Rudi's View | Oct 19 2017
In this week's Weekly Insights (this is part two):
-Resources Stocks: What's The Problem?
-Big Switch In Market Sentiment
-Insurers Versus Climate Change
-Conviction Calls: Ord Minnett, Shaw, Citi, Morgans
-Rudi's Public Appearances
-Rudi On BoardRoom.Media (Updated)
-All-Weather Model Portfolio
-Rudi On TV
-Rudi On Tour
[Note the non-highlighted items appeared in part one on the website on Wednesday]
Resources Stocks: What's The Problem?
By Rudi Filapek-Vandyck, Editor FNArena
2017 is the first year of global synchronised growth post 2011 and 2018 is expected to at least extend the positive global momentum, so why haven't share prices of miners and energy producers performed better than they have thus far this year?
As per always, investing in commodities and related stocks in the share market is a matter of timing and of perspective. Twelve months ago, BHP's ((BHP)) share price was lingering around the $22 mark, which makes today's share price of around $27, including two dividend payouts in the meantime, look like an excellent performance. But this ignores the fact the share price touched $28 in January.
Rio Tinto's ((RIO)) share price this week set a new high for the calendar year, carried by a strong rally for mining and energy stocks in recent weeks, but many share prices across the sector still remain below share price levels registered earlier in the year.
Another observation is the sector is already now attracting broker downgrades with the likes of Galaxy Resources ((GXY)), Independence Group ((IGO)), New Hope Corp ((NHC)), Orocobre ((ORE)), Perseus Mining ((PRU)), South32 ((S32)), Whitehaven Coal ((WHC)) and Western Areas ((WSA)) receiving downgrades from stockbroking analysts over the past week or so.
Clearly, global growth is not the only factor in play here. In fact, there is but a fair argument to be made that policy changes in China have a more decisive impact on prices for commodities, as again witnessed this month through sharp divergence in iron ore producers performances.
Whereas share prices for BHP and Rio Tinto have rallied strongly since September, the same cannot be said of Fortescue Metals ((FMG)), Mt Gibson Iron ((MGX)) or Atlas Iron ((AGO)). The pronounced difference between both groups can be explained as high quality product producers versus low quality producers of iron ore.
China's policy of winter pollution controls is forcing steel manufacturers in the country to buy higher grade ores (62% Fe). This has in a short time created a price gap of 40% between higher-grade and lower-grade ore. As a result, producers like BHP, Rio Tinto and Vale continue to enjoy highly profitable conditions, but a number of lower grade producers are now underwater and at risk of going out of business.
As Beijing is likely to keep the pollution controls in place until spring next year, this tale of two sharply different dynamics inside the sector might not be resolved anytime soon.
What else should investors be aware of?
This week (18th October) the 19th Chinese Communist Party Congress starts and it is widely assumed President Xi will significantly consolidate his political leadership. After the Congress, Chinese authorities are expected to focus on pollution control and on improving air quality which means government officials are putting the brakes on industrial output. This is why analysts are anticipating a slowdown in Chinese economic activity should soon manifest itself.
Is this bad news for commodities? Not necessarily. China's focus on less pollution will also hit the domestic mining sector. The world will be watching closely, while trying to ascertain the precise impact from Chinese policies. There's a fair chance the shift towards higher product quality, which already is dividing the iron ore industry, might serve as a blueprint for other sectors in the months ahead.
Commodity analysts at ANZ Bank and Macquarie recently stated they expect prices for high-grade iron ore to remain well-supported. ANZ Bank predicts a price of US$70/tonne by year-end (versus below US$60/t last week).
Recent sector updates by analysts all share one common observation: the outlook for aluminium prices has improved significantly. Again, policy measures in China are responsible through smelter curtailments in the country combined with supply discipline from ex-China producers (think Rio Tinto). Deutsche Bank, for one, now predicts global aluminium will remain in deficit through to 2019.
