Material Matters: Outlook For Miners & Potash

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A glance through the latest expert views and predictions about commodities: commodity outlook; miners; iron ore; and potash

-Perceptions of tighter monetary policy a source of investor nervousness
-Yet despite peak earnings miner expenditure plans remain modest
-Is now the time to sell iron ore miners?
-BHP Group's Jansen outlook a positive for Australian Potash
 

By Eva Brocklehurst

Commodity Outlook

The past year has been good for commodities amid strong demand, low interest rates and supply disruptions. While demand has played a major role in driving prices higher the impact of supply disruptions and constraints should not be underestimated, in Morgan Stanley's view.

At this point there is little sign prices are turning around, as port disruptions are occurring in China and supply is only just starting to recover. Yet China is making efforts to limit price increases by tightening credit and controls on speculative activity across commodity markets.

Moreover, in the US, expectations of eventual interest rate increases have strengthened the US dollar and triggered a sell-off across base and precious metals. Morgan Stanley observes this has now brought base metal prices to more sustainable levels on a six-month view and there is more significant downside likely for bulks.

Citi notes confirmation of China's tighter monetary policy is now a source of investor nervousness regarding the mining segment. While acknowledging earnings are at a peak for the sector, the broker envisages strong dividend yields for the majority of companies where there is no commensurate pick-up in expenditure.

Morgan Stanley expects a recovery in supply will meet up with more normal demand levels in 2022 and bring further downside across most commodity markets. As some speculative money exits the market those commodities with limited exposure to futures should fare better, and this puts uranium, alumina and metallurgical coal at the top of the order of preference.

Aluminium is considered the most defensive of the base metals, given the ongoing impact of transport disruption and a likely limit on excessive supply growth. There is also near-term support for copper from supply disruptions although downside is building as a market heads towards a surplus on a 12-24 month view.

Gold and silver are also facing headwinds from US Fed policy and the increased risk of a reduction in asset purchases (tapering) could trigger a sell-off over the next 12-18 months. Iron ore is Morgan Stanley's least preferred commodity amid expectations of weakening Chinese steel production through the second half of 2021 and beyond.

Miners

The mining cycle, in terms of forward earnings forecasts, has surpassed the peak of March 2011 but remains below the peaks in November 2008, Citi points out. On consensus estimates, the miners' forward PE is now 9.7x, in line with the average at previous peaks.

What is different about the current cycle is that despite peak mining earnings, capital expenditure forecasts remain modest and this should enable a continuation of historically high dividend pay-out ratios, the broker contends. Usually, cycle-high earnings result in production increases that ultimately undo a commodity bull cycle.

Morgan Stanley finds mining stocks cheap relative to other industrials ex banks. The broker maintains an Attractive view for the industry and 50% of its coverage is rated Overweight.

A preference for alumina and aluminium stocks means South32 ((S32)) and Alumina Ltd ((AWC)) are top selections. The former has divested its thermal coal assets and has plenty of cash with a potential catalyst in Hermosa.

Meanwhile, Alumina Ltd has fallen -11% over the past quarter because of the arbitrage trade having experienced higher freight rates. Morgan Stanley expects this will normalise over the next six months and the stock will reclaim ground.

Whitehaven Coal ((WHC)) has been volatile but the broker continues to envisage high cash flow can provide deleveraging that could be ahead of market expectations. Morgan Stanley downgrades nickel heavyweight Western Areas ((WSA)) to Equal-weight, finding the stock fairly valued at current levels.

JPMorgan has increased copper forecasts for 2022-23 by 10% and retains an Overweight rating for OZ Minerals ((OZL)). Strong Chinese demand has also because the broker to upgrade aluminium price forecasts by 7-10%.

Iron Ore

Iron ore prices continue to reach new highs and producers are well in the money. Morgan Stanley expects above-consensus dividends for BHP Group ((BHP)), Rio Tinto ((RIO)), Fortescue Metals ((FMG)) and Mineral Resources ((MIN)).

The low-grade iron ore discount has widened, now at -26.2%, and Morgan Stanley recommends investors avoid low-grade iron ore miners as the cycle turns, retaining Underweight ratings for both Fortescue Metals and Mineral Resources.

Citi prefers base metals over iron ore but does not find a compelling reason to sell the iron ore heavyweights at this juncture, while JPMorgan remains disappointed with the performances of the large miners, despite the significant strength in commodity prices.

JPMorgan retains a preference for the large iron ore and diversified miners, noting Chinese steel output was up 13% in April setting another record run rate. JPMorgan also likes South32 for the probability of increased capital returns and assesses the stock is cheap.

Potash

Shaw and Partners notes BHP Group will make a final decision on the Jansen (Canada) potash program in coming months and finds a number of positives for Australian Potash ((APC)) stemming from the briefing.

Australian Potash is preparing to start up its Lake Wells sulphate of potash project in Western Australia. BHP's view of muriate of potash pricing implies a valuation for Australian Potash of $0.38, Shaw and Partners maintains.

It also implies a realised sulphate of potash price for Australian Potash of around US$600/t. This assumes a US$50/t premium for the Australian Potash product which is granular and richer in potassium than the benchmark.

The long-run fundamentals appear attractive as additional mines are required to meet growing demand and producers will need to act promptly, given it takes 7-8 years to build and commission a large project.

Shaw also suggests decarbonisation could amplify demand for potash. Australian potash developers are also producing sulphate of potash from natural brines and these have a cost advantage versus the Mannheim Process (which derives sulphate of potash from muriate of potash). Shaw and Partners reiterates a Buy rating on Australian Potash with a $0.32 target.

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