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Material Matters: Metals, Aluminium & Coal

Commodities | Sep 25 2018

A glance through the latest expert views and predictions about commodities. Base, precious metals; aluminium; and thermal coal.

-Opportunities seen forming in base and precious metals
-Aluminium likely to remain in surplus, curbing price rises
-Buoyant pricing continues for high-grade thermal coal


By Eva Brocklehurst

Base, Precious Metals

2018 was expected to be a good year for metals but JPMorgan notes an escalating trade war between the US and China became reality and the base metal segment, in particular, took a beating. Barring a macro move into recession, the broker believes base metal prices are bottoming and a rebound should ensue in coming quarters. Metals appear quite cheap on both an absolute and relative basis to other asset classes.

The broker screens zinc and copper as particularly cheap. Moreover, JPMorgan expects China's fiscal easing to provide a material lift to metal demand over the next two quarters, offsetting reduced demand in the rest of the world.

Citi agrees copper appears oversold, particularly with inventories approaching a two-year low. The broker notes equity prices are being driven by negative sentiment towards base metals and also upgrades nickel player Western Areas ((WSA)) to Buy after a pull-back in the share price.

Morgan Stanley observes, over the September quarter, selling across base and precious metals occurred as markets priced in US dollar strength and the potential threat of tariffs. Only bulk commodities held up, supported by a lack of speculative selling and strong demand.

The price deck now carries a bullish tilt versus the spot price for base metals and the broker believes negative moves in both gold and base metals have created opportunities from a commodity perspective. Morgan Stanley also considers a weakening US dollar and eventual pullback in US equity markets supports a constructive outlook for precious metals. A long-standing bullish view on palladium is retained.

The move lower in gold and copper prices brings these two metals to the top of the broker's commodity ranking. Morgan Stanley expects copper, gold and silver prices to recover in 2019, with steady demand fuelling a recovery in copper and capital flowing back to precious metals.

JPMorgan also keeps a bullish bias in place for gold for the second half of FY19, believing the inversion of the yield curve will likely attract increased interest in the yellow metal.

UBS has Buy ratings on Northern Star Resources ((NST)), OceanaGold ((OGC)) and Alacer Gold ((AQG)). The broker likes Northern Star for its momentum and potential to turn around the recently-acquired Pogo mine. OceanaGold is expected to produce solid results from its operations, while Alacer Gold offers the largest potential return, albeit contingent on a successful ramp up of the sulphide project.

In aggregate, the broker believes Australian stocks are trading at similar forward enterprise value/operating earnings ratios versus their North American peers. Moreover, free cash flow yields for the ASX peers are generally higher and debt is lower.

Gold bellwether Newcrest Mining ((NCM)) is rated Sell as, while the UBS forecasts strong production growth in FY19, this is modelled as a near-term peak. Nevertheless, the stock screens well against the global majors, having the longest mine life at its major producing assets.

Morgan Stanley also notes lithium stocks have fallen significantly on the back of Chinese prices dropping to US$10,120/t from US$16,000/t during the September quarter. The broker upgrades Orocobre ((ORE)) to Equal-weight from Underweight and maintains an Equal-weight rating for Galaxy Resources ((GXY)), albeit with modest upside envisaged.

Morgan Stanley also envisages significant upside for graphite stock Syrah Resources ((SYR)), although it remains not without risk given the Balama project is yet to be declared commercial.


China will be implementing cuts to alumina production over the winter but leaving aluminium relatively unchanged. The reason is that aluminium smelters are designed to run continuously and it takes three months to power down and re-start, so winter curtailments would theoretically mean full production for only two months in a year.

The final quarter of the year is usually a period of restocking for aluminium smelters in China and the domestic alumina price is already 22% of the Shanghai aluminium price, a peak level.

Credit Suisse doubts a push from a cost perspective will lift aluminium prices as demand is softening. Hence, aluminium is expected to remain in surplus and circumvent any attempt by smelters to raise their prices. Meanwhile, global alumina supply is likely to tighten but the broker is uncertain whether the price will rise further, as aluminium smelters cannot afford to pay any more.

Credit Suisse's best guess for the fourth quarter alumina price is that Australia may settle its prices at $550/t and the price differential to China would be insufficient to incentivise Chinese alumina exports.

Citi agrees the alumina market is structurally tight and likes the strong dividend yield from Alumina Ltd ((AWC)) as cash is returned to shareholders. The main risk for the stock is how long the AWAC strike persists in Western Australia as the risk of a material loss of production is growing.

Thermal Coal

Shipments of Australian thermal coal to China have increased by almost 30% at the expense of other east Asian nations, which have turned to Russia as a result. Macquarie observes, faced with domestic shortages, Chinese buyers are importing Indonesian lignite and Australian top grade thermal coal to create a substitute product.

Mid-range seaborne coal is being avoided, despite favourable economics, because of its high sulphur content. This has led to a dislocation in prices, with premium high-grade thermal coal rising to levels not previously seen. Emerging economies that are more price sensitive, such as the Philippines and Malaysia, are sourcing most of their additional coal from nearby Indonesia. Meanwhile, faced with higher competition for Indonesian coal, India has turned to South Africa and the US.

Macquarie remains bearish on the outlook for all internationally-traded coal products based on an expected recovery in China's domestic production, which in turn should reduce demand for imports. The broker notes most of the increase in international production has come from Indonesia and the US, traditionally high-cost operators, which have stepped in to fill the gap as seaborne miners in Australia, South Africa and Colombia have failed to deliver meaningful growth.

Citi has revised up fourth quarter thermal coal prices, expecting the high-quality market to stay tight in the run-up to annual contract negotiations. After the winter in the northern hemisphere, utilities in Japan and Korea are expected to start switching to mid-level coal because of the current price differential.

The broker also expects more coal to shift to the Pacific Basin from the Atlantic as physical premiums are expected to remain significantly higher. The broker suspects a possible convergence between coal and gas pricing, if coal demand in Europe comes under pressure as utilities burn more gas and less coal on the back of an anticipated fall in local gas prices. Citi also upgrades Whitehaven Coal ((WHC)) to Buy from Neutral on the back of earnings upgrades and lower share prices.

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