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Material Matters: Iron Ore And Base Metals

Commodities | Jul 10 2019

A glance through the latest expert views and predictions about commodities. Iron ore and base metals.

-Record steel production in China and supply shortages continue to elevate iron ore
-Will China's credit impulse drive a turnaround in metal prices?
-JPMorgan expects copper surplus to return in 2020


By Eva Brocklehurst

Iron Ore

Chinese steel production was at another record in May while the output from the rest of the world was up just 0.3% year-on-year. JPMorgan notes shipments have recovered from Australia and Brazil and there has been an rise in domestic Chinese production, although port inventory is still shrinking. The broker upgrades iron ore prices (again) with 62% iron estimates up 13% and 18% for 2019 and 2020, respectively.

The broker has been surprised by the strength in iron ore, which rose to US$127/t in early July. The main triggers were lower Chinese port stocks and a potential ban on tailings dams in Brazil over the medium to longer term. The broker expects non-traditional supply re-starts and a seasonal downturn in Chinese demand will drive prices down in the second half.

Citi suspects a banning of all tailings dams in Brazil and the proposed Special Participation Tax are unlikely. The broker believes it more likely that royalties will be raised, as this may not substantially affect the planned output of iron ore.

Morgan Stanley suspects a boom-bust cycle could repeat in iron ore, noting the price tends to revert back to marginal cost within the year after the price rises or falls sufficiently to resolve market imbalances.

A drop in Chinese steel production can pull the iron ore price down very quickly. While current price movements are modest from an historical perspective, the broker assesses the cost curve has structurally changed, as low-cost supply from Australia and Brazil has driven out Chinese and Indian supply.

Morgan Stanley believes the market is currently in incentive territory with an incentive price of US$63/t for a selection of 127mtpa of unapproved projects at a 10% internal rate of return. However history suggests that new mines often start producing when the price has fallen. India could also be a key player in the seaborne market again, given its rising steel output.

While reiterating Outperform ratings, Macquarie switches preference to Rio Tinto ((RIO)) over BHP Group ((BHP)), given the former's greater exposure to the upgraded outlook for iron ore. Fortescue Metals ((FMG)) remains the preferred pink of the pure bulk miners and the broker is also positive about Champion Iron ((CIA)) and Mount Gibson ((MGX)).

Macquarie upgrades 2019 and 2020 forecasts for iron ore by 27% and 25% respectively, reflecting a combination of stronger Chinese steel production and ongoing supply shortages.

Base Metals

Citi expects metals particularly, and commodities generally, could obtain strong cyclical support in the northern autumn, were China to continue adding credit to the system at the current pace of growth. If the current pace of growth continues through to the end of 2019 the broker estimates the Chinese credit impulse could rise above 1.8 percentage points by September and to 4.0 percentage points by November.

In early 2016, such growth signalled a turn in metals. However, the broker assesses that in prior Chinese easing cycles, metals prices tended to grind lower until the credit impulse was large enough. Hence, the broker recommends waiting for Chinese credit data to improve further before buying the metals complex aggressively.

In base metals and alumina, Macquarie downgrades South32 ((S32)) to Underperform as cuts to forecasts translate to material reductions in the earnings outlook.

Alumina price forecasts are reduced by -9% for 2019 and -15% for 2020. As a result Macquarie downgrades earnings estimates for Alumina Ltd ((AWC)) and cuts the rating to Underperform. Sandfire Resources ((SFR)) is downgraded to Neutral as a result of material downgrades to the outlook for more leveraged stocks.

The broker retains a preference for OZ Minerals ((OZL)) and Independence Group ((IGO)) in the base metals space. The stocks offer positive organic catalysts, while having a higher exposure to gold than peers.

Although copper miners have underperformed the wider sector in the year to date, JPMorgan takes a cautious view on copper. Volatility is likely to be supported by the ongoing trade dispute between China and the US but a significant surplus is expected to return in 2020.

Significant supply additions are expected from smaller projects as well as from the Democratic Republic of the Congo and China. The latter two are regions where there is a lack of clarity on projects and this could means the market may underestimate the amount of supply.

JP Morgan also believes technological innovations could offer solutions to the challenges with water and tailings at mines in water-stressed areas such as Chile, Peru, Mexico in Australia, while also improving project economics. However, JPMorgan does not envisage water security impeding near-term growth in copper supply. The broker envisages an opportunity among inexpensive copper miners with strong balance sheets.

Citi is not convinced that high copper premiums in the US could be a signal for demand improvement. Freight is the dominant driver of the level of the US copper premium and freight costs have retreated from highs of 2018.

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