Material Matters: Iron Ore, Steel And Gold

This story features RIO TINTO LIMITED, and other companies. For more info SHARE ANALYSIS: RIO

A glance through the latest expert views and predictions about commodities. Iron ore; steel; coal; gold; mining strategy; and Myanmar Metals.

-Price curve continues to favour high-grade iron ore producers
-Steel prices likely to improve but not re-gain 2017 heights
-Gold prices likely to move in line with US dollar until mid 2019
-Firm commodity prices underpin UBS' overweight strategy on miners
 

By Eva Brocklehurst

Iron Ore

Citi believes quality dominates among iron ore producers. Using a basic iron ore cost curve is not a particularly accurate way to compare producers and the broker takes into account a large number of of factors such as ratios of fine/lump, grades, costs, maintenance, and transport to make more meaningful comparisons.

The outcome indicates that the break-even price curve continues to favour high-grade producers. The curve has shifted lower, mainly based on the quality of premiums being received, but also falling freight rates which have offset inflation pressures. Vale is the biggest beneficiary of the broker's analysis.

Citi retains a Buy rating for Rio Tinto ((RIO)) amid continued upside risk to estimates from spot commodity prices, particularly iron ore. China's environmental curbs have also resulted in the premium for a higher grade ores remaining elevated. While premiums are record levels, Citi believes demand for higher grade ore will moderate and low-grade supply balance will improve with capacity additions.

Deutsche Bank's visit to China has confirmed that some mills are switching to lower-grade 58% iron ore. Modelling for Chinese mills shows an extra RMB100/t in gross profit margins can be obtained by using more 58% iron ore in feed and a further drop in the rebar price, currently RMB3400/t, would accelerate the switch, in the broker's opinion.

This would be incrementally positive for Fortescue Metals ((FMG)). However, Deutsche Bank points out that steel output is boosted by around 5% when using higher-grade iron ore and environmental concerns also influence decision making.

Steel

Credit Suisse notes downstream demand for steel has finally kicked off in China, as evidenced by trader stocks falling for two weeks. The drawdown started a full month later than in 2017 and the delay caused an erosion in the steel price.

Macro factors suggest steel demand should remain solid in 2018 and the broker cites a senior NDRC economist who has indicated China's infrastructure expenditure will be up 15% and housing supply should remain robust. Nevertheless, steel prices are starting from a lower base this time, which may prevent them regaining last year's heights.

The broker also notes support for a weaker 2018 outlook comes from the possibility that Chinese steel exports may be blocked by other countries following the lead of the US. If this leads to a Chinese steel glut then steel and iron ore prices may soften.

Coal

Coal trains have commenced re-loading at key coking coal ports in Queensland as Tropical Cyclone Iris subsides. Hay Point has started unloading trains and Dalrymple Bay and Abbot Point are expected to begin unloading shortly. The ports were closed Tuesday, despite the cyclone never making landfall. Commonwealth Bank analysts expect the impact on coking coal markets to be minimal.

Gold

The prospect of a potential trade war between China and the US has helped safe-haven demand for gold, as has the weaker US dollar. US 10-year real yields usually have a strong inverse relationship with gold prices but Commonwealth Bank analysts note this once reliable relationship has broken down recently. The last time the correlation diverged was in 2012.

The analysts observe, surprisingly, the US dollar has emerged as a more reliable correlation with gold prices over the last six months. The analysts suspect gold prices will move in line with the US dollar until mid 2019. After that, US 10-year real yields are expected to become the primary driver of gold prices once again.

Commonwealth Bank analysts upgrade gold price forecasts amid expectations for a weaker US dollar. The gold price is now expected to steadily lift to US$1380/oz by mid 2019.

Mining Strategy

Miners have been able to repair balance sheets, thanks to strong commodity prices in the March quarter, UBS observes. The quarter produced a good return to shareholders in the form of dividends and buybacks as a result.

While cost pressures are forecast to increase for raw materials and labour the broker suspects a firm commodity pricing environment will offset the impact. Most projects being approved, or developed, focused on supply replacement rather than growth.

UBS remains confident in investing in lithium/graphite producers, despite the teething problems. The broker is also watching the geopolitical scene, given a number of announcements made regarding longer-term power and tax issues, such as at Oyu Tolgoi in Mongolia, Rio Tinto's likely equity reduction at Grasberg (imposed by Indonesia), and any impact from US-China trade tensions.

The broker's overweight call on miners is predicated on no trade war occurring. Preferred exposures include BHP Billiton ((BHP)) and Iluka Resources ((ILU)).

Myanmar Metals

Myanmar Metals ((MYL)) has an option to acquire a majority stake in the Bawdwin mine in Myanmar, which Argonaut regards as the best under-explored poly-metallic asset globally. Large-scale mining at the site ceased during World War II leaving intact a high-grade core resource of silver, lead, zinc and copper.

By exercising its option in May, Myanmar Metals would gain a 51% majority stake and operate the mining concession. Argonaut has a Speculative Buy rating and $0.25 target on the stock.

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

Click to view our Glossary of Financial Terms