Material Matters: Bulks, Base Metals And Gold

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-Iron ore marginals being squeezed out
-Structural changes augur poorly for coal
-Larger copper deficits expected from 2018
-Stainless steel demand non existent
-Will gold resume an uptrend eventually?
 

By Eva Brocklehurst

Bulks

The outlook is gloomy. Credit Suisse observes bulks have entered a multi-year trough and a bottom is not yet in sight. The broker believes this will doom marginal producers and subdue the survivors. In iron ore, major miners appear determined to add more capacity to a saturated market while demand for steel in China is ebbing. The price of iron ore is the casualty and the broker considers this is now approaching the level where marginal producers will be pushed out.

Metallurgical (coking) coal has the same poor outlook as iron ore, in Credit Suisse’s view, coupled with the fact that China is intervening to support domestic suppliers. The supply side in this instance is more benign as expansions have ended. In thermal coal a structural change is underway that the broker observes will shrink exports. China is moving its coal burning inland where imports cannot compete and will use long-distance UHV transmission to connect power to the cities. Meanwhile, India plans to double domestic coal production by 2020, reducing imports.

Base Metals

Credit Suisse observes some more positive fundamentals are evident in base metals and remains constructive on copper this year, expecting another deficit. Surpluses in 2016-17 are expected to be moderate. The broker notes guidance downgrades from major producers and significant disruption in the first months of this year have cut the supply side. Chinese construction is looking like contracting in terms of the demand side although overall growth is bolstered by the state grid proposal to spend more than it did in 2014 with long distance transmission work.

Credit Suisse forecasts a modest deficit of 120,000t, spread between copper concentrate and refined copper. The broker now envisages a peak of US$6,600/t in the middle quarters of 2015 for the copper price, with prices receding in the face of a modest surplus in 2016-17. From 2018 the broker expects large and growing deficits, which will require new mine production to come on board.

Zinc and lead remain in a deficit situation because of mine exhaustion, although Credit Suisse notes the zinc shortfall should be less than what was exhibited in 2014, given China has lifted refining capacity. Aluminium is again challenged by over-production in China, Credit Suisse observes, and the premium is falling as physical tightness disappears. The broker notes aluminium curtailments are due in China and this should hinder alumina prices in 2015.

Credit Suisse expects nickel to recover from being oversold, because of the cost base of nickel pig iron production, but there is not a case for the price to move over US$9/lb. Macquarie, on the other hand, has pared back its bullish forecast for nickel because of weak stainless steel demand. The broker observes growth in stainless steel demand in both China and the rest of the world is non existent. Macquarie still expects the nickel market to be in deficit from the second half of 2015 and beyond, but this deficit is now likely to be 50% less than what was previously forecast.

Macquarie retains Outperform ratings for Australian nickel miners Western Areas ((WSA)) and Sirius Resources ((SIR)) despite material cuts to earnings estimates and valuation. Western Areas generates positive cash flow at spot prices while Sirius is expected to do the same once production starts. Higher cost producers Panoramic Resources ((PAN)) and Mincor Resources ((MCR)) are both loss making at current nickel prices and, given the downside risk and lack of valuation upside, Macquarie has downgraded both to Underperform.

Gold

Credit Suisse expects gold to trade between US$1,100-1,300/oz over the next few quarters. The broker’s gold price view is constructive for the next couple of months before becoming bearish over the northern summer and constructive again subsequently. In 2016 Credit Suisse expects the gold price to be supported by declining mine supply as well as global bar hoarding and jewellery demand. A gold market deficit is forecast for 2016. The yellow metal is expected to maintain its value in US dollar terms. Monetary policy drivers are somewhat bearish for the outlook while non-US dollar factors are considered more supportive. This includes Asian demand, central bank purchases and curtailing mine supply.

Credit Suisse believes the role of US dollar strength in determining gold’s value has diminished since 2013 because of the reduced size of exchange traded fund holdings. Furthermore, Chinese influence has increased in the international monetary system with the launch of the Asian infrastructure Investment