Material Matters: Steel, Base Metals And Oil

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A glance through the latest expert views and predictions about commodities: outlook; steel; iron ore; base metals; oil; and gold

-Delicate balance emerging in commodity markets
-Steel demand in China expected to remain positive in 2022
-Has the peak in iron ore prices passed?
-Copper tightly balanced, nickel subdued, potential for more upside in aluminium
-Oil inventory being drawn down at higher rates than previously assumed
-Bullish narrative on gold being challenged

By Eva Brocklehurst

Commodity Outlook

A delicate balance is developing after the recent boom across most commodities and Citi is not surprised that many are outperforming, as this regularly occurs when the world economy emerges from a recession. The pandemic has created supply shortages that could last into 2023.

A sell-off in the third quarter appears to have been driven by a combination of weakening signs in the world's two largest economies, the US and China, particularly China. Yet, as the broker points out, China has limited ability to affect prices of natural gas, thermal or coking coal, which are more related to global and localised conditions.

Restricting steel manufacturing could take some of the heat out of coking coal yet higher demand for power generation has put pressure on China to increase natural gas and even thermal coal use.

In sum, Citi's most bearish medium-term view is on fossil fuels while remaining bullish for crude, global gas, aluminium, palladium, thermal coal and soybeans for the rest of 2021.

Steel

Credit Suisse believes Beijing will be less inclined to "heavy" the steel industry next year. The crackdown on property amid the Evergrande crisis and a restriction on manufacturing because of power shortages is not expected to be the "new normal".

Why? Urbanisation has not finished and infrastructure has been a driver of the country's 14th five-year plan. China will find it hard to achieve GDP growth without further investment, particularly after an economically-depressed and power-restricted winter.

Assuming China will not relax its stance against property speculation, Credit Suisse believes investment in infrastructure will need to grow by 5% to achieve 5% GDP growth. This should be positive for steel demand in 2022. More than half of China's steel is used in construction and participants in its steel markets do not believe peak steel will occur until 2025.

Morgan Stanley notes steel has the most immediate exposure to China's property sector and disruptions are likely to persist through the fourth quarter, with a gradual normalisation in 2022. The broker forecasts zero steel output growth in China in 2022.

Iron Ore

The sharp correction in iron ore has been driven by curbs to China's steel production amid weakening demand and Morgan Stanley is bearish on iron ore going into the northern winter because of continued cuts to steel production.

Some upside is envisaged by the second quarter of 2022 because of a tighter market yet the broker finds few reasons to expect a bounce in iron ore demand and prices.

Morgan Stanley retains a recommendation to avoid low-grade iron ore producers and is Underweight on Fortescue Metals ((FMG)) and Mineral Resources ((MIN)). Selective exposure could be considered for Deterra Royalties ((DRR)) or Rio Tinto ((RIO)) for those with a bullish iron ore view.

China's steel output is a major influence on iron ore prices and with the drop in construction in the second half and the issues with steel production, Credit Suisse now asserts there is a perceived excess of iron ore. This should mean prices go below US$100/t yet supply issues have kept the price above that level so far. Despite weaker demand, Chinese port stocks have also not built.

Credit Suisse expects iron ore prices may well decline to US$90/t at times but recover ahead of holidays such as Chinese New Year. The price could push back towards US$120/t in 2022 during the northern spring as Australia and Brazil should be immersed in their wet seasons when supply usually softens.

Subsequently, in the second half, Brazilian output is likely to recover and the iron ore price settle below US$100/t. Hence, Credit Suisse believes the peak has passed.

Base Metals

China has made cuts to stainless steel production because of energy shortages and this has caused prices to rise sharply higher. Morgan Stanley suspects limited impact on stainless from a lack of China steel output growth in 2022, as increased scrap use across the market mitigates the effect of production controls.

The broker believes the copper market is tightly balanced and vulnerable while Citi is bullish on copper over the medium to longer term, advising clients to buy any dips below US$8800/t over the next quarter as global growth stalls.

Strong consumption related to decarbonisation and global restocking of manufactured goods are the reasons the broker expects copper demand will grow over the medium term.

Against this backdrop, Macquarie retains a preference for OZ Minerals ((OZL)) and 29 Metals ((29M)) for copper leverage and Chalice Mining ((CHN)) for exploration. Sandfire Resources ((SFR)) is highlighted, given a binding agreement to acquire Spain's MATSA, which consists of three underground mines that can produce 100-120,000tpa of copper equivalent.

Meanwhile, Sunrise Energy ((SRL)) offers unique long-term leverage to cobalt, in the broker's view, although there are downside risks because of uncertainty over the timing of the project.

Macquarie notes nickel prices have fallen despite the prospect of cuts to China's nickel pig iron production. The net impact has pushed the market into a significant surplus and remove some of the upward pressure on nickel prices. The broker maintains a cautious view on nickel miners, and prices that vary compared with forecasts are the main risk to earnings estimates for Nickel Mines ((NIC)).

Morgan Stanley prefers aluminium because of rising cost pressures and ongoing power constraints in China. This provides a significant uplift to forecasts for aluminium prices and, in turn, support for South32 ((S32)) which has around 34% of FY22 revenue exposed to aluminium and 19% to alumina.

The broker asserts Alumina ((AWC)), while rallying recently, still has potential upside and is likely to benefit from improving margins and inflationary environment.

Citi also remains bullish on aluminium, expecting over 25% in upside potential from current forward prices. China is enforcing targets at levels that are not consistent with rising energy-intensive aluminium production, and the broker points out this is a large change to the market, as China has represented 90% of refined aluminium supply growth.

Oil

Morgans asserts the majority of oil market indicators are now bullish as the fundamentals improve and a supply deficit grows. Oil prices appear to have disconnected from the marginal cost of supply and are moving to a level where demand destruction will start to materialise, at around US$80/bbl.

The broker observes inventory is being drawn at high rates, suggesting the market is more under-supplied than previously understood. Mobility statistics are also improving as are jet fuel crack spreads.

There is more improvement to the latter likely on the way, too, as the US government this travel restrictions for vaccinated passengers from the EU and UK. Refining margins are now sufficiently high to incentivise refiners.

Gold

Citi believes the bullish narrative for gold is being challenged. While understanding the inflation narrative amid concerns about debt loads and fiscal balance sheets, the broker ultimately believes this just lifts the long-term floor price for gold as opposed to underpinning a rally.

Gold is outperforming against commodity-linked currencies such as the Australian dollar and Canadian dollar but underperforming in US dollar terms. This is unlikely to change without a more dovish turnaround by the US Federal Reserve, as the broker notes a slightly hawkish June FOMC statement and strong July US payrolls number have reversed the gold/US dollar dynamic in 2021.

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