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Material Matters: Iron Ore, Oil & Base Metals

Commodities | Oct 13 2021

This story features RIO TINTO LIMITED, and other companies. For more info SHARE ANALYSIS: RIO

A glance through the latest expert views and predictions about commodities: iron ore; energy; and base metals.

-Despite flagging iron ore prices, JP Morgan considers Rio Tinto, Fortescue Metals oversold
-More downside expected for iron ore with Chinese steel prices poised to fall
-Re-start of US shale production in 2022 could boost oil supply
-Power cuts likely to hit supply/demand of base metals over the next six months


By Eva Brocklehurst

Iron Ore

JPMorgan downgrades iron ore price forecasts -4% for 2021, -16% for 2022, and -13% for 2023.

The broker concedes more downside is likely but considers both Rio Tinto ((RIO)) and Fortescue Metals ((FMG)) oversold, and recommends investors accumulate on any weakness.

Rio Tinto does enjoy a greater spread of commodities which reduces its valuation by just -4%. The company is also net cash and has an estimated dividend yield of more than 10%, assuming an 80% pay-out.

The broker asserts that once sentiment towards China improves so could the share price, most likely after the winter Olympics in February 2022.

Fortescue Metals enjoys significant valuation support despite earnings pressure.

Sure, there is uncertainty regarding the Fortescue Future Industries expenditure and the widening of discounts for low-grade iron ore as well as potential escalation in capital expenditure on Iron Bridge. Yet JP Morgan says the stock is a value play and retains an Overweight rating.

The outlook for Mineral Resources ((MIN)) is more challenging given the sharp fall in cash flow.

Previously, gains from existing iron ore mines were expected to fund the 30mtpa Ashburton project, and potentially South West Creek. Now the timing of the former is uncertain and there is no news about the latter.

Morgan Stanley agrees there is more downside to come for the iron-ore price, which has recovered to US$125/t and is outpacing fundamentals.

The broker suggests China's steel-mill margins are supporting the price for now but that, eventually, iron ore should set its own supply/demand fundamentals.

Morgan Stanley points to the overhang in rising iron-ore port stocks in China, and the 200-plus vessels that are queueing to discharge an estimated 25mt of ore, and remains bearish on iron ore (it is the broker's least preferred commodity for the next six months).

Despite China's steel prices being poised for a correction (which should trigger further weakness in iron-ore prices) the broker spies some demand for iron ore given China's power-intensive, scrap-based electric-arc production has fallen more than blast-furnace output that uses iron ore. It expects this should provide mitigate downside and provide a floor.

A supply response is also starting to emerge as swing producers are reducing production. Domestically, China's operating iron ore mines are down -10% and India's low-grade exports fell to just 1mt in August.

Meanwhile, seaborne costs are rising because of the higher dry bulk freight costs and Morgan Stanley believes rising energy costs will further raise the cost curve (energy constitutes about 30% of iron-ore mining's cash costs).


Investors are trying to come to grips with whether the oil and gas price pressure is a direct result of underinvestment.

Citi believes a fundamental point is often missed: that US shale has high unit productivity on initial production and a re-start of investment in US shale, expected in 2022, could influence supply over the near term.

Investment in oil has been reduced more than gas and, within the oil sector, deepwater, heavy oil and other investments have suffered most, with US shale and Middle East oil proving more resilient.

Citi reports the latter are more protected given their low cost of production, and remains cautious towards those on the high-end of the cost curve, despite their potential leverage.

Spot prices are considered a reflection of the OPEC alliance policy and underinvestment in Asian power (which consumes gas) rather than an underinvestment in oil-and-gas supply.

So the deflationary impact of US shale remains a threat for several years, honing the broker's focus on equities at the lower end of the cost curve.

Base Metals

Macquarie reports big falls in inventory for all metals in the September quarter has underpinned price strength, while Citi suspects China's power crisis will hit metal demand and provide a neutral-bearish outlook for base metals until year-end.

Average prices of base metals rose, quarter on quarter, to the end of September with the exception of copper. The strong performance of metals stems from the recovery in global growth.

While demand may have peaked, Macquarie suggests supply issues are a major price driver, and that rolling power cuts, particularly in China, could affect both supply and demand over the next six months.

While the copper price fell -3.4% quarter on quarter, it remains at record levels.

Yet Citi expects a fall of more than -10% over the next three to six months, to US$8200/t given manufacturing curtailments relating to shortages in global power, coal and gas, and slowing Chinese growth.

Any short-term weakness provides a long-term buying opportunity and the broker remains incrementally bullish on the medium to longer term outlook for copper, retaining a long-term price estimate of US$9000/t.

Moreover, the global green transition supports the outlook for copper consumption.

Tin was the main outperformer over the September quarter, Macquarie notes, jumping 11.4% (and up 96.9% from the second quarter of 2020), and hit a record quarterly average price of US$34,821/t in nominal terms.

The broker also points out aluminium, zinc and lead prices have reached their highest since 2008, and nickel since 2012.

Citi believes aluminium premiums will fall faster because of silicon and magnesium shortages and an end to Russian export taxes. Europe could be particulalry vulnerable to an excess of refined aluminium given a shortage of silicon and magnesium. Both minor metals are critical in the casting of semis and alloys.

On zinc, Citi expects an average price in the December quarter of US$3000/t. China has a low reliance on imports of refined zinc so the supply risk relative to demand is greater than for nickel or copper. The risk of higher electricity prices also affects EU refined zinc which constitutes about 15% of the global supply.

Several trends are emerging at the inventory levels, Macquarie points out.

Data for the year to date reveals that all stocks, with the exception of tin, rose in 2020 and then trended lower in 2021, except for lead. Nickel experienced the biggest fall in inventories this year, although total exchange stocks of nickel are still higher than for other base metals.

Primary nickel production is forecast by the International Nickel Study Group to reach 2.64mt in 2021 and 3.12mt in 2022. But uncertainty surrounds Chinese and Indonesian production and no adjustments are made in those numbers for possible disruptions.

Macquarie notes world primary nickel usage was 2.384mt in 2020. The implied market balance, therefore, suggests a deficit in nickel in 2021 and a surplus returning in 2022.

Citi points out nickel demand is more exposed to Chinese power cuts than supply and believes the recent rebound in the metal should be sold.

Major stainless steel hubs are likely, once again, to face power restrictions and this could worsen before year-end. China sources more refined nickel from imports than from domestic refining than for any other metal and this puts demand at higher risk versus supply from a top-down perspective.

Citi would become even more bearish on nickel were it not for the energy and oil-driven cost inflation at Chinese nickel pig iron producers. Nickel pig iron uses substantial amounts of contained nickel.

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