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Material Matters: Gold, Thermal And Met Coal

Commodities | Jul 08 2020

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Downside risks for Aussie gold producers in FY21 on account of higher costs; no takers for thermal and met coal; Iron ore demand to see a material boost from rising steel output in China

-Preview of production and risks for Aussie gold producers
-The worst is not yet over for thermal coal
-No buyers for spot metallurgical coal in the third quarter
-Increase in Chinese demand for iron ore

By Angelique Thakur

Gold: Expectations and risks

JP Morgan is bullish on gold and gold equities and expects some gold companies to begin pre-releasing quarterly production this week.The broker's focus is on cost creep and grade decline and is not too worried about the results.

While the gold stocks have had a great run so far, JP Morgan believes FY21 is about predicting accurately how much of the volume upside has already been factored in by the markets. Some other risks include underestimation of costs and capital expenditure.

Similar to the June quarter production numbers, consensus earnings for June year-end companies are also in a fairly tight range.

JP Morgan prefers large caps like Newcrest Mining ((NCM)) while noting production and guidance risks for the company's Lihir mine (Papua New Guinea).

In small-caps, JP Morgan likes Gold Road Resources ((GOR)) and St Barbara ((SBM)) for value and catalysts in the coming 12 months.

For UBS, the June quarter production has been a dampener of sorts, guiding to a financial year expected to be below market on production and/or costs.

UBS believes the high Australian gold price may encourage gold miners to mill lower grade ore which may extend mine-life but reduce production while increasing costs. Northern Star ((NST)) may choose to do this in at its Kalgoorlie operations.

Evolution Mining ((EVN)) is expected to report production of 210koz, which translates to an upside of 27% with AISC of $1,094/oz.

UBS expects the company to provide guidance in its quarterly result but forecasts FY21 production of 723koz, materially lower than consensus estimates of 796koz.

FY21 brings downside risks for gold producers on account of production and higher costs, comment UBS analysts.

Saracen Mineral Holdings ((SAR)) is considered to have the lowest risk of lower production or higher costs due to large stockpiles at its mines. UBS expects Saracen Mineral Holdings to produce 662koz at AISC of $1,315 in FY21.

IGO ((IGO)) is likely to beat expectations due to higher grades.

Thermal Coal: In the doldrums

The first half has been tough for the thermal coal market with the worst yet to come as China's appetite for coal dries up, comments Credit Suisse.

After enjoying a period of strong thermal coal import demand from January to May (up 20% year on year), China's imports are slowing and Morgan Stanley expects imports to decline -5% in 2020.

The decline from India is even bigger, driven by a higher supply of domestic coal as compared to demand at present. Morgan Stanley expects demand prospects in India to improve post-monsoon in September.

European coal imports also continue to decline this year and have reduced by -50% between January and April.

Seaborne thermal coal prices remain subdued with Morgan Stanley estimating about 30% of the seaborne supply to be cash negative.

Exporter countries have woken up to the fact that supply seems to be running way (way, way) ahead of demand while supply cuts occurring aren't enough so far to rebalance the market.

Leading exporter Indonesia has cut down its production the most at -9% in the first half of FY20 and the week ending July 5th saw more miners being urged to reduce output.

Australia, even as it stands in a favourable position in terms of the cost curve, saw exports declining by -7% over January to May (year on year) although coal exports have picked up since mid-June.

Morgan Stanley predicts total seaborne supply to shrink by -70mt or -6% in 2020.

On a more positive note, with coal imports up 60% year on year between January-May, Vietnam saves the day (or rather, months) with over 3GW of coal-fired capacity being commissioned this year.

Near term prospects for Japan and South Korea are also looking better, highlights Morgan Stanley, with limited nuclear availability and recovering power generation providing support to coal demand.

With crude oil prices rising and LNG prices oil-linked, Morgan Stanley notes a lesser risk of a switch from coal to LNG by Japan and South Korea.

Credit Suisse expects a modest price recovery in thermal coal in 2021, with global electricity demand expected to recover from the impact of covid-19.

LNG may remain oversupplied into 2022 with low prices expected to continue. Credit Suisse raises estimated prices for thermal coal to US$75/t in 2023 but mostly on the logic of low prices not being sustainable rather than optimism about demand.

The current price levels will lead to more supply cuts, Morgan Stanley agrees, leading to modest price recovery in the second half. A thermal coal price of US$50/t fob Newcastle is not sustainable in the medium term, opines Morgan Stanley.

