Commodities | Jun 29 2020
This story features FORTESCUE METALS GROUP LTD, and other companies. For more info SHARE ANALYSIS: FMG
Copper price not reflecting economic conditions; iron ore supply constraints easing up as shipping volumes rise for Australian miners; steel output for most geographies continues to contract.
– The recent red metal rally may not reflect on the ground reality
– Iron ore supply concerns easing with Vale back in the game
– Global steel demand remains China-dependent
By Angelique Thakur
Copper: Wrong end of the stick
Copper is seen as a proxy for global economic health, a barometer of sorts for financial markets.
Citi’s proprietary China copper end-use tracker has seen an increase for the first time since May. The tracker, which fell -28% in February year-on-year grew by 1.6% in May. Citi analysts note this to be led by construction activity and automotive sales.
Copper prices are up 25% since the peak of the pandemic and it appears demand for the metal seems to be doing well, backed by strong Chinese imports with inventories falling sharply in the last few months. This is also supported by a steady increase in industrial activity.
However, ANZ Bank’s research team believes this rally may not be giving a true picture of the global economy. They believe the current rally is not demand driven.
The ANZ Bank Copper Demand Index, which tracks activity in downstream sectors, shows no sign of improvement, instead falling -20% (yoy) in May, the lowest since the global financial crisis.
There are also indications of a build-up in finished goods, on the expectation of increased demand from China due to its stimulus measures.
The ANZ Bank Downstream Copper Demand Indicator, which turned negative in January to March and has been falling steadily throughout the pandemic, points to weak underlying conditions. It indicates sales of consumer durable items like air conditioners and washing machines are weak.
Citi analysts also corroborate stockpiling by traders, which started during the covid-19 lockdowns and continued into the second quarter, helped by low copper prices and reduced borrowing costs.
This stocking may turn to de-stocking in the third quarter, fear Citi experts, pushing down refined markets and weighing down the ongoing end-use recovery.
China’s end-use copper consumption is predicted to fall by -1.8% in 2020, state Citi analysts.
ANZ reports supply-side constraints have been the main driver of the recent rally, led by rising covid-19 cases in South America, now considered the epicentre of the pandemic by the World Health Organisation.
With 40% of total global mine supply coming from this region, the risk to production will remain for the rest of the year, comments ANZ.
Leading producer countries, Chile and Peru, have been hit the hardest with major operations in both countries impacted. Other countries like the US, Mexico and Zambia are also facing mining closures.
Citi anticipates a recovery in end-use demand in the second half to the tune of 3-5%, less than what would be expected in normal times. This also means there is an upside risk to the analysts’ figures if covid-19 issues are resolved earlier than expected.
ANZ expects prices to come under pressure once the supply issues are worked out, and will depend on how successfully China’s stimulus measures boost demand.
Iron Ore: Easing supply constraints and increasing shipping volumes
The recent rally in iron ore is mostly underpinned by supply concerns from Brazil, grappling with an outbreak that is worsening by the day. Vale was ordered to shutdown operations in its Itabira complex from June 5, after 188 workers tested positive to covid-19. The Itabira operations make up about 10% of the miner’s total output.
Vale has now resumed operations and reports impact on production to be less than -1mt. The miner has not made any changes to its FY guidance of 310-33mt.
Shaw and Partners expects the supply issues to mellow down in the coming times with Brazil already reporting an increase in iron ore exports in the first few days of June.
The analysts also expect demand from China, another key driver, to moderate in the coming months. Offsetting this somewhat will be increased demand from other parts of the world in the second half, predicts Shaw.
The analysts have downgraded Fortescue Metals Group ((FMG)) to Hold, expecting pricing tail winds to become headwinds supplemented by Brazil’s improving supplies.
Macquarie reports all major Australia miners to be on track to achieve guidance even as the latest weekly shipping figures were a mixed bag, with volumes for Rio Tinto ((RIO)) and BHP Group ((BHP)) increasing while Fortescue shipments saw a decline of -10%. Vale shipments, at 4.7mt, remain below the circa 6mt per week level needed to achieve its guidance.
Macquarie highlights that while shipping volumes for Australian majors were impacted by Cyclone Damien in the first quarter of 2020, all ports recovered by March and this strength carried over into April and May. Shipping in June so far has been strong for the miners at 986mt, with almost no damage from the pandemic.
There has been a jump in freight rates, with the Australia-China freight rate increasing by 125% since May while the Brazil-China rate has shown an increase of 186%.
This jump can be attributed to factors like oil price recovery, growing demand from China, strong Australian shipments and increasing Brazilian shipments.
In fact, earnings upside for FY22 and beyond are expected to be 100% for pure-play stocks like Champion Iron, Mount Gibson Iron, Fortescue and Mineral Resources.
Stocks favoured by Macquarie analysts are Fortescue and Rio Tinto in the large-cap segment and Mineral Resources with its leverage to iron ore price.
Champion Iron, due to its long life and expansion potential, is preferred over Mount Gibson Iron.
Steel: Subdued global ferrous scrap demand
According to the World Steel Association, global crude steel production decreased by -8.7% (yoy) in May while production in China grew 4.2% (yoy). The fall was broad-based, driven by contraction in steel output across geographies including the US, Japan, India, EU and Australia (among others).
On a monthly basis, there is an improvement of 5.5% in global production from April. Goldman Sachs anticipates a gradual recovery in production with easing of lockdowns although it expects volumes to remain subdued (except in China). The US, EMEA and Japan continued to post negative growth month on month.
Goldman Sachs remains cautious on the broader ferrous scrap demand outlook. Broad-based weakness in global steel demand is likely to put downward pressure on electric arc furnace (EAF) production. This idea is supported by data for the month of May which shows production declines to be skewed towards EAF-heavy markets like Turkey, India, the US and Mexico.
Goldman Sachs has a Neutral recommendation for Sims Metal Management ((SGM)).
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