Material Matters: Iron Ore, Copper, Zinc & EVs

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A glance through the latest expert views and predictions about commodities: iron ore peaking; copper deficit; zinc balanced; and electric vehicles recovery

-Some of the exuberance in iron ore likely to diminish
-Tightening copper market as demand remains strong
-Does a dip in zinc prices represent a buying opportunity?
-Sharp recovery in electric vehicle sales heralds robust 2021
 

By Eva Brocklehurst

Iron Ore

Has iron ore hit its peak? ANZ Bank commodity analysts suspect so. The focus is now on the downside risks although the fundamentals remain broadly positive. Steel production in China has been strong with output in December up 7.7% and a large part of the demand stemming from the construction sector.

Restrictions on the property sector could take the shine off steel demand growth. The analysts suspect Chinese authorities will struggle to lower the effective capacity of the industry over the next five years but even so this will remove some of the "exuberance".

China is considering stricter controls on the leverage of property developers by capping the ratio of their debt-to-cash flow, assets and capital. The analysts point out this tightening would be a blow to property investment which delivered growth of 8.8% in 2020.

Meanwhile, weak margins for Chinese steel mills could lead to capacity reductions. Margins for China's blast furnaces have slumped amid rising costs, turning negative late in 2020. The analysts note the last time steel margins fell below zero for a significant time was in 2015. Given capacity reductions and supply-side reforms, a 12-month price target of US$100/t is reiterated for iron ore.

The analysts note the government in China is also determined to reduce its exposure to the international market, wanting 45% of China's iron ore consumption to be met by domestic mines by 2025 and  20% of imports to come from offshore mines that are owned by Chinese investors.

Nevertheless, the analysts note China has struggled to increase domestic output in iron ore amid a lack of resources and relatively high cost of production because of very low grades.

Hence, despite the plan, it is difficult to envisage China reducing reliance on imports in the medium term. Moreover, output from major exporters is rising and BHP Group ((BHP)) and Rio Tinto ((RIO)) are targeting higher output in 2021.

While infrastructure construction was boosted during the pandemic this coincided with supply disruptions. Now Brazil's exports have rebounded although Vale has struggled to return to normal capacity. Vale still expects output will rise to 315-335mt in 2021 from 300mt last year.

Copper

February is typically the weakest month in any year for copper demand, Morgan Stanley points out. Yet a tightening market has been signalled as exchange inventory is low and bonded stocks are falling.

A shortfall of copper concentrate has driven spot tolling charges to an eight-year low of US$37/t. Mine supply, meanwhile, remains weak. Hence, the broker suspects the supply of copper metal will get weaker over the short term before recovering mine and scrap feed into some growth later in the year.

There is also a short-term disruption to shipments because of limited port capacity in Peru stemming from the pandemic while bad weather in January has affected supplies from Chile.

In the absence of fresh disruptions from mines, and Morgan Stanley acknowledges a heightened risk, the concentrate market is likely to be as tight as it gets. Logistics are expected to improve and smelter maintenance over the lunar New Year should bring some relief.

Demand, on the other hand, is likely to remain strong for the manufacturing, consumer and automotive sectors. Morgan Stanley is cautious about China's refined demand, given an extremely high copper intake in 2020.

Still, conservative assumptions suggest a slight -2% drop for China and, outside of China, global demand recovering to just 2019 levels will be sufficient to keep the market in a substantial deficit.

Zinc

Morgan Stanley suggests a recent correction in zinc reflects inventory that was built up during 2020. As demand recovers during 2021 this should enable the price to recover. The market has responded to the inflows into warehouses with a move down to US$2547/t and the broker suggests the price is now a truer reflection of inventory levels following the 2020 surplus.

Is the dip presenting a buying opportunity? Morgan Stanley anticipates some constraints on smelter output and strong demand will lend upside risk to the price on 3-6-month view. Yet, hidden inventory, opaque Chinese supply and a tight concentrate market makes the outlook less bullish than copper.

Tight zinc markets are expected to ease as mines ramp up but smelters are likely to take breaks for maintenance in China and constrain supply as demand recovers.

Morgan Stanley believes there is a danger of overplaying the risks stemming from automotive constraints, lockdowns, and China's steel production policy in the face of a bullish outlook for global manufacturing and broader recovery in demand.

All up, the broker suspects 2021 will be a strong year for zinc, maintaining the market in balance even as supply recovers. Morgan Stanley maintains price forecasts at US$2623/t for the second quarter and envisages upside risk to the third quarter forecast of US$2425/t.

Electric Vehicles

Macquarie notes the "remarkable" recovery in the second half of 2020 for electric vehicle sales, which have extensively exceeded forecasts. To illustrate, sales of all electric vehicles were down -7.5% in January to June but ended 2020 up 47.5%.

The broker notes the market is currently dominated by China and Europe, which have accounted for 87% of all sales. A large rise in European sales reflect the roll-out of new models and also more stringent emissions regulations.

In China a depressed sales rate is unlikely to be repeated because subsidies have been extended and sales promotions for electric vehicles have been strong. For 2021 Macquarie suspects unit sales will be closer to 5m, implying growth of over 50%.

In turn, the recovery in EV sales has led to a surge in implied use of lithium, cobalt and nickel. The broker assesses the global production of the latter for battery precursor production only grew by 4.5% in 2020, with large amounts of destocking contributing as production in the fourth quarter was up 41%.

A surge in fourth-quarter demand has also had an impact on cobalt and lithium although over recent years both these metals entered bear markets and inventory was run down. A recovery in demand has taken the market by surprise and the scramble to push inventory higher has had a commensurate response in pricing.

Lithium carbonate, Macquarie observes, has outperformed hydroxide because of rising production of lithium iron phosphate batteries that contain no nickel or cobalt. Tesla is using these batteries in the Model 3 and the surge in production in 2020 reflects in part batteries that will be used in 2021 vehicle sales.

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