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Material Matters: Coal, Copper & Gold

Commodities | Dec 10 2019

A glance through the latest expert views and predictions about commodities. China's growth; environmental issues; coal; copper; Oz gold and base metal equities.

-Pressure on China's economy building but steel still robust
-Impact of environmental issues on commodity markets likely to grow in 2020
-China's coking coal production remains below 2014 peak
-Australian gold equities pullback now beyond spot price decline


By Eva Brocklehurst

China's Growth

Pressure on China's economy is building. Longview Economics points to a deterioration, as speculative capital is leaving China. This is reflected in tightening liquidity for small regional banks, rising non-performing loans and indications China's banking system is "too tight". Meanwhile, the trade war with the US is affecting the manufacturing sector.

Exports and imports are shrinking and the manufacturing PMI (purchasing managers index) has generally been below 50 in the past 12 months. Numbers below 50 indicated contraction whereas numbers above 50 indicate an expansion.

The main issue, in Longview Economics' view, is whether the signs of stress in the financial system and the economic weakness will spread and/or intensify. On balance, in the absence of increased stimulus, an acceleration of Chinese economic growth remains unlikely in 2020.

Platts data indicates the record steel output reported in China in 2019 was not overstated but rather driven by a surprisingly robust property construction market. Winter output cuts are no longer a concern for steel mills, which will be able to maintain production should margins be favourable. Platts expects steel output to be underpinned in 2020 by low interest rates, more proactive fiscal policy and low property inventory.

Resources Outlook

UBS believes December 15 will be a pivotal day for commodities, as the markets await news of whether US President Donald Trump will put previously announced tariffs into effect. More tariffs are likely to weigh on commodity prices, in particular base metals, while any Chinese stimulus is expected to favour bulk commodities through infrastructure expenditure.

Meanwhile, global production reductions in coal have begun and prices are below the cost curve for manganese, aluminium and alumina. Further cuts to production could be favourable for prices in 2020. UBS expects manganese will rebound into 2020, with copper and aluminium also higher. Iron ore is expected to decline over the year but remain strong at US$80/t. Lithium remains a story for the second half of 2020.

Environmental Issues

ANZ analysts expect there to be a noticeable impact on commodity markets from environmental issues in 2020. Tighter emissions regulations, such as IMO 2020, are expected to weigh on crude oil. The move to low-sulphur fuel in shipping could also mean crude runs increase and stronger demand for LNG should also emerge.

Increased spending on renewable energy is also boosting demand for value-added minerals such as copper. There has been a notable increase in wind and solar investment in China this year. For each megawatt of capacity, wind generator use five times more copper in construction than do coal-fired or hydro generators. The analysts calculate copper demand from the sector is up 20% and the trend is expected to accelerate in 2020.

Demand for higher grade iron ore should also rise as the analysts envisage another clean air campaign in China. Tougher environmental regulations are also contributing to demand for palladium. Demand for thermal coal imports to China is expected to weaken, as a new railway line was constructed to shift the transport of coal from trucks to rail and reduce coal dust emissions. The completion of this is likely to boost domestic coal consumption.

The analysts note energy companies are already re-directing capital away from the fossil fuel industry to markets more aligned with the renewable energy sector. Hence, growth investment in oil, gas and coal markets is expected to remain subdued and the impact should broaden to the wider resources industry. Capital for use in energy and mining expansion will become harder to obtain as a result.


China's domestic coking coal market is more than twice the size of the seaborne market, Macquarie calculates. Total coke production has grown strongly this year, reflecting strong steel production and a move away from scrap to pig iron in the furnace as steel margins weakened. The broker points out metallurgical coke is mainly used as a reductant in iron making and small quantities are also used in sinter and ferro alloy production.

In contrast to coke, steel production in China has grown by more than 100mtpa over the past five years. Coke production remains below the 2014 peak as margins are small and low rates of utilisation and overcapacity in the industry have meant profitability has lagged consistently.

While data on Chinese domestic coking coal production is problematic because of the abundance of "cross-over" coals, several points can be made, Macquarie suggests. The domestic market is becoming increasingly concentrated, with Shanxi now taking 50% market share, while hard coking coal output, in terms of share, is declining. The vast majority of the industry remains profitable at current prices.

After reforming its steel, coal and aluminium industries, China's asset supervision and administration department has proposed a plan to reduce over-capacity in the power generation sector. This proposal seeks to retire between 1/4 and 1/3 of coal-fired power capacity in five provinces.

Macquarie notes this comes after several state-owned power plants declared bankruptcy this year, amid low utilisation rates and weak electricity prices. At this stage, the current proposed cuts are dwarfed by new capacity that is under construction, the broker adds.


Copper prices have risen to all-time highs in pesos amid protests in Chile. Chile is the world's largest copper producer and accounts for around 30% of global mine supply. Usually copper prices and the peso are positively correlated but since mid October the peso has collapsed, affected by ongoing protests by the Chilean population. The protests are disrupting supply but only at the margin at present.

Citi does not assume major disruptions but the unrest is an upside risk for copper prices over the short to medium term. Citi also suspects there may be less money from the government for future copper projects as it seeks to appease the population. However, local miners may have more money to fund copper projects to the extent that copper prices and the peso hold at current levels.

Globally, the broker notes copper's capital expenditure cycle has collapsed in recent years ,which has supported prices and left copper leveraged to a 2020 economic upturn. Already, the bullish impact of slowing copper mine expenditure has offset the bearish impact of a deteriorating global industrial cycle.


UBS believes gold equities were mostly overvalued in mid 2019 relative to the gold spot price. Subsequently, a modest decline in spot gold to US$1470/oz has now driven a -20-30% decline in gold stocks. UBS assesses stocks are now pricing in a gold price of US$1350-1450/oz.

In this environment, the broker prefers Northern Star Resources ((NST)), upgrading to Buy from Neutral. The broker believes the fall in the share price can be partially linked to a loss of market confidence regarding the turnaround at Pogo and is confident the turnaround is coming although it is behind target.

Meanwhile, Alacer Gold ((AQG)) is also a preferred stock as the investment case continues to improve. The least preferred gold stock is Newcrest Mining ((NCM)) as UBS is concerned about the decline in production and lack of free cash flow.

Base Metals

UBS upgrades Western Areas ((WSA)) to Neutral from Sell as the share price has declined -20% since October. Western Areas remains highly leveraged to the nickel price which the broker forecasts lifting to US$8/lb by 2021. OZ Minerals ((OZL)) and Independence Group ((IGO)) remain the preferred base metal stocks, with UBS noting a large number of options to deploy capital and new projects and expand production.

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