Commodities | Nov 28 2016
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Outlook for metals; iron ore outlook becoming more constructive; steel demand; the upcoming OPEC meeting.
-Supply restrictions, economic reductions should boost oil, coking coal, nickel, natural gas and zinc
-Sustained downturn in iron ore pricing looking less likely
-Chinese steel demand improving and more resilient than expected
-Oil market expected to move into deficit in 2017
By Eva Brocklehurst
Goldman Sachs notes that historically, when the US and Chinese output gap closes and inflation begins to rise, this is a buy signal for commodities. Supply restrictions from policy actions should benefit oil, coking (metallurgical) coal and nickel in the near term, while economic reductions should boost natural gas and zinc. The analysts downgrade three and six-month gold price forecasts to US$1200/oz on a stronger cyclical outlook.
Morgan Stanley notes the shock of the US election is now passing and commodity prices are normalising, largely via currency adjustments. The broker suspects the proposal to rebuild US infrastructure is probably bullish for metal trades given the size of the US economy. The US economy currently consumes up to 20% of the world's metal ore supply and was the biggest buyer before China became fully engaged in global trade a decade ago.
The US remains heavily dependent on oil, lead and coal. Nevertheless, Morgan Stanley highlights that any lift in demand growth these particular commodities can probably be met by domestic supply. The broker calculates that a reasonable boost for the US economy would be one where consumption rates lift back to historical highs, which would represent a 2-5% lift in global demand for copper, aluminium, alumina, zinc and lead but little change to nickel.
ANZ's analysts believe a sustained downturn in the iron ore prices looks increasingly unlikely. A combination of seasonally strong steel demand in China and risks for further supplier disruptions could mean the market enters a period of tightness.
Supply-side issues are seen having a greater potential impact on the market. Growth in exports from Australia have been slowing for some time but there are signs the slowdown will accelerate in coming months. Rio Tinto ((RIO)) recently announced it would shut its Hope Downs mine for two weeks in December to reduce operating costs and maximise cash. While a shut-down of this nature will only have a small impact, the analysts note this appears to signal a shift from the strategy of expansion at all costs.
Meanwhile, the potential for further disruptions over the southern hemisphere summer is also higher. The Australian Bureau of Meteorology is forecasting an above average number of cyclones in 2016/17 and the Pilbara coastline has a 63% chance of more tropical cyclones than average.
Goldman Sachs is also more constructive on the iron ore outlook in 2017. Demand has surprised to the upside in China after the credit stimulus earlier this year. Supply, on the other hand, was slow to increase because of delayed capital expenditure and operational challenges.
Besides the fundamentals, a rally in metallurgical coal prices and a weaker Chinese currency, as well as the risk-on sentiment after the US election, have also supported iron ore prices. Goldman Sachs upgrades its iron ore price forecasts for the next three months to US$65/t, six months to US$63/t and 12 months to US$55/t.
From 2018 and beyond, the broker revises up its long-term equilibrium price forecasts to US$45/t from US$35/t. The broker expects Chinese steel demand will weaken in 2018 and the iron ore inventory re-stocking process run into physical constraints. Political uncertainties at the macro level and elevated levels of port inventory at the micro level suggests significant risks to the broker's forecasts, and the high level of volatility seen in the market this year is expected to continue.
Macquarie's latest steel survey from China shows a broader based improvement in demand and sentiment. Domestic orders improved over the past month for Chinese steel mills and, while property and infrastructure demand for steel has eased, a clear improvement has been witnessed in the machinery and automotive sectors.
The analysts note steel mills continue to re-stock raw materials and coking coal inventory is falling on tight supply, while iron ore stocks are flat month on month. Despite the rise in raw material costs, such as iron ore and coking coal, steel mills report they are in positive margin territory and are maintaining stable capacity utilisation rates.
Goldman Sachs also notes steel consumption is more resilient than previously expected and demand for iron ore is likely to be supported by further incremental re-stocking across the steel supply chain.
ANZ analysts expect OPEC (Organisation of Petroleum Exporting Countries) will reach an agreement at next week's meeting in Vienna and observe money managers have been aggressively shorting oil as OPEC members have increased their output. This suggests the market remains unconvinced that the cartel will reach an agreement.
Yet the analysts note comments from various OPEC members signal an agreement is possible. Iran's oil minister has said it was highly probable that members would reach a consensus. OPEC production is near a record high, driven by strong output from Saudi Arabia and smaller members. Nevertheless, the analysts point out that any agreement must take into account Iran's production remains below its peak achieved nearly 10 years ago.
Prices have been trading in a tight range over the past six months, and strong support appears established around US$43-44/bbl. With positioning already so short, even if OPEC fails to reach agreement the analysts expect selling to be relatively limited. Instead, the risks are seen firmly skewed to the upside in the short term, with agreement on production cuts likely to mean prices test the highs seen in 2016, at around US$53/bbl for Brent.
The analysts estimate the market will move into a deficit in the first quarter of 2017, assuming OPEC cuts production by 750,000 b/d in the first half. Without production cuts the deficit would likely be delayed until the September quarter. This is because most members are pushing towards capacity and this should mean limited increases in output in 2017.
Stronger-than-expected demand growth and lower production from high-cost countries increases Goldman Sachs' confidence that the global oil market will shift into deficit by the second half of 2017, even with OPEC production at current levels. Thus, there is now stronger incentive for OPEC producers to halt inventory growth in the first half and normalise the current high level of inventories with a short duration cut to production, in the broker's view.
Goldman Sachs believes a cut to production would help OPEC grow market share by sidelining higher-cost producers and reducing oil price volatility, which would increase the valuation of members' debt and equity.
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