Material Matters: Gold, Contractors & Steel

Commodities | Jun 08 2021

A glance through the latest expert views and predictions about commodities: gold; contractors; bulks; and steel

-Gold back in vogue amid surge in inflation but investment window narrow
-Contractors threatened by inflation, labour shortages
-Demand remains robust for coal as industrial production recovers
-Bluescope Steel, Sims riding high on demand and price strength

 

By Eva Brocklehurst

Gold

The love of gold has been rekindled. So say the analysts at ANZ Research, as the yellow metal regains most of the losses endured during the first part of the year amid a surge in inflation.

This has caused a sell-off in bonds and pushed the US dollar down. The analysts expect the US CPI will be above 3% for the present, allowing gold prices to rally as inflation expectations are ramped up.

The analysts note, in March, as risky asset classes such as equities touched record highs, gold-backed funds experienced significant outflows, sustaining the largest declines since 2013.

Now, increasing labour shortages, supply bottlenecks and rising raw material prices have brought inflation back into focus. Despite gold being seen as an inflation hedge, the analysts note, surprisingly, the relationship to changes in the US CPI is poor.

Rather, it is the market's perception of inflation that supports increases in investor demand. Nevertheless, the window for gold pushing US$2000/oz is likely to close quickly once the Federal Reserve observes inflation is becoming entrenched and adjusts policy accordingly.

The analysts expect growth in the US will improve and broaden out beyond to the global economy, enough to generate modest weakness in the US dollar. In order for the US dollar to drop more sharply, central banks would need to allow inflation to overshoot.

This is deemed unlikely. As the world economy recovers from the pandemic, should inflation prove persistent and inconsistent with the 2% mandate, the analysts expect the US Fed will not hesitate, and any subsequent rise in interest rates or reduced bond purchases will weigh on investor demand for gold.

Contractors

Credit Suisse assesses most of the Australian contractor names underperformed in May amid the threat of inflation and labour shortages. The broker suspects the issues will persist as long as travel restrictions remain in place and the risk of coronavirus transmission stays elevated.

The broker's index of ASX-listed contractors declined -1% in the month which compares to an ASX 200 increase of1.9%. This represents the third month of underperformance for contractors inside the last four.

Perenti Global ((PRN)) triggered a review and subsequent negative sentiment for the sector, Credit Suisse points out, as it downgraded forecasts citing labour as the biggest issue.

While the sector appears particularly cheap, the broker suspects investors are not trusting the earnings bases, even if the issues may be transient. Credit Suisse notes investors quickly de-rated Monadelphous ((MND)), NRW Holdings ((NWH)) and Maca ((MLD)).

Those that have outperformed during the month include ALS ((ALQ)), which has experienced accelerating sample flows across both its commodities and life sciences segments, and CIMIC ((CIM)) which has been awarded the M6 project, providing more visibility beyond 2022.

Credit Suisse observes the market is gravitating to those names that have low labour intensity and pricing power, given the enduring strength in commodity prices. The broker's top pick in the mid-caps is Seven Group ((SVW)) although recent developments, such as the bid for Boral ((BLD)), require further time to fully assess.

Bulks

Coal supply within China has been disrupted by various inspections and Macquarie notes only Shanxi managed to maintain peak production rates in March and April. At the same time demand has been very strong for thermal coal.

Current burn rates are over 25% higher year-on-year, the broker points out. Moreover, the ban on Australian coal imports is unlikely to be lifted over the short term and Chinese buyers have been purchasing high-value seaborne thermal coal from elsewhere.

They are also willing to pay elevated prices because of the wide arbitrage against domestic coal prices. Those buyers facing competition from China have to switch to Australian coal or pay higher prices from their traditional suppliers to meet the improved demand from recovering industrial production.

In this way Australia has benefited, managing to switch thermal exports away from China and avoid a large drop in total exports. Meanwhile, thermal coal imports to India have disappointed, as local thermal coal plants chose to de-stock their inventory amid higher freight rates, while domestic supply also improved.


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