Material Matters: Mini-Cycle, Oil & Metals

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A commodity mini-cycle is underway; China aims to increase self-reliance in iron ore and steel; Uptrend in oil prices is expected to continue

–A Mini-cycle in commodities
-Cyclical case for metals remains strong
-Oil production growth expected to be sluggish in 2021
-Nickel and steel: bullish outlook

By Angelique Thakur

Most commodities have seen a surge in prices over the last few weeks as markets continue to price in the end of the pandemic.

Brent oil price is up 19% since the beginning of December while coking coal and iron ore prices have also rallied by 22-30%. The only exception to this are precious metals which have remained under pressure.

The advent of a mini-cycle

Longview Economics’ analysts are excited about what they believe is a new commodity “mini-cycle” in progress.

Enhanced by the quantum of monetary and fiscal stimulus, the cycle presents a strong environment for commodity prices.

Consequently, Longview Economics has retained its longer-term bullish take “until markets begin to worry about the withdrawal of cheap money from the Fed”, something not expected until late 2022.

Delving deeper, Goldman Sachs analysts assert the current commodity boom cycle will be different from the previous two booms.

A concoction of high demand from China, sluggish response from the mining sector (a result of many years of under-investment) and low inventories were some key themes during the 2003-2007 cycle.

In contrast, the next relatively shorter cycle during 2009-2011 was driven by a rebound in demand post the GFC slump.

Now, with the mining sector observing capital discipline and deleveraging over the last five years, Goldman Sachs believes the current cycle will be a supply-side driven rally as global demand recovers from the pandemic.

However, Goldman Sachs is not as optimistic as Longview Economics and does not think demand would shoot beyond 2019 levels. The road to recovery is also expected to be fraught with volatility.

Ample liquidity but trouble looms

In 2021, Goldman Sachs predicts the commodity sector will revolve around the themes of recovering global demand and supply constraints. Based on this, the analysts prefer met coal, iron ore, copper, aluminium and zircon.

Bullish on commodities, Goldman Sachs’s price forecasts for the mining sector are right at the top with its operating income forecasts for the sector on average higher than consensus estimates.

Goldman Sachs also foresees consensus earnings forecasts upgrades for the sector over the first half of the year along with strong capital returns, especially for companies exposed to iron ore and copper.

Longview Economics takes a slightly different view here. While conceding the cyclical case for commodities like iron ore remains strong, with any near-term risks supported by ample central bank liquidity, Longview fears over the long term, the outlook isn’t quite so optimistic.

This looks especially true for iron ore in light of China’s recently unveiled five-year plan for iron ore and steel. The plan aims at increasing self-sufficiency in iron ore supply to 45% from the current 30%.

The Chinese-owned iron ore mine in Guinea will be playing a key role in this mission, further supplemented by increasing the use of scrap steel and using more efficient furnaces.

Among the large-cap companies, Goldman Sachs prefers BHP Group ((BHP)) and South32 ((S32)). In the mid-caps, Iluka Resources ((ILU)), Alumina Ltd ((AWC)), New Hope Corp ((NHC)) and Coronado Global Resources ((CRN)) are preferred.

Oil: Sluggish production increase to help prop up prices

As mentioned earlier, Brent oil price has seen a 19% rise early December. The strategies employed by the US and OPEC will likely ensure this uptrend in oil price will continue in 2021, argues Longview Economics.

With Saudi Arabia announcing a voluntary production cut of -1m barrels per day (mbpd) on top of the official OPEC-Plus quotas, the total OPEC production cut is expected to rise to -8.025mbpd in March. Of this, Saudi Arabia will be responsible for 35% of it.

While undoubtedly a clear demonstration of Saudi Arabia’s willingness to re-balance the market and drive oil prices higher, Longview Economics is concerned about the extent to which the Saudis can continue to prop up the market.

The US shale producers, in similar vein, have indicated their reluctance to increase shale production with Devon Energy’s CEO Rick Muncrief stating he has a “hard time” seeing the need for shale producers to go back to double-digit growth over the “next several years”.

The company plans to keep its production flat in 2021, similar to Occidental Petroleum and Pioneer Natural Resources.

Such comments hint recovery in US shale production is expected to be sluggish, further confirmed by the low levels of leading indicators for shale production.

Nickel: Recharge those batteries

Aided by stronger battery demand and an expected bifurcation between the London Metal Exchange and nickel pig iron markets, Macquarie’s commodity team has increased its FY21-22 nickel price forecasts by 7-8% and is bullish on the metal over the medium term.

Reflecting the bullish outlook, Macquarie analysts have increased their earnings forecasts considerably for IGO ((IGO)), Nickel Mines ((NIC)), and Western Areas ((WSA)) over FY21-25.

Similarly, earnings forecasts for development plays like Mincor Resources ((MCR)) and Panoramic Resources ((PAN)) have been upgraded for the medium term.

Macquarie reiterates its Outperform ratings on Western Areas and Nickel Mines, noting both stocks offer strong leverage to nickel. Mincor Resources is preferred over Panoramic Resources for development and exploration upside.

Steel: On fire

The steel complex market is being propelled by a mix of very strong demand, tepid supply recovery, low inventories and rising prices of raw materials, report analysts.

With steel spreads having gone vertical and scrap prices at record highs, Macquarie considers BlueScope Steel ((BSL)) and Sims ((SGM)) the top picks in the sector.

The plethora of drivers have also set the stage for earnings momentum in the near future, believes Macquarie. The US steel spreads which have surpassed the 2018 high levels despite the high prices of iron ore and steel scrap are a case in point.

While the sustainability of current levels is difficult to predict, Macquarie notes these are far above what is currently expected and there will likely be substantial upgrades in the coming months.

Having said that, Macquarie believes even if prices were to moderate somewhat, the reflation theme remains in favour of these stocks.

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