Material Matters: Copper, Gold & LNG

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Copper overvalued; economic backdrop to drive gold prices up further; Asia benefiting from low LNG prices.

-The copper market is likely to be in surplus for the next 12-18 months
-Gold prices expected to hit US$2300/oz by 2021
-Iron ore prices forecast to continue to rise in FY21-22

By Angelique Thakur

Copper: Danger ahead

Copper has been one of the best performers in the commodities market in recent weeks. Most of this can be attributed to China’s rapid economic recovery along with pandemic-related supply disruptions in the world.

In spite of this, ANZ Bank sees risks skewed to the downside for copper prices. The economic backdrop remains challenged with global industrial production growth in negative territory.

Resurging covid-19 cases globally are threatening to disrupt the economic recovery that began in the second quarter. China is the outlier, with manufacturing and industrial activity rebounding strongly, but this can only offset the weakness in the rest of the world for so long.

The analysts forecast demand to fall -4% in 2020. Growth is forecast to remain subdued in 2021. Thus, copper at current price looks overvalued to ANZ Bank.

With the pandemic-related supply disruptions expected to ease in the coming months, the bank analysts see a surplus in the copper market for the next 12 to 18 months.

This will likely see copper prices come under pressure, they warn.

Gold: The party continues

Goldman Sachs has raised its 2021 gold price forecast by 15% to US$2,300/oz, with additional rises of 10% and 5% in 2022 and 2023. Long term, the broker's gold price forecast remains unchanged at US$1,550/oz.

With more downside expected in US real interest rates, Goldman Sachs’ commodities team expects gold to remain a beneficiary.

For gold producer stocks under Goldman's coverage, upgrades in forecast gold prices have led to operating income estimates being revised upwards for FY21-22. While the sector is already trading at a premium to the analysts' base case valuation, Goldman continues to see relative value in selected names.

In this environment, companies that are leveraged to higher gold prices, have organic growth options and are trading at a discount relative to the sector, will outperform, the analysts suggest .

Switching focus to the August reporting season, gold producers Newcrest Mining ((NCM)), Evolution Mining ((EVN)), Northern Star Resources ((NST)) and Western Areas ((WSA)) in the nickel sector are all expected to provide FY21 guidance.

The analysts retain their Buy rating on St Barbara ((SBM)), Saracen Mineral Holdings ((SAR)), Resolute Mining ((RSG)) and OceanaGold Corp ((OGC)). Sell ratings remain in place for Evolution Mining ((EVN)) and Regis Resources ((RRL)).

Iron Ore: No material increase in supply expected

Ord Minnett expects iron ore prices to rise further and has increased its price forecasts by 19% in 2021 to US$100/t and by 10% to US$86/t for the following year.

Despite the recovery in Vale’s output to about 1mt per day, Ord Minnett feels the miner is unlikely to improve output materially over the next 12 months. China, expected to rev up its steel production in 2020 by 3%, is another reason for Ord Minnett's change of heart. 

The analysts think prices could remain well above cost curve support levels until production from Rio Tinto’s ((RIO)) Simandou project comes to market. But this could still be five to seven years away.

Unsurprisingly, higher prices will also affect the miners' prospects. Ord Minnett expects net profits to rise by 26-45% in FY21. 

Among miners, Ord Minnett prefers BHP Group ((BHP)) and Rio Tinto. While iron ore has surged about 30%, both stocks have given a lacklustre performance, trading flat year to date. Between the two, Ord Minnett favours Rio Tinto a tad bit more because of its relatively cheaper valuation.

Despite factoring in higher earnings for Mineral Resources ((MIN)) in FY21, Ord Minnett notes the valuation hasn’t kept up with the share price. This compels the analysts to downgrade their recommendation to Lighten ahead of the company providing FY21 guidance.

Ord Minnett's updated iron ore price forecasts remain below the current price of US$121/t implying earnings risk remains to the upside.

LNG: Production continues to decline

LNG production in July was on the weaker side, yet again, with US plants reducing production. This is the sixth consecutive month of production decline. JP Morgan estimates global plants to be operating at utilisation of 74%.

LNG prices are starting to recover with JP Morgan estimating a 16% increase in July prices to US$2.83/mmbtu. This price implies a 9% slope on the three-month lagged Brent oil.

With the Brent oil price falling considerably in February and March, JP Morgan expects LNG contract prices on a three-month lag to fall in the months ahead.

Forward rates, too, indicate considerably stronger prices by year-end with the JKM forward prices in contango.

On the demand front, imports to Asian countries have increased in 2020 to 1.6% versus 0.3% last year.

Despite weak global economics led by the pandemic, Asian LNG demand remains steady with China’s imports up 11% year to date while South Korea’s imports are up 30% versus -10% in 2019.

It looks like in the current weak demand environment, mostly centred in Europe due to high gas storage levels, the ultimate winners are Asian countries taking advantage of these low prices.

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