Material Matters: Iron Ore, Aluminium & Gold

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A glance through the latest expert views and predictions about commodities. Iron ore; aluminium; copper; and gold.

-Many drivers contributing to the widening spreads in iron ore
-Aluminium market seen shifting to deficit out to 2019
-Are copper investors getting ahead of the data?
-Some gold stocks still have value despite rally: Deutsche Bank

By Eva Brocklehurst

Iron Ore

UBS outlines numerous factors affecting the iron ore market at present, and the spread between low and high quality iron ore. Despite gyrations in the iron ore price, the spread between low and high grade iron ore has moved between -35% and -45%, suggesting this increasing spread could be more structural than cyclical.

Strong domestic growth in China has meant steel production is elevated this year and demand for an iron ore has remained strong. The Chinese government crackdown on polluting and idle capacity commenced last year in earnest and Chinese steel makers are looking to maximise output per tonne of input. Hence, higher grade is being sought.

To meet this demand Australia and Brazil are lifting supply, while India is lifting low-grade supply. Even the Indian monsoon, which means exports drop away, limited the spread decline to -35%. It is now back out at -43%. This suggests there are many drivers contributing to the discounts being seen in the market.

Macquarie takes a look at the niche segment, lump, and suspects panic by by Chinese mills following government-led sinter production cuts has meant the premium is well above equilibrium. Lump is a coarse type of iron ore that can be charged directly into the blast furnace. This typically trades at a premium compared to the benchmark iron ore fines price because it saves steelmakers the cost of sintering.

Seaborne supply of lump accounts for less than one fifth of the total seaborne iron ore market and the market is dominated by Australian producers. Rio Tinto ((RIO)) and BHP Billiton ((BHP)) control more than 60% of the market. The broker believes Chinese government induced cuts to sintering are the major driver behind the current rally in lump prices.

Macquarie forecasts the lump premium to stay above equilibrium premium of US$10/t for the rest of the year, although suspects any expansion above US$15/t will be short-lived. Yet, even if restrictions to sintering stay in place in the December quarter, the broker expects a correction in mill profitability, and thus a reduction in crude steel production, should soften demand.

Aluminium

Deutsche Bank expects the global aluminium market to shift into material deficit in the second half of this year and hold this state through to 2019. On the back of a tighter market the broker upgrades aluminium price forecasts by 11% for the second half, to US$0.85/lb, and by 12% for 2018, to US$0.94/lb. The broker expects prices to be well supported until the end of the Chinese heating season reductions in March next year.

Deutsche Bank observes a shutdown of the legal smelting capacity in China is accelerating. A total of 5.7mt of illegal capacity across three provinces has been identified, with around 1.4mt Xinjiang and 1.6-2.1mt in Shandong already closed. The broker does not expect major Western re-starts apart from Alcoa's Warrick smelter, Rusal's Taishet and Vendanta's Jharsuguda expansion. Deutsche Bank lifts 2018 expectations for the global aluminium producers and upgrades Alcoa to Buy.

Copper

Strong economic data and solid supply and demand fundamentals have supported a rally in copper. Yet Goldman Sachs, in looking at the historical relationship between copper and global growth, suggests copper is above fair value. Futures positioning also suggests the copper investors are getting ahead of the data. Goldman Sachs expects lower copper prices over the next 6-12 months, although momentum and technical suppose upside risks in the near-term.

The broker's preferred copper exposure is OZ Minerals ((OZL)), given its long-life portfolio. Planned expenditure should deliver a broadly flat production profile over the next decade and a 13% return, which can be achieved while the company still maintains dividends in line with 2016.

Sandfire Resources ((SFR)) has a project in the wings at Monty and first copper is forecast for 2019. Yet even with the Monty feed, the current ore reserves indicates that DeGrussa is likely to have an end-of-mine life at around 2022. The broker notes there is yet to be a major extension discovery in the region. While the stock screens well on multiples and has a strong free cash flow, the broker's concerns mean a Neutral rating is maintained.

Gold

The ASX gold index has risen 15% since the start of reporting season and now the sector appears fully valued, in Deutsche Bank's view. The broker incorporates a proposed 3.75% WA state royalty into its forecasts and believes this will be a marginal drag on sector valuations. Across the broker's coverage, value is still envisaged for St Barbara ((SBM)) and OceanaGold ((OGC)). Alacer Gold ((AQG)) and Dacian Gold ((DCN)) are also screening cheap as their projects develop.

The broker downgrades Evolution Mining ((EVN)) to Hold and Newcrest Mining ((NCM)) and Northern Star Reasources ((NST)) to Sell, on valuation. Deutsche Bank notes mostly stable gold prices throughout FY17 and steady operating performances have resulted in profits being in line with expectations, amid strong cash flow and a strengthening balance sheet.

The broker also notes gold has regained its safe-haven status this year, with the mood shifting in early July when market expectations of the fourth US rate hike began to fade and the US Federal Reserve took a more dovish stance. This was exacerbated by rising political tensions on the Korean Peninsula.
 

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