In a recent update on the mining sector, Deutsche Bank analysts showed a notable lack of enthusiasm for investing in the sector, noting mining equities in general appear "fully valued", highlighted by the broker's reiterated Sell ratings for Iluka ((ILU)), Newcrest Mining ((NCM)), Northern Star ((NST)), Regis Resources ((RRL)) and Western Areas ((WSA)).
Deutsche Bank is more optmistic on the outlook for base metals prices than for bulks, and in particular where supply-side cuts and constraints are likely. Deutsche Bank thinks this is the case for metallurgical coal, copper, nickel, zinc and mineral sands. High grade iron ore, predicts Deutsche, should be back at US$70/tonne by mid next year.
In contrast, commodities analysts at Credit Suisse believe the price of alumina in China is peaking and likely due for a sizeable fall in the months ahead. Their view is prices have rallied strongly on the back of Xinjiang smelters restocking, but this will change as destocking follows early in 2018.
As is not uncommon in the sector, commodities analysts at Morgan Stanley do not share this forecast. They predict ongoing support for alumina prices because of tight bauxite supply over the Chinese winter.
Macquarie's team of specialists earlier this month highlighted potential upside risks from the global switch towards Electric Vehicles, including new-technology batteries. The impact is likely most pronounced for cobalt. Even as battery producers are moving away from heavier cobalt loadings, Macquarie still projects global demand to grow by 8.9% CAGR between 2017 and 2022.
For a relatively small market, with primary supply highly concentrated in that top five producers supply more than 50%, and with 60% of total mine output from the as ever unstable Democratic Republic of Congo, Macquarie suggest global cobalt seems poised to experience severe shortages. This should translate into much higher prices.
Macquarie has also become more positive on the price outlook for other lithium-ion battery related commodities nickel and lithium. A recent sector update saw the broker lifting the price target for Clean Teq Holdings ((CLQ)) by no less than 75% to $2.10. Clean Teq is the owner of the Syerston Nickel/Cobalt/Scandium Project in NSW, which the company wants to develop into a low cost supplier of nickel sulphate and cobalt sulphate into the lithium-ion battery market.
In the same vein as Deutsche Bank, Macquarie analysts note 2017 and 2018 should see the best global growth since 2011, which should -all else being equal- prove supportive for commodities. But current strong momentum underpinning global growth should soon be replaced with a slowdown, argues Macquarie, albeit a rather mild one.
This means individual market dynamics will become increasingly important throughout the year ahead. Supply restraints are but the most obvious differentiator, alongside Chinese policy measures.
Macquarie's preferred short for the final quarter of 2017 is thermal coal, primarily because the price is too high for Chinese government comfort, say the analysts. In contrast, aluminium and steel stand to benefit the most from China's winter production cuts. Macquarie is also of the view the US dollar will remain weak. This should boost gold, silver, and platinum.
Current forecasts are for stronger-for-longer prices for zinc and lead, before demand destruction kicks in next year. Macquarie suggests copper looks better further out than short term. LNG remains under threat of a severe price decline, while uranium, simply, is priced unsustainably low.
As with Deutsche Bank, Macquarie's top favourite stock to play the sector is Rio Tinto.
Morgan Stanley analyst Rahul Anand recently returned from a trip through China, Korea and Japan with the notion that heavy government subsidies in China are likely to translate into a noticeable jump in production from the local Electric Vehicles and batteries industry in 2018.
Earlier this month, UBS's update on base metals prices was equally dominated by improved expectations regarding demand for Electric Vehicles, but UBS analysts were equally quick to express their low enthusiasm to jump on stocks including Independence Group and Western Areas, despite higher price forecasts for nickel. Also, UBS sits above market consensus for gold prices in the four years ahead, targeting US$1400/oz but here too preaches caution and restraint.
Stockbroker Morgans took a more company-specific angle in its commodity forecasts update at the beginning of October. While pointing out the economic cycle remains supportive for commodities demand in general, the December quarter is nevertheless seen as possibly triggering a "breather" for the sector.
Equally important is that producers in Australia and elsewhere in recent years have concentrated all their efforts on bringing down operational costs, which means operations are lean and mean and margins are high, with cash flow abundant, but this is where the trend approaches its natural conclusion. To put it in Morgans lingo: the sector has reached peak cost-out.
