Material Matters: Miner PEs, Iron Ore, Metals & Shale

Commodities | Mar 19 2021

A glance through the latest expert views and predictions about commodities: mining stock valuations; iron ore premiums; metal supply/demand; shale oil re-starts

-Miner earnings probably not yet at peak levels
-China impacts both premium and low-grade iron ore
-Recovery in demand to push up aluminium
-Significant deficit looming for copper
-Shale production recovery on the way


By Eva Brocklehurst

Super Cycle?

Australia's mining sector has contracted to an average of 10x consensus price/earnings (PE) and Citi notes commodity prices are, on average, well below previous peak cycle levels. Mining PEs tend to contract at commodity cycle highs, resulting in a Sell signal.

Yet, running spot commodity prices through the broker's BHP Group ((BHP)) and Rio Tinto ((RIO)) models results in a 15% increase in 2021 estimates for Rio and 41% in FY22 for BHP. Hence, the broker assesses 12-month forward earnings estimates for the mining sector have probably not yet peaked.

Historically, the earnings peak in 2008 was short lived as the financial crisis unfolded and in 2011 it was not as sharp but more prolonged. Citi assesses the industry is 12 months into a strong recovery.

Yet, this is no commodity super-cycle, nor is one forecast, the broker asserts. If the cycle is extended and iron ore prices do not roll down as fast as anticipated, then 2024 PEs based on normalised balance sheets could be lower still.

Looking out to 2024 and a US$75/t iron ore price, while adjusting for excess cash on the balance sheet, means 2024 PEs for BHP and Rio are at 13.3x and 10.2x, respectively.

Iron Ore

Longview Economics notes the premium for higher-grade iron ore has accelerated, reflecting the reduced availability of high-quality coking coal (metallurgical) from Australia in China.

The analysts point out, without Australia's high-quality product, the steel mills have had to increase imports of higher-quality iron ore, which requires less coke in the blast furnace. This, in turn, has driven up the premium for higher grades of iron ore.

Morgan Stanley notes, historically, the iron ore grade discount has increased and decreased in line with profitability at steel mills and, with strong demand and tight market conditions, the low-grade discount has again narrowed.

Hence, strictly enforced environmental controls such as those contemplated in Tangshan, could support mill profitability and negatively affect low-grade producers. Longview Economics notes China's efforts to be carbon neutral by 2060 could also continue to pose a risk for overall iron ore demand.

Morgan Stanley still expects China's steel demand to grow and a reduction in crude steel production could mean 2021 finished steel exports fall by -36-54mt. Other steel producing countries, with higher scrap usage and excess capacity, could take up the slack. This would lead to a more balanced iron ore market and high mill profitability, another blow for lower-grade producers.

The broker notes in 2016 when China's supply-side reforms were introduced, realisations fell to a low of 60% for Fortescue Metals ((FMG)) and 66% for Mineral Resources ((MIN)).

Subsequently, after the Vale dam disaster and amid pandemic-related stimulus, price realisations have reached 90% for Fortescue Metals and 89% for Mineral Resources. The broker's base case does not encapsulate a return to realisation lows but to 82% in FY23 for Fortescue Metals and 80% for Mineral Resources.

This means dividend yields would fall to 8% in FY22 from 13% in FY21 for Fortescue Metals and, likewise, to 4% from 7.2% for Mineral Resources.


Citi anticipates aluminium prices will rally, raising forecasts to US$2300/t to reflect tighter Chinese supply. The boom in premiums across the globe is also supportive of a broader recovery in demand. Inner Mongolia has instituted additional smelting curtailments and prices on the Shanghai Futures Exchange have risen to decade highs as a result.

Moreover, the supply cuts have come with seasonally higher Chinese end-use demand, leading to a tight market and resulting in the opening of an import arbitrage. At present, Citi notes the market is behaving as if it is already in deficit.

Challenges exist in restocking and re-starting capacity, which the broker suggests are common themes across markets from steel to semiconductors. As a global deficit occurs in 2022, as opposed to just a regional one, Citi expects a tighter curve will drive prices on the London Metal Exchange higher and premiums lower.


Citi expects, given nickel supply disruptions at Norilsk, palladium is likely to remain in deficit in 2021 and 2022 amid an increase in automotive production and industrial demand.

Uncertainties exist on the supply side with a slow rebound in South African production, which should further tighten the market. Visible inventory is low. The broker also suspects a recovery in global growth should attract investor flows into palladium as current positioning is tight.


Longview Economics notes cobalt, mostly use in lithium ion batteries, has recently hit new two-year highs. Hence, recent news flow on electric vehicles is instructive. Electric vehicle sales in Europe jumped by 137% in 2020, largely in Germany where the category reach 22% of total passenger car sales.

Longview Economics notes a shift in EV policy is also underway in China where sales grew by 12% in 2020 despite total vehicle sales falling by -4%.

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