With crude oil prices rising and producer currencies strengthening against the greenback, Morgan Stanley believes it signals the end of cost benefits that came with the lower price.

Morgan Stanley forecasts a price of US$57/t in the second half with the key risk to this outlook being a lack of discipline by producers, who would look to expand production as soon as the price picks up.

Metallurgical coal: It is always darkest before the dawn

Metallurgical (met) coal prices are well below incentive prices and even cash costs in some cases, points out Credit Suisse.

With China the only country really interested in met coal right now, it did not come as a surprise to see prices declining in the second quarter.

The analysts expect things to go from bad to worse this year, especially in the third quarter. Credit Suisse expects Chinese demand to fall on account of exhausted import quotas.

In fact, there may be no buyers of spot coking coal in the third quarter. Japan has idled blast furnaces and does not seem ready to start due to poor demand conditions, while India probably won't be needing any more coking coal until late-August on account of seasonal factors.

Europe also seems to be facing slow demand for autos and a slow restart of steel mills after its industrial lockdown.

Credit Suisse forecasts global steel demand to recover post the pandemic led lockdowns. Thus, it believes the current weak demand is temporary with recovery expected from the fourth quarter. Prices are expected to move higher in 2022-23.

Coronado Global Resources ((CRN)) is expected to suffer but Credit Suisse retains its Outperform rating, expecting a price recovery to US$140/t in the first half of FY21.

New Hope Corp's ((NHC)) Newcastle-originated price is not expected to touch US$60/t until 2022 with negative earnings per share predicted in FY21. The broker retains its Neutral rating.

Earnings estimates for FY21-22 also fall for South32 ((S32)) although Credit Suisse retains its Outperform rating.

Credit Suisse expects margins to remain under pressure for Whitehaven Coal ((WHC)) and lowers its target price to $2.25 from $3.10 while maintaining its Outperform rating.

Iron ore: Material increase in demand expected

China has turned (yet again) to infrastructure stimulus in a bid to bring its economy back to life. This provides substantial upside to steel demand, notes Credit Suisse.

The broker highlights global steel production is still dominated by China with an estimated 56% of the world's steel to be produced there this year. As a result, China is also expected to consume almost 75% of all seaborne iron ore trade this year.

Credit Suisse has increased its 2020-21 iron ore price forecasts and expects supply to overtake demand in the third quarter, allowing prices to ease below US$100/t.

However, it expects prices to remain elevated for the most part.

China's imported iron ore demand, expected to increase by 41mt, will almost fully offset the iron ore demand reduction from other importing nations including the EU.

A deficit of -6m is predicted for iron ore this year by Credit Suisse from the surplus of 14mt predicted in April.

Food for thought

The recent outperformance of commodities has mostly been on the back of supply issues induced by covid-19, comments Shaw and Partners. Looking at the iron ore prices over the last 18 months, one can see how supply constraints can be supportive of commodity prices.

However, Shaw and Partners reminds investors that supply disruptions, while leading to a favourable price response, cannot be permanent.

Instead, the broker considers supply constraints driven by economics to be more important. These constraints are more definitive and enduring.

Such supply issues often lead the companies to curtail capacities in a bid to reduce costs. Thermal coal is an apt example here.

With 2020 demand projection for seaborne thermal coal suggesting a decline of about -9%, the lower prices are pinching suppliers. This has led Indonesia to announce it would be curtailing 2020 supplies by -10-15%.

Another example is trimmed alumina capacity in China.

Shaw and Partners believes now would be a good time to fade the iron ore rally and instead focus on gold equities and other commodities. The broker also considers coal and alumina as options after recent decisions on limiting supply.

For coal, Shaw and Partners prefers Whitehaven Coal and New Hope Corp while suggesting Alumina Ltd ((AWC)) and South32 for alumina.

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CHARTS

AWC CRN EVN GOR IGO NCM NHC NST S32 SAR SBM WHC

For more info SHARE ANALYSIS: AWC - ALUMINA LIMITED

For more info SHARE ANALYSIS: CRN - CORONADO GLOBAL RESOURCES

For more info SHARE ANALYSIS: EVN - EVOLUTION MINING LIMITED

For more info SHARE ANALYSIS: GOR - GOLD ROAD RESOURCES LIMITED

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For more info SHARE ANALYSIS: WHC - WHITEHAVEN COAL LIMITED