Material Matters: Miners, Zinc, Gold & Oil

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A glance through the latest expert views and predictions about commodities. Oz miners; zinc; gold & gold miners; and oil.

-Ord Minnett suggests Oz miner valuations approaching fair value
-Zinc deficit likely to continue, amplified by the supply side in China
-Several factors push gold into a higher price range
-Are techniques used in forecasting oil prices overly simple?
 

By Eva Brocklehurst

Miners

Australia's mining sector has outperformed the ASX200 by around 10 percentage points over 2017, Ord Minnett observes. Miners are doing well, with strong free cash flow yields and under-geared balance sheets. Nevertheless, the broker considers the risk/reward more evenly balanced now, as commodities are close to peak cycle levels and this is not sustainable. Valuations are also broadly approaching fair value. Share prices could be vulnerable to sector rotation heading into 2018.

Despite factoring in material upgrades to copper and nickel next year the broker's forecasts are generally below spot across the base metals and bulks. Chinese momentum is fading and Ord Minnett observes late-cycle indicators in base metals. On a relative basis, the broker prefers copper and zinc as well as gold over the bulks such as iron ore and coal, and over aluminium and nickel, which are both driven by the 2018 supply outlook.

BHP Billiton ((BHP)) is preferred ahead of Rio Tinto ((RIO)) given a more favourable commodity mix and potential asset sales. While constructive on Alumina ((AWC)), the broker downgrades South32 ((S32)) to Hold from Buy following recent share price gains.

Ord Minnett suggests the Chinese winter heating season may be a negative catalyst for Fortescue Metals ((FMG)) in the next 3-6 months. In gold, Evolution Mining ((EVN)) is preferred over Newcrest Mining ((NCM)) and the broker also likes OceanaGold ((OGC)) and St Barbara ((SBM)).

Zinc

The zinc deficit will continue, even though, over the next few months, Glencore is likely to re-start mines that were curtailed more than two years ago. ANZ analysts make this call noting that, while the Glencore closures of over 500,000t of capacity in late 2015 pushed the market into deficit, supply side issues in China amplified it.

Environmental and safety-related concerns have resulted in zinc mine production falling -10% in 2017. The decline appears to have accelerated recently, while underlying demand has been picking up. China has relied on concentrate imports, that are up 22% year-on-year.

There has also been upside from the automotive sector this year and the latest data shows sales accelerated in September, which should mean demand for zinc remains strong. Hence, the analysts suggest the zinc market will not move back into a more balanced position until other projects, such as Gamsberg in South Africa and Dugald River in Australia, ramp up in 2019.

Gold & Gold Miners

Citi observes geopolitical tensions have moved gold towards a higher-for-longer price range. US interest rates are expected to be range-bound and this is coupled with a softer trajectory for the US dollar, all supporting gold. Industry is reaping the benefits of past expansion, generating significant cash flow.

Citi suspects there are insufficient new projects for expenditure and is sceptical of attempts to grow through acquisition, wary of miners that do not have an internal path to growth, particularly if production is falling. A lift in dividends and share buybacks is expected.

The broker's top picks include Evolution Mining, as it has diversified, low-cost operations in stable jurisdictions and compares favourably to the global majors. Value is concentrated in long-life assets and the company will reach a net cash position only in FY19, which reduces the capacity and need for, potentially poor, acquisitions.

Resolute Resources ((RSG)) is also rated highly and successful de-risking of all growth projects in the next few years could create significant value. The broker notes the long history of developing and operating mines and has confidence in current management. The company trades at a higher geographical risk because operations are in West Africa but this perception may soon be turned on its head, in the broker's opinion.

In general, Macquarie notes gold price volatility remains exceptionally low. The broker recently visited the Fosterville gold mine in Victoria, and notes the promising increase in grade with depth. Significant exploration upside exists down dip of underground reserves.

Regional exploration prospects are also strong as previous ownership undertook very little sulphide targeting below the old oxide pits. The mine is owned by Kirkland Lake ((KLA)), a Canadian company that listed this month on ASX.

Northern Star ((NST)) has also recently presented to shareholders, revealing drilling success at Jundee and Kalgoorlie. The company has highlighted a pathway to 600,000 ounces per annum production across a group. A two-year toll treatment agreement has been signed at Kalgoorlie to process ore from the Millennium mine.

Macquarie also notes suggestions by management that organic production potential could exceed 600,000 ounces per annum with increased milling capacity at the two centres.

Oil

Deutsche Bank finds the techniques used in forecasting oil prices too simple. Switching from monthly average contango (upward sloping) to backwardation (downward sloping) is historically followed by a rising price, and the reverse by a falling price. Along with this, average analyst forecasts tend to undershoot the oil price.

Using the historical average oil price premium to analyst forecasts, the broker believes simple calculations would support the argument that next year's average Brent price would be US$66/bbl.

Yet for four years running, Deutsche Bank notes the unusual occurrence where forecasts have exceeded the actual average Brent price for the year and analysts have overestimated Brent crude by around 2%.

However, assuming Brent averages US$63.11/bbl next year this returns the analysis to the more customary excess of actual prices above forecasts, by around 11% in this case. Deutsche Bank also highlights that the bias is not explained away by undersupply, as the oil market was in deficit for only eight of the 19 years between 1999 and 2017.
 

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