Commodities | Nov 10 2016
This story features RIO TINTO LIMITED, and other companies. For more info SHARE ANALYSIS: RIO
Outlook for metals; downside risks diminish for Oz miners; oversupply in aluminium; thermal coal set to weaken; strengthening in pigment markets.
-Macquarie not expecting resurgence in growth projects for metals in the near future
-Capital management potential opening up for Rio Tinto, inevitable at South32
-Increasing evidence suggests thermal coal price may be peaking
-Ord Minnett unable to identify positive catalyst for zircon
By Eva Brocklehurst
Macquarie believes prices for most metals and bulk commodities are now at a level where producers are making money, given the cost reductions that have occurred over the past year. In many cases current prices are near, or below, the broker's long-run forecasts, most notably base and precious metals. As a result Macquarie does not expect a resurgence in growth projects in the near future.
There are three major metals on which more than 10% of the market is still making losses. Even with the price moving back above US$5000/tonne, a proportion of copper supply does not break even, notably the smaller mines in Chile and Chinese domestic output.
In nickel, despite strong gains recently, a substantial portion of global output cannot cover cash costs, on the broker's analysis. Much of this is because the nickel price is being anchored by the cost of nickel pig iron production in China. Uranium, with the spot price moving below US$20/lb, is the only market where increased supply loses money now compared with back in January.
In bulks, coal and manganese prices are well above the level Macquarie would expect to incentivise new projects. Nickel, copper, uranium and platinum group metals, meanwhile, are below the broker's long-run expectations. Many others, including zinc and gold, are only just above. The broker notes marginal units of iron ore have come back into the market, with both Chinese domestic output and China's imports from small suppliers recovering.
The most spectacular turnaround story for 2016 is coal, Morgan Stanley notes. The broker believes the next few weeks are critical as trade flows typically leap 20-50% in November to December. Prices should then fall. Other price winners of the year include steel and most of its raw materials.
The broker notes China's credit-backed, steel-intensive infrastructure programs have pulled 40-50m tonnes more crude steel into the construction industry and the typical pull-back in September to October has been delayed.
Morgan Stanley still expects this pull-back to occur by mid winter but the impact will probably be mitigated by positioning for another year of stable steel production in China. The broker remains a bull on nickel and zinc because of tight supply and subdued about aluminium and copper, as global supply growth exceeds China's moderating demand.
Credit Suisse observes, after China returned from its Golden Week holidays, there was a break out in iron ore, coal and nickel prices. The broker believes downside risks have diminished and there is a positive skew for Australian miners' earnings. While the bears will argue China has too much stimulus and there is a risk policy settings will now tighten too aggressively, the broker believes the balance of risks remains reasonable.
Credit Suisse also expected steel input prices would have eased by now, as production slows ahead of reduced construction in the Chinese winter. Instead prices are climbing as buyers readily accept higher prices, which the broker believes points to strong demand preventing a glut of materials. The rally in commodity prices is envisaged to be strong enough and last long enough to banish balance-sheet concerns for Australian mining names.
Valuations are considered to be around fair value, based on an average of the broker's base, upside and downside cases. The broker believes capital management possibilities are once again, opening up for Rio Tinto ((RIO)). Capital management also seems inevitable for South32 ((S32)).
National Australia bank analysts expect the aluminium market to be shaped by significant capacity additions in China's north-western region, where there is access to coal mines and lower cost electricity. This is despite the industry being singled out by the Chinese government in its new five-year plan for the non-ferrous metal sector as having severe over-capacity.
The analysts expect demand growth in China will continue to slow and growth in the rest of the world is unlikely to be fully offsetting over-supply. The run up in premiums has now reversed and the analysts note inventory levels at various London Metal Exchange locations have been on the decline. Premiums now more closely reflect underlying supply and demand factors.
They do flag some positive long-term trends for demand, such as increasing use of aluminium in car manufacturing and use of aluminium wire in preference to copper in the power sector. Overall, the analysts forecast a well-supplied market in 2016 and 2017, with prices averaging US$1595/t and US$1670/t respectively. In 2018 demand prospects may improve and a higher average price is forecast of US$1740/t.
Macquarie examines high-frequency port data which indicates thermal coal production run rates have increased materially. Rail deliveries into northern Chinese ports are now running at rates that are higher than when the 276-day rule was first implemented. The strength of the coal price over the past month has been underpinned by scepticism that the Chinese were actually raising production. The market is also suspicious that supply will be large enough to fill the entire deficit.
The broker has increasing evidence which suggests thermal coal prices may start to roll over. Any normalisation of coal markets will be determined by China, as its domestic market is 2.5 times the size of the whole seaborne market. While the data is not directly applicable to coking (metallurgical) coal, Macquarie continues to favour being long metallurgical coal versus short thermal coal exposure.
This is because the Chinese government appears to be more concerned about the effects of rising thermal coal prices than it is about steel-maker margins. Also, the seaborne thermal coal market is relatively more flexible in terms of supply compared with the seaborne coking coal market.
Ord Minnett observes strengthening pigment markets are likely to flow through to titanium dioxide while the prices for sulphate ilmenite have started to move higher. Commentary from the TZMI conference about zircon markets was more subdued than expected, with most participants expecting a surplus over the next two years. The broker has strengthened its view that titanium dioxide feedstock markets will improve.
The sulphate ilmenite market is observed to be moving into deficit from a surplus, with positive price momentum set to continue. Chinese domestic ilmenite tonnage has fallen and this is a key driver of the rise in domestic prices over the last six months and an opportunity, the broker envisages, for ilmenite importers such as Base Resources ((BSE)).
In zircon, half of the projects under development that were analysed by TZMI have an inducement price below US$1000/t, which indicates to the broker that long-term consensus zircon pricing could be optimistic. On the other hand, Iluka Resources ((ILU)) believes zircon demand may be underestimated. This is because some market participants are not factoring in the movement in inventories.
Illuka believes it holds over half the world's zircon inventory and does not plan to release this until market conditions are appropriate. At the conclusion of the conference, Ord Minnett came away positive about titanium feedstock prices the near-term, with miners exposed to sulphate ilmenite particularly likely to benefit. The broker was unable to identify a positive catalyst for zircon.
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