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Material Matters: Gold Rises, Nickel Shines, Iron Ore Suffers

Commodities | Aug 21 2019

Gold up on safe haven buying; base metals drop on economic uncertainty; nickel shines; China steel-making slowdown hits iron ore and metallurgical coal. 

-Gold miners glitter as investors seek safe haven from economic uncertainty
-Copper, aluminium, zinc sag on fears of global slowdown
-Indonesia’s ban on nickel ore exports buoys nickel price
-Slowdown in China steel making depresses iron ore, metallurgical coal

By Nicki Bourlioufas

As the US-China trade war goes on, gold has hit its highest levels in over six years and analysts are upgrading forecasts for the precious metal. UBS now forecasts gold will reach US$1,600 in 2020-21, though the risks are skewed to the upside. It has adjusted its overall strategy towards the minerals sector, tilting towards bulk commodities rather than base metals and increasing its weighting towards gold.

UBS’s moves are largely a response to the failure of the US and China to resolve their trade tensions, which have prompted a downgrade of growth expectations in both countries through 2020. Pessimism on growth has dragged down industrial metals, pushing investors into gold as a safe haven asset.

Rise of gold creates opportunities for discerning investors  

UBS raised its price target for gold by +7-10% over the next 18 months, pushing its estimate to between US$1,550/oz and US$1,600/oz in 2020-21. Its favoured gold equity is Alacer Gold Corp ((ACQ)), which is still trading at a small discount to UBS’s Net Present Value (NPV) calculation for the stock. “The rest of the gold space appears to us to be expensive in absolute terms, trading at or above our NPVs,” UBS analysts said.

UBS gave Neutral ratings to Evolution Mining ((EVN)) and Oceanagold ((OGC)), and posted Sell ratings on Newcrest Mining ((NCM)), Northern Star Resources ((NST)) and Regis Resources ((RRL)).

In relative terms, UBS recommended Evolution for investors seeking exposure to Australian/North American gold assets. Newcrest is its least preferred stock, with UBS estimating near-term production will peak in 2020.

Macquarie said it may upgrade its estimates for copper-gold miner Sandfire Resources’ ((SFR)) 2019-20 earnings by 25%. By contrast, UBS cut its forecast for Sandfire’s Net Profit After Tax (NPAT) for 2020-21 by about -10%, noting that the remaining life of its Degrussa mine is only three years.

Copper, aluminium and zinc gloom casts a pall over base metal miners 

UBS lowered its estimates of prices for copper, aluminium and zinc by up to -10% over the next 18 months. The UBS team downgraded its forecast for copper to US$2.80/lb in 2020 and US$3.00/lb in 2021. UBS maintained its Buy rating on OZ Minerals ((OZL)), which it said continues to stand out against other copper miners, with a large number of options to deploy capital on new projects or expand production. The company’s Carrapateena copper-gold project is expected to post its first production in the fourth quarter of 2019.

UBS cut its rating on mineral sands specialist Iluka ((ILU)) from Buy to Neutral after the company announced an expected cost blowout at its rutile mining hub at Sembehun in Sierra Leone. The UBS team believes lithium and graphite miners are challenged by the risk of further falls in the prices of the commodities.

Nickel shines on fears Indonesia may tighten ban on ore exports

The exception to the depressing outlook for base metals is nickel. UBS raised its price forecast for nickel to US$6.50/lb in the second half of 2019. Macquarie Wealth Management points out nickel prices have remained high for some time due to speculation that Indonesia might tighten its ban on nickel ore exports. This continued strength has created significant potential that nickel miners’ earnings will come in above forecasts.

Macquarie said it may raise its nickel price estimate by 100% for Western Areas ((WSA)), Panoramic Resources ((PAN)) and Independence Group ((IGO)).

UBS nominated Independence Group ((IGO)) as its preferred exposure to nickel, raising its 2019-20 Net Profit After Tax (NPAT) outlook for the gold, nickel and copper, zinc and silver producer by 26%. However, UBS maintained its Neutral rating given that the stock is trading above its valuation of $5.13.  

UBS also maintained its Neutral rating for Western Areas ((WSA)) while raising its NPAT forecast by 41%. The forecast reflects Western Areas’ greater sensitivity to nickel prices.

Iron ore and metallurgical coal suffer from China uncertainty around steel

Macquarie notes that iron ore prices have fallen about -25% in August, driven by sentiment and a fall in steel prices, both of which have been affected by the depreciation in the Chinese currency, the renminbi (RMB).

The possible counterweight to this negativity is the potential for another round of government stimulus in China, focused on infrastructure investment, which could stimulate demand for steel.

UBS lowered its forecasts for metallurgical coal, used in steel making, by -6% in 2019-20 to reflect increased supply from Australia and import restrictions in China.

The turmoil surrounding iron ore has split opinion among analysts regarding leaders BHP Group ((BHP)) and Rio Tinto ((RIO)). UBS says it prefers BHP to Rio Tinto because of lower exposure to iron ore.

By contrast, JP Morgan retains its Neutral rating on BHP, which has fallen -12%, and upgrades Rio Tinto to Overweight in response to the stock’s price fall. JP Morgan argues that the aggressive sell-down of Rio means the stock is now trading at a significant discount, opening up a trading opportunity.

Fortescue Metals Group ((FMG)) “continues to offer the highest risk/reward and remains our top iron ore play”, JP Morgan said. Fortescue is likely to pay a dividend of about 20% in 2019-20, and generates a 63% margin for Earnings Before Interest Tax Depreciation and Amortisation (EBITDA), putting it at the head of its sector.

UBS raised its rating on Fortescue from Sell to Neutral following the recent -20% fall in the share price.

Explorer Watch List highlights potential miners of tomorrow

Canaccord Genuity has launched its new Explorer Watch List, which it says is “designed to highlight speculative, un-rated companies with active exploration programs on quality gold and base metal exploration and/or development projects”. Canaccord does not provide ratings, estimates or target prices for the 16 companies, which range across gold and base metals.

The Watch List comprises 13 gold hopefuls and three with a base metals focus. The companies have returned an average of +52% over three months and +174% over six months, compared to the ASX Gold Index returns of +28% and +35%. These returns would be + 27% and 36% if gold venture Spectrum Metals ((SPX)) is excluded. Spectrum shares have risen +424% in three months and +2100% in six months.   

The other gold companies are Apollo Consolidated ((AOP)), Breaker Resources ((BRB)), Calidus Resources ((CAI)), Carnaby Resources ((CNB)), Catalyst Metals ((CYL)), Exore Resources ((ERX)), Matador Mining ((MZZ)), Musgrave Minerals ((MGV)), Navarre Minerals ((NVM)), NTM Gold ((NTM)), Oklo Resources ((OKU)), and Prodigy Gold ((PRX)).

The base metals interests are Adriatic Metals ((ADT)), Blackstone Minerals ((BSX)), and Canterbury Resources ((CBY)).

Canaccord says there is a relative shortage of developers among ASX-listed gold and base metal companies. But with gold prices reaching all-time highs in A$ terms, there is likely to be greater speculative interest in earlier-stage explorers and stronger capital flows into these companies.

This will boost exploration activity and may spark mergers and acquisitions (M&A) activity from established producers.

At the same time, market valuations for larger, more established gold producers have started to contract, perhaps in recognition that valuations for large-capitalisation companies are stretched.
This could indicate that investors are now seeing greater potential in smaller-cap producers or earlier-stage developers and explorers.

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