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Material Matters: Zinc, Iron Ore And Oil

Commodities | Jan 17 2018

A glance through the latest expert views and predictions about commodities. 2018 outlook; zinc; iron ore & steel; coal; aluminium; nickel; oil; and Australian miners.

-Mining and energy commodities expected to peak in current quarter
-Zinc market should become more balanced towards end 2018
-Iron ore and steel prices expected to retrace from March
-China likely to boost local production of coal
-Crude prices expected to head lower over 2018

By Eva Brocklehurst

Commodity prices have continued to rally into 2018 amid a synchronised improvement in the global economy and re-accelerating demand in China, but appear set to retrace as the year gets underway.

Commonwealth Bank analysts observe demand conditions are presenting better than many predicted, in spite of the reduction in industrial activity from the northern winter. This has supported iron ore and coal to a much greater extent than the metals.

The analysts suspect most mining and energy commodities will experience a peak in the current quarter before sliding lower once the Chinese New Year holiday is over in March.

The main upside risk to forecasts, the analysts believe, is another year of aggressive supply-side reform in China, which would affect aluminium, alumina and steel the most. Oil prices are expected to fall as the OPEC-led deal fails to draw down stockpiles to the five-year average.

Deutsche Bank expects global demand to improve, even with a softening Chinese property market. The broker also envisages 2018 as a year in which M&A accelerates in the mining sector. Base metals appear more attractive to the broker versus the bulks.

There appears to be upside risk to demand from China and Southeast Asia in terms of infrastructure and machinery and a weaker US dollar is also expected to be positive for commodities because of upward pressure on marginal costs.

Deutsche Bank retains a preference for aluminium, nickel, zinc and copper miners. The CBA analysts expect most mining and energy commodities will peak this quarter. Supply is expected to respond to higher prices, while demand will slow slightly in China.

Zinc

Zinc prices have retreated on the London Metal Exchange, breaking a month-long run to the upside, and Macquarie, having flagged the current quarter as the peak for zinc prices for some time, assumes demand destruction and new mine supply will confront the structural deficit.

Fresh 10-year highs were hit briefly, at US$3400/t, accompanied by a steady draining of LME warehouses, although the broker points out that the LME is not the only location for zinc stockpiles globally.

The latest data signal that a large percentage of recent Chinese imports came from Spain, from what the broker suggests is a re-positioning of some of Glencore's Asturianas material to the bonded arena. Hence, a short-term pullback for zinc is seen becoming more likely, before a renewed pick up in Chinese galvanising activity and seasonal demand in March.

Timing is critical, the broker warns, and later in the year an orderly unwinding of fundamentals on either side of the supply/demand equation should ensure the market becomes more balanced.

Glencore appears committed to reintroducing tonnage carefully, while Chinese mine supply has struggled to grow. Macquarie observes many other new entrants have challenges which may result in weak initial output.

On the demand side, galvanising (60% of demand) appears undisturbed by price levels and there are few appropriate substitutes for chemicals (9%), while brass demand (11%) remains more a function of copper prices and fashion.

Iron Ore & Steel

Deutsche Bank's base case in 2018 is for flat steel demand and a modest -1% reduction in seaborne demand for iron ore. Seaborne supply is expected to increase by around 2%, mostly stemming from increases in production from the major miners.

This should increase the market surplus to around 65mt, even with further reductions in Chinese domestic iron ore production. Chinese steel production is expected to increase from March, and both steel and iron ore prices are expected to retrace from current levels.

Deutsche Bank lifts its 2018 benchmark iron ore price forecasts to US$66/t but reduces lump forecasts to US$78/t.

The CBA analysts anticipate iron ore prices will ease later on this year amid concerns about a surplus. Chinese iron ore supply, the most expensive in the world because of its low-grade, will be key to this outcome. If prices stay as high as they did in 2017, the analysts suspect China's iron ore output may lift again.

With the seaborne market expected at 30-50mt in 2018, global steel production would need to rise 2-3% to absorb the additional tonnage. This may not be impossible, but the analysts anticipate China's steel demand will slow and weigh on expectations for global steel output to increase this year.

The analysts believe steel margins will dictate the price action for iron ore, once output restrictions for steel are lifted by mid-March. They expect the premium being paid for higher grade ore will ease from current levels but emphasise that the broad preference for higher grade ore is a structural change to the market.

Coal

The CBA analysts expect import demand for coking coal in China to wane, amid a recovery in local production. With spot prices at US$260/t, the Chinese steel mills are expected to look for cheaper domestic product, and this will incentivise new production. The analysts expect coking coal prices will weaken in 2018 while they upgrade near-term forecasts to reflect the recent surge in prices.

Meanwhile, thermal coal prices have also picked up in response to strong heating demand in China during a cold winter, but should reverse once the weather subsides. Thermal prices are expected to average US$82/t, above the price level that policy makers are targeting but below spot levels. The analysts suggest the impetus remains strong for China to boost its domestic supply.

Aluminium

CBA analysts find enough evidence to suggest the supply of aluminium is adequate, despite the risk of significant cuts to production. They expect prices will trend lower from current levels as Chinese demand weakens and the market realises there is enough physical aluminium in the market.

Nickel

Downside pressure is seen building on nickel prices in 2018 because of surpluses in the nickel ore and nickel pig iron market. The CBA analysts expect battery demand to be an important driver at some point for nickel but consider it too early for this to affect nickel prices, and the shortage story is likely to be one for the next decade.

Australian miners

Deutsche Bank considers the Australian mining sector fairly valued, given its commodity prices outlook, but attractive on a enterprise value/EBITDA and free cash flow yield basis versus historical averages. The broker is positive for both Rio Tinto ((RIO)) and BHP Billiton ((BHP)), citing improving shareholder and group returns along with production growth.

For base and precious metals the broker flags Sandfire Resources ((SFR)), OceanaGold ((OGC)), Alacer Gold ((AQG)) and Dacian Gold ((DCN)). Deutsche Bank has a Sell rating for Newcrest Mining ((NCM)), Northern Star ((NST)), Regis Resources ((RRL)), Independence Group ((IGO)) and Western Areas ((WSA)).

OceanaGold is upgraded to Buy while St Barbara ((SBM)) and Independence Group are downgraded to Hold and to Sell respectively, on valuation.

Oil

The CBA analysts upgrade crude forecasts to reflect the sharp rise in prices, as Brent recently touched a three-year high of US$70/bbl. Nevertheless, they believe prices are likely to head south from here.

Compliance among OPEC and allied countries in terms of production cuts may falter at current prices. Moreover, despite the US shale sector promising to focus on returns and developing assets, the availability of capital and rising prices could mean production grows strongly. The analysts suggest US supply may surprise on the upside if prices remain near spot levels.

The main bullish risk for oil prices this year are geopolitical tensions. A dispute between the Iraqi Kurds and the local government has already sidelined some oil. Friction between Iran and Saudi Arabia and growing anti-Iran sentiment in the West are also issues. Re-instating sanctions on Iran would put at risk nearly 4% of global oil supply.

The analysts suggest the only hope for oil prices to rally further is demand growth but remain sceptical as to whether this will save the market from a surplus by the year's end.

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