Material Matters: Gold, Oil, Coal & Iron Ore

This story features NEWCREST MINING LIMITED, and other companies. For more info SHARE ANALYSIS: NCM

A glance through the latest expert views and predictions about commodities. Gold stocks; oil; coal; and iron ore.

-UBS forecasts company-specific catalysts to drive gold stocks
-Oil inventories may not reach five-year average
-Coal supply to lift in 2018 and demand expected to shrink
-Bearish outlook for iron ore prices
 

By Eva Brocklehurst

Gold Stocks

UBS observes the three main ways to gain exposure to gold on the ASX100 are via Newcrest Mining ((NCM)), Evolution Mining ((EVN)) and Northern Star Resources ((NST)). In balancing the risk/reward outlook, the broker's preference is for Evolution Mining, giving it a Buy rating. The broker remains neutral on the outlook for gold and believes catalysts that are stock-specific will drive performances over the next 12 months.

The stock has recently outperformed heavyweight Newcrest but this is mostly a reflection of Newcrest weakness following the specific seismic event at Cadia. The broker nevertheless believes Evolution can re-rate towards Newcrest's valuation, all things being equal. It will take time, nonetheless, for foreign investors to familiarise themselves with the stock and for local fund managers to overcome their Newcrest fixation, the broker suggests. UBS has lifted its target to $2.70 from $2.59.

While there are a few catalysts for Evolution Mining on the horizon, the broker suspects this is a good aspect, as the company's diversified portfolio reduces the impact from any potential upset to operations.

For Newcrest, UBS suspects the use of stockpiles masks the pace of the return to full production at Cadia, after an earthquake crimped production. The broker expects nameplate production by late this year. The stock remains a best proxy in the ASX100 for gold, in the broker's opinion. However the market historically values Newcrest with a -5% discount (mining risk) but the broker believes -10% is more appropriate given longer term concerns at Lihir. The broker suggests -10% is conservative, but -5% is too generous. If the broker assumed -5%, its valuation would rise to meet the current share price.

UBS thus retains Sell, despite Newcrest being Australia's "go-to" gold name. Aside from Lihir issues, Cadia is still out. The broker nevertheless lifts its target to $12.98 from $12.68.

UBS recently initiated on Northern Star with a Sell rating and is convinced the shares are fully priced. With a growing proportion of the company's output coming from lower grade surface material and most of its resources attributable to underground, the broker wonders if the latter ounces will be commercialised sooner rather than later.

Oil

Morgan Stanley suspects oil inventories will not reach their five-year average. Saudi Arabia has suggested bringing stock levels back to the five-year average as an objective for OPEC. The broker agrees that bloated inventories are maintaining pressure on oil prices but does not believe a return to normal levels is likely.

Nevertheless, the seasonal upswing in demand suggests inventories will decline throughout the rest of the year before a reversal in 2018, as strong growth from US shale should coincide with rising production from OPEC and Russia after the expiry of the current output agreement in the March quarter.

The broker does not expect OPEC to flood the market but, on current trends, even a partial unwinding of production cuts should mean the market is oversupplied again next year. Morgan Stanley estimates OPEC would need to continue with its current quota for the whole of 2018 to prevent an increase in inventories, or would need to cut much deeper to get inventories back to five-year averages.

Coal

Morgan Stanley observes the spot price for thermal coal's top grade product, Newcastle, at US$85.50/t has converged on the FY17 contract price that was settled last month. The broker suspects re-stocking in China has kicked spot prices along, helped by the fact that China is still stabilising its local output after previous reforms.

The broker expects these trading conditions to reverse in 2018, as supply lifts on higher prices and demand shrinks on a withdrawal of China/India from global trade, subsequently undermining prices.

Morgan Stanley flags the fact that seaborne thermal coal trade is heavily dependent on the import demands of China and India. Together these two countries account for almost 40% of globally traded thermal coal. Yet both are, in fact, largely self-sufficient in coal. Furthermore, the broker suspects China's reform of its industry and India's expansion of its resources may prompt a sustained withdraw from the global trade.

Macquarie raises its medium-term price forecasts for thermal coal by 4-9%. This reflects a view that a US$65/t spot price will now be sufficient to displace marginal Indonesian production. The broker reduces second half 2017 coking (metallurgical) coal forecast by -7-11% on the back of a faster-than-expected supply response but raises long-term forecast by 9% to US$125/t to reflect changes to modelling.

Iron Ore

Higher shipping rates and widening product discounts affect Macquarie's estimates for iron ore stocks and material downgrades are made to earnings estimates for Fortescue Metals ((FMG)) and Mount Gibson ((MGX)). The broker now expects Fortescue to report a realised price below 70% of benchmark for the June quarter.

Citi downgrades average estimates for 2017 iron ore prices to US$61/t from US$70/t, which reflects a reduction in the second half price forecast to US$49.50/t from US$62/t. The broker notes prices have slumped despite steel prices/margins remaining healthy.

After a surplus in 2016, port inventories have built to over 440mt and, with further low-cost supply coming on board, the broker is bearish on the outlook for iron ore, as prices need to go below US$50/t to shut down high-cost domestic Chinese and other supply which has re-started. The broker also notes discounts for lower grade ore have also widened as mills prefer higher grades in order to maximise production and take advantage of rebar margins.

Ongoing environmental pressures favour higher grade ore. The broker does not expect the larger discounts to be structural but suspects the cyclical component may hang around until port inventory is reduced, high-grade supply increases and margins are normalised.

Citi downgrades Fortescue to Sell and reduces the target to $3.90 from $5.80. The broker forecasts a realisation of 65% of benchmark in the June quarter with an FY17 average of 79%.

With the exception of cobalt, manganese and zinc Macquarie's 2018 forecasts are largely unchanged. Marking-to-market prices across base metals reduces the broker's June quarter forecasts for copper, zinc and lead by -8%, -11% and -10% respectively. Small upgrades are made to alumina, aluminium and gold.

Cobalt continues to surprise on the upside and the broker raises 2017-18 forecasts by 11-20%, and long-term prices by 32% to US$16.50/lb. The broker upgrades its estimates for lithium in the longer term, with a 19% increase to 2021 forecasts.
 

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