Material Matters: Metals, Iron Ore And Oil

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A glance through the latest expert views and predictions about commodities. Metals; copper; gold miners; iron ore; and oil.

-Solid value envisaged for metal producers despite escalating trade tensions
-Continued deficit likely for copper market in 2018
-Gold sector is now benefiting from strong balance sheets and cash
-Iron ore premiums may ease but unlikely to revert to historical levels
-US bottlenecks suggest crude demand likely to exceed supply in 2019
 

By Eva Brocklehurst

Metals

Ord Minnett suggests macro indicators are robust for the metals sector, despite escalating trade tensions and a pullback in prices. Solid value is envisaged at spot prices as most stocks are averaging yields of 10%-plus amid earnings multiples that are typically 5x or lower, and there is negligible debt.

The broker does not expect US/China tensions will cause a material decline in commodity demand. Global steel production is robust and improved credit conditions are expected in China in the second half of 2018. Overall, the broker considers the recent sell-off offers an attractive entry point.

Ord Minnett lifts long-term metal price forecasts with the main changes including nickel, up 10%, copper, up 12%, aluminium, up 9%, alumina, up 20% and zinc, up 27%. The broker believes investment hurdle rates are increasing and this will drive higher prices given the lack of tier-1 projects.

The broker prefers BHP Billiton ((BHP)), Rio Tinto ((RIO)), Fortescue Metals ((FMG)), Alumina Ltd ((AWC)), Independence Group ((IGO)), Newcrest Mining ((NCM)), OceanaGold ((OGC)) and Orocobre ((ORE)).

Copper

The copper price has fallen -16% from its peak in early June to US$2.80/lb because of concerns over the escalating US/China trade war, as well as the capitulation of a large long position on the Shanghai Futures Exchange. UBS expects the copper market will have a deficit of around -300,000t in 2018.

However, the broker notes supply disruptions in the first half of the year were materially less than expected and risks in Indonesia and the Democratic Republic of the Congo have moderated, although the latter's risks remain elevated.

The recent agreement to restructure the ownership of Grasberg reduces the near-term risk of disruption, UBS believes, and the technical risk will also reduce in 2019 when the mine moves to a block cave from being an open pit. The main risks to the copper outlook in the near term are labour contract agreements at Escondida and Chuquicamata.

Gold Miners

The recent performance of the Australian gold sector has easily outpaced offshore peers and eroded much of the value and upside to price targets, RBC Capital Markets notes. This has eventuated despite a falling US dollar gold price which is commonly the key driver of the sector.

The analysts suggest strong balance sheets, margins and consistent operating performance have supported domestic equities while there are less compelling investment arguments elsewhere for offshore producers or domestic small cap stocks. In this environment the broker believes long-term valuation tends to matter less than momentum and there remains scope for stocks to run further.

Outside of mid-tier stocks, and for those that focus on absolute valuation support, RBC Capital Markets advocates looking further down the curve, as smaller stocks appear to be trading at a discount to net asset values. They also now benefit from strong balance sheets and excess cash.

As with their larger peers, the analysts suggest free cash flow directed towards exploration has a good chance of yielding upgrades and providing further upside beyond the current base case estimates.

The analysts suggests large to mid-cap gold miners on ASX are fully valued and stocks like Evolution Mining ((EVN)), Northern Star Resources ((NST)) and Regis Resources ((RRL)) are screening expensive on valuation. The broker suggests looking further down the curve at Ramelius Resources ((RMS)) and Resolute Mining ((RSG)).

Ord Minnett recommends caution entering gold stocks at current levels but envisages upside potential in Newcrest and OceanaGold.

Iron Ore

Iron ore has sustained relatively stable benchmark pricing as it heads into a slower season and has not experienced the same declines as the base metals complex. Morgan Stanley suggests the relative outperformance is partly because of the differing nature of the end markets, as most steel is installed on the domestic capital stock and not immediately affected by international trade tariffs.

China's crude steel production has been solid. However, the real issue is the blowout in high-grade differentials. The high-grade 65% iron premium versus the 62% grade reached a record 43% in early July, from 20% in January. The broker notes low-grade 58% iron discounts have not diverged further but remain large.

Some normalisation is considered likely but Morgan Stanley does not expect premiums to revert to historical levels. Steelmakers may be paying more for high-grade iron ore than the actual value of the additional benefit to productivity. Still, as environmental pressures continue, this is unlikely to fully revert.

The broker also does not envisage much in the way of near-term high-grade expansion of supply beyond Vale's S11D ramp up. Yet, low-grade, high-cost supply is likely to drop out of the market and narrow the low-grade discount.

Oil

Nomura, assuming OPEC production remains at the June level, expects crude oil demand will exceed supply by 120,000 bbl/day in 2018 and, while envisaging downside risks to demand because of increasing trade tariffs between the US and China, rising prices and US dollar depreciation, expects demand will still substantially exceed supply in 2019.

US output is not expected to run significantly higher than is currently forecast, even if oil prices rise. The International Energy Agency forecasts US crude oil production will increase 1.72m bbl/day in 2018 and 1.19m bbl/day in 2019.

In the Permian region, that drives the growth in output, a lack of pipeline capacity is expected to persist until 2019. There are also issues regarding production costs and a lack of engineers. A detailed review of pipeline capacity expansion plans and the potential for truck/rail crude shipments also reinforces Morgan Stanley's call that Permian growth will be well below expectations.

The broker believes takeaway capacity has emerged as a limiting factor and there is little change in sight until early 2020. Around 98% of capacity is already used. Crude will inevitably need to be moved by truck and rail in the US but this also has limitations.

The broker reiterates a view that production will be constrained. Meanwhile, the market faces an usually large number of supply risks, primarily from Venezuela, Iran and Libya. As US shale growth is hampered by infrastructure bottlenecks an undersupplied market is expected in the second half of 2018 and 2019, and inventories are already low.

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