Commodities | Nov 14 2018
A glance through the latest expert views and predictions about commodities. Iron ore; nickel; copper; and mining services.
-Tightness in iron ore pellet supply may be easing
-Macquarie calculates 70-80% of China's iron ore imports could be displaced
-Nickel unlikely to be supported as trade war plays out
-Upside likely to be limited in copper until trade tensions ease
-The more east coast exposure the better for mining services contractors
By Eva Brocklehurst
Credit Suisse is surprised by the compression in iron ore grades as China's winter curtailment period commences. In 2017 the price of lower-grade ore, particularly Fortescue Blend, was slashed in winter, as it is an undesirable product when blast furnace capacity is restricted.
Winter reductions are just starting, so the broker acknowledges it may be a little early early in calling out the procurement strategies of the steel mills. Nevertheless, steel profits and outlook are considered to be less buoyant and mills may be more cautious. Hence, aggressive premiums and discounts for grade may not occur. As margins weaken for flat steel, the mills become more cost conscious and seek cheaper alternatives.
Meanwhile, the broker's analysts are calling the end of the Chinese property boom although, while authorities are trying to restart infrastructure investment, they are considered unlikely to embark on another major round of stimulus.
The fact that low-grade iron ore has rallied, despite rebar steel spreads being robust, is a sign of a tight market, Ord Minnett believes. The broker expects steel prices to remain buoyant into the first quarter, because of the lagged effect of fiscal easing, shutdowns of capacity over winter and low steel inventory and upgrades forecasts for iron ore prices over the next two quarters to US$70/t, expecting 2018 to average US$69/t, on the back of higher Chinese steel demand.
Since the collapse of the Samarco dam took a chunk out of the export market in 2015, iron ore pellets have been in tight supply, reflected in a contract premium of US$58/t in 2018. While miners remain bullish on 2019, Morgan Stanley notes China's spot price has been falling, to US$64/t from a US$90/t peak in September. This suggests a pick up in domestic feed supply.
China is mainly served by Indian exports and, while being the largest pellet consumer imports only 10% of its requirements, manufacturing pellets from its domestic high-grade concentrate. Morgan Stanley observes the country's appetite to pay for pellets increases when steel margins are high and increased productivity is required, as during winter capacity reductions.
Given spare pelletising capacity and ample feed, the broker believes a sustainable premium should be close to marginal cost on the pellet conversion curve, i.e. around US$30/t.
While pellet feed supply may recover in 2019, as Minas Rio re-starts and Canada's Bloom Lake ramps up, this may not be reflected in premium settlements as yet. Meanwhile, India's pellet exports are likely to continue falling as more iron ore is consumed domestically.
All three major Australian iron ore miners continue to look compelling from a valuation perspective, in Ord Minnett's opinion. Rio Tinto ((RIO)) remains the preference versus BHP ((BHP)). The broker envisages a greater risk/return ratio in Fortescue Metals ((FMG)) although the catalyst, the ramp up of the new West Pilbara fines production, is 6-9 months away.
The stigma surrounding the company's low-grade iron ore is overdone, in Ord Minnett's view, and the stock offers greater potential upside than other majors should it deliver on the West Pilbara strategy.
Macquarie suggests an investment boom in metal shredding capacity is rapidly boosting China's capability. The constraints that have historically held back recycling in China, such as lack of scale, investment and poor quality, may soon be overcome. The broker believes, for investors in dry bulks, it is important to track the pace of development of the Chinese electric arc furnace (EAF) industry and the local scrap market. Yet information is scarce.
Nevertheless, a big expansion program in EAF is underway. Mysteel estimates total capacity of 50mt is under construction. Macquarie suspects increased capacity will allow plenty of room to lift scrap consumption as this becomes more available.
The broker also highlights the fragmented nature of the Chinese recycling industry is changing and estimates China will consume nearly 200mt of scrap this year, significantly above 2017. The majority still comes from domestic sources but, with almost twice as much shredding capacity, China will soon be able to process a lot more. Macquarie calculates that, given the maturing of the Chinese economy, between 70-80mt of iron ore requirements, most probably imports, may soon be displaced.
Citi notes nickel fell last week to its lowest level in around 11 months on both the London and Shanghai exchanges, as rebar steel prices fell. This stems from concerns over slowing demand in China.
The broker suggests a de-escalation of the trade conflict and further Chinese stimulus could mean prices rally over the next 3-12 months but, given a trade war is becoming the base case for many investors, points out nickel is unlikely to be supported by either cost or fundamentals in that scenario.
ANZ analysts continue to observe a dislocation between fundamentals and investor sentiment in the copper market, the latter predicated on escalating trade tensions. Nevertheless, strong growth in Chinese imports suggests demand remains robust but, until any trade tension eases, upside is likely to be limited.
The analysts note inventories at both the London and Shanghai exchanges have been on a steady decline for most of the year and Chinese premiums are elevated. Moreover, tariffs on scrap imports have boosted demand for refined metal.
The fundamentals are not positive enough to offset the expected weakness from the trade conflict while, in some downstream sectors such as grid investment, demand is weak.
Bailieu Holst has identified several developments from a visit to Western Australian mining services businesses. The pipeline of work remains robust but margin pressures are persisting.
Moreover, those with exposure to the east coast are gaining more than just diversification. The broker believes broader earnings growth across the sector will be driven by revenue growth. A highly competitive tender landscape can be illustrated by gross margins, which have been steadily falling over the last five years as activity subsided.
The significant amount of work on the east coast reduces some of the competitive tightness versus Western Australian mining-related work for these companies. The east coast exposure for all three of the stocks the broker covers has increased, via acquisitions and organic growth, and all three have strong track records.
Monadelphous ((MND)) has won several wind farm contracts as well as appointment to the Hunter Valley Water Corporation Panel. Global Construction Services ((GCS)) has had a number of wins on the east coast including a $30m contract in Brisbane. Veris Ltd's ((VRS)) guidance for surveying work of $125m is weighted towards the east coast.
Among those companies the broker does not cover, east coast revenue for MACA ((MLD)), Southern Cross Electrical ((SXE)) and Decmil ((DCG)) has increased as a percentage of their respective order books.
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