Material Matters: Oil, Gold, Coal & Iron Ore

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A glance through the latest expert views and predictions about commodities. Oil; gold; thermal coal; and iron ore.

-Oil price likely to remain volatile over 2020 as geopolitical risks cannot be ignored
-Credit Suisse assesses best performing gold stocks are those promising returns to shareholders
-Broader recovery in manufacturing across Asia augurs well for thermal coal
-Buoyant iron ore price could persist amid momentum in Chinese property and infrastructure
 

By Eva Brocklehurst

Crude Oil

The oil market appears to view the emerging shale industry in the US as a buffer to geopolitical risks in the Middle East. The oil price spiked after recent US killing of General Qassem Soleimani and the subsequent retaliation by Iran.

However, once it was evident there was no direct hit to oil supply the price lost all gains, ANZ Bank analysts note. The market is fundamentally different from a couple of decades ago when similar tensions would mean prices were higher for sustained periods.

The analysts point out US shale production is amongst the most flexible in the industry. While traditional deep-sea wells can take several years to come online, US shale producers can have oil flowing within months.

The US also appears less threatened by disruptions to global oil supply because of its shale production. Still, oil inventory remains relatively high and OPEC (Organisation of Petroleum Exporting Countries) is ready to boost output if disruptions become significant.

Nevertheless, the analysts caution that the market would be naive to completely ignore geopolitical risks and, as a result, the oil price is likely to remain volatile over 2020.

Last year the European Union threatened to re-impose sanctions following Iran's resumption of uranium enrichment. The probability of this occurring rose significantly recently after Iran announced it would remove the curb on its atomic energy program that was agreed under the 2015 nuclear deal.

Also, Iraq supply has been steadily increasing over the past decade and the country is OPEC's second largest producer, behind Saudi Arabia. The Iraqi parliament has resolved to expel foreign forces and this has triggered an angry response from the US. Hence, the analysts suspect the likelihood of US sanctions on Iraq has risen.

Gold

Gold prices are likely to remain strong in 2020, Credit Suisse asserts, amid lingering fears of a global economic slowdown. Central banks have generally been cutting official rates, supporting gold prices and, while the US Federal Reserve has signalled a pause, this could change quickly if economic fundamentals weaken.

Meanwhile, over US$10trn in bonds globally are yielding negatively. Low or negative yields support gold prices as the opportunity cost for holding gold diminishes and gold screens as a more attractive safe haven.

Credit Suisse expects prices in 2020 to average US$1540/oz and peak in the first half at US$1560/oz. Typically, a gold bull market has a growth focus but this time around the broker notes capital returns to shareholders appear to matter more.

The report states the best performing gold stocks over the year are expected to be those that generate meaningful cash flow at current gold prices and can return capital to shareholders via increased dividends and/or buybacks. Investors appear wary of production growth via acquisition.

Thermal Coal

Macquarie assesses the fundamentals for the thermal coal market have improved, particularly in the Pacific. While the broker still struggles to define a clear direction, divergent performances and regional spreads are expected to present opportunities for investors.

It appears sustained reductions in supply and some re-stocking demand in Asia have placed a floor under prices for thermal coal. Moreover, a recovery in manufacturing activity in China has boosted the country's thermal coal usage whereas hydro output, which dragged on thermal coal power generation for most of 2019, has moderated.

Macquarie's bull case for thermal coal features a broadening of the recovery in manufacturing across the rest of Asia, particularly to export-driven economies of Japan and South Korea where coal still fuels 29% and 43% of power generation, respectively.

A re-stocking event and curtailment of seaborne supply could mean a rally unfolds in thermal coal. However, for that to occur, the broker acknowledges there needs to be a change in two of the features that hit coal prices in 2018/19, notably Chinese domestic supply growth and the gas surplus.

The latter remains very much the issue and Macquarie forecasts a surplus in 2020 equivalent to 22mt of seaborne coal demand.

Iron Ore

Large volumes of iron ore have been arriving at Chinese ports since early December although inventory levels have not moved as steel mills replenish stocks ahead of Chinese New Year.

Morgan Stanley assesses the pre-holiday re-stocking is complete yet market tightness has not abated. Cyclone Blake caused significant seasonal disruption to Australian supply yet the price has shown no signs of easing, remaining at the mid US$90/t level.

Turning more positive on China's steel demand, the broker believes another year of a surprisingly high iron ore price could be in store.

Morgan Stanley calculates China will need 20mt more ore in 2020 amid positive momentum in the two key pillars of demand: property and infrastructure. The broker envisages limited scope for supply to meet demand growth this year, although Vale, Rio Tinto ((RIO)) and BHP Group ((BHP)) are all expected to increase shipments on a year-on-year basis.

With supply growth constrained and the first disruptions from the cyclone season commencing, Morgan Stanley considers it unlikely the price will step down and stands by forecasts of US$93/t for the first quarter and US$85/t for the second quarter of 2020.

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