In this environment, argues the stockbroker, genuine value is harder to find. In terms of stock picks, Morgans suggests investors look for two key elements: whether a company is already holding value-accretive growth, or whether higher prices are not as yet priced in.
Rudi On BoardRoom.Media (Updated)
Audio interview from Tuesday, this time with charts:
2016 – L'Année Extraordinaire
It was quite the exceptional year, 2016, and I did grab the opportunity to write down my observations and offer investors today the opportunity to look back, relive the moments and draw some hard conclusions about investing in the world today.
If you are a paid subscriber to FNArena, and you still haven't downloaded your copy, all you have to do is visit the website, look up "Special Reports" and download your very own copy of "Who's Afraid Of The Big Bad Bear. Chronicles of 2016, A Veritable Year Extraordinaire" (in PDF).
For all others who still haven't been convinced, eBook copies are for sale on Amazon and many other online channels. You'll have to visit a foreign Amazon website to also find the print book version.
All-Weather Model Portfolio
In partnership with Queensland based Vested Equities, FNArena manages an All-Weather Model Portfolio based upon my post-GFC research. The idea is to offer diversification away from banks and resources stocks which are so dominant in Australia, while also providing ongoing real time evidence into the validity of my research into All-Weather Performers.
This All-Weather Model Portfolio is available through Self-Managed Accounts (SMAs) on the Praemium platform. For more info: email@example.com
Rudi On TV
This week my appearances on the Sky Business channel are scheduled as follows:
-Tuesday, 11.15am Skype-link to discuss broker calls
-Thursday, 1pm-2pm, Trading Day Live
-Thursday, between 7-8pm, interview on Switzer TV
-Friday, 11.15am Skype-link to discuss broker calls
Rudi On Tour
– I will be presenting in Adelaide on November 14th to members of Australian Investors Association and other investors, 7pm inside the Fullarton Community Centre, 411 Fullarton Rd, Fullarton. Title of presentation: Investing In A Slow Growing World – An Update
(This story was written on Monday and Tuesday 16th & 17th October, 2017. This first part was published on the day in the form of an email to paying subscribers at FNArena, and again on the following Wednesday as a story on the website. This is Part two).
(Do note that, in line with all my analyses, appearances and presentations, all of the above names and calculations are provided for educational purposes only. Investors should always consult with their licensed investment advisor first, before making any decisions. All views are mine and not by association FNArena's – see disclaimer on the website.
In addition, since FNArena runs a Model Portfolio based upon my research on All-Weather Performers it is more than likely that stocks mentioned are included in this Model Portfolio. For all questions about this: firstname.lastname@example.org or via the direct messaging system on the website).
BONUS PUBLICATIONS FOR FNARENA SUBSCRIBERS
Paid subscribers to FNArena (6 and 12 mnths) receive several bonus publications, at no extra cost, including:
– The AUD and the Australian Share Market (which stocks benefit from a weaker AUD, and which ones don't?)
– Make Risk Your Friend. Finding All-Weather Performers, January 2013 (The rationale behind investing in stocks that perform irrespective of the overall investment climate)
– Make Risk Your Friend. Finding All-Weather Performers, December 2014 (The follow-up that accounts for an ever changing world and updated stock selection)
– Change. Investing in a Low Growth World. eBook that sells through Amazon and other channels. Tackles the main issues impacting on investment strategies today and the world of tomorrow.
– Who's Afraid Of The Big Bad Bear? eBook and Book (print) available through Amazon and other channels. Your chance to relive 2016, and become a wiser investor along the way.
Subscriptions cost $380 for twelve months or $210 for six and can be purchased here (depending on your status, a subscription to FNArena might be tax deductible): https://www.fnarena.com/index2.cfm?type=dsp_signup
(Do note that, in line with all my analyses, appearances and presentations, all of the above names and calculations are provided for educational purposes only. Investors should always consult with their licensed investment advisor first, before making any decisions.)
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