Material Matters: Copper, Iron Ore, Coal And Mineral Sands

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-Copper deficit looming
-Red metal holds up better
-Rally in iron ore likely short-lived
-Modest rebound in coking coal
-Downside risks for thermal coal
-Mineral sands weighed down
 

By Eva Brocklehurst

Copper

A copper supply boom was expected to develop over the two years from 2013, as certain mines ramped up, but this has not occurred to even Morgan Stanley’s relatively more subdued expectations. The broker retains a bullish copper price forecast on this outlook, now expecting deficits will characterise the copper market in 2015-17. From a demand perspective, copper consumption growth is actually better and still led by China. The recent price correction lacked a fundamental driver, in the broker’s view, and this has created an attractive entry point.

The mill failure at BHP Billiton‘s ((BHP)) Olympic Dam operation in South Australia may result in a 60-70,000 tonne fall in copper production and, Morgan Stanley suspects, provide a small boost to the global prices. The company expects the mill to be out of commission for up to six months. This shortfall, relative to the market, may be small but, relative to the forecast supply balance, it is significant. As Morgan Stanley already expects a 110,000t deficit in 2015 this event could increase this forecast to around 180,000t, and creates some upside risk to the price outlook. The event may remind the market that the mine supply growth story is challenged and, in the broker’s view, alter bearish sentiment in the trade.

UBS notes soft demand growth in copper in the second half of 2014 in China, Europe and Japan. The price is now at the marginal cost of production. There is some support from China’s state grid investment plans for 2015 and a likely drop in scrap supply as well as a spate of downgrades to supply growth. On the demand side, UBS observes copper consumption is later in the cycle and more enduring than steel. While commodity prices and margins are under pressure in 2015 and copper is experiencing a cyclical downswing, the broker considers the fundamentals for the red metal are much better than for those commodities with structural headwinds, such as iron ore and thermal coal. UBS expects a balanced market now, with deficits developing in 2017.

Iron Ore

What is driving the rally in iron ore prices? This is the question Credit Suisse asks as the price climbs back to US$65.50/t ahead of the Chinese Lunar New Year holidays. The analysts doubt the mills are re-stocking to tide them over the holidays and steel prices have not improved to stimulate demand. Rather, mills and traders are betting on stronger demand arriving in March and expect steel makers will be looking to re-stock at that point. Falling port stocks could also be a contributing factor as buyers turn to cargoes.

Commonwealth Bank analysts expect iron ore prices will remain under pressure as supply is not curtailed. The market is expected to be well supplied from 2015 to 2019 despite lower prices. Supply from both Brazil and Australia is expected to increase, while production costs reduced sharply because of cost cutting initiatives and lower fuel prices. Oil price are likely to recover in 2016 and 2017 when nominal costs in iron ore mining will also increase. However, demand is unlikely to keep up. China’s steel output growth is expected to be flat this year and slow in 2016-2020. The combination of weaker demand and increased supply with lower costs should weigh on prices. The analysts downgrade long run price forecasts to US$70/t CFR China.

National Australia Bank analysts believe a recovery in steel output after the New Year could provide some short term support for iron ore, but further growth in low-cost supply and comparatively weaker steel demand over 2015 should drive prices lower again. Prices are expected to be around US$67/t by year end. UBS is also bearish, expecting iron ore prices of US$66/t over 2015 and US$65/t over 2016. Although the broker estimates over 25% of current production is loss-making at these prices not all players are expected to exit the market, prolonging the supply glut. A lower oil price will flatten and lower the cost curve and this adds further downside risk to the price forecasts.

Coal

Prices for metallurgical (coking) coal have remained relatively stable since March last year and the NAB analysts expect sustained production cuts could support a modest recovery to around US$125/t by the end of the year. Meanwhile, thermal coal prices have continued to drift lower. The analysts believe negotiations for the Japanese financial year contracts are likely to be protracted. These contracts usually settle at a premium to spot prices and the analysts expect, for now, risks are to the downside.

UBS expects coking coal prices of around US$119/t and US$128/t for 2015 and 2016 respectively. The analysts expect demand will slow from China amidst supply growth in Australia while a lower Australian dollar will enable the Australian producers to manage lower prices. Thermal coal is expected to trade around US$64/t and US$66/t in 2015 and 2016 respectively. The spot price has been volatile recently but UBS believes this is coming from small trades relating to the upcoming Japanese negotiations and bidding by producers for quality coals for blending.

Mineral Sands

Credit Suisse is dubious about any improvement in mineral sands prices. Prices have fallen since the boom of 2011-12 and there appears to be no substantial recovery on the horizon. A housing downturn in China and economic problems in Europe are hindering key markets. Titanium dioxide pigment prices need to lift to bring margins upstream to feedstocks but the analysts suspect Chinese exports and a lift in Dupont’s production will prevent any price rises. High grade feedstocks are also burdened by existing inventories. Credit Suisse expects prices will remain flat for two years.

Zircon also has a large inventory overhang that needs to be eliminated. Major producers such as Iluka Resources ((ILU)) and Rio Tinto ((RIO)) have had to run at reduced capacity to prevent inventories from growing further. The broker expects a slow rise from a trough for prices in the first half of this year.
 

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