end on a clear over-valuation of the sector and a bubble in growth stocks, of which neither has been witnessed so far.
The risk for the near term is that bond yields rise more than expected, given net long positions in bonds are extreme and the financial and economic proxies for cyclicality are improving. The broker believes equity valuations can accommodate a 50-75 basis point rise in bond yields.
Cash Rate Forecasts
National Australia Bank economists expect underlying inflation to remain below the Reserve Bank’s 2-3% target band until mid 2018. Factors suppressing inflation are expected to persist, being strong retail competition, low wages growth and low commodity prices. The RBA forecasts CPI inflation of 1.5-2.5% out to 2018.
The economists observe the RBA is less worried than they previously thought about using up some of its remaining monetary policy ammunition and the case for further reductions in the cash rate appears to be mounting. Despite the central bank’s focus on downside risks in the near term, it has maintained its expectations for economic growth to lift well above trend by 2018.
The economists envisage a firm economy in the near term, supported by an improvement in the non-mining sector and increased hard commodity production but believe the risks going into 2018 are becoming increasingly apparent as LNG exports flatten from a high level and the dwelling construction cycle turns lower.
Consequently, these forecasts are factoring headwinds for GDP growth forecasts and the spread between the economists’ outlook and that of the RBA is widening, to around 1.5 percentage points by late 2018.
The economists expect the RBA will include two more 25 basis points reductions to the cash rate in May and August 2017 to a new low of 1%, to stabilise the unemployment rate at just over 5.5% and prevent economic growth from dropping below the NAB forecast of 2.6% in 2018.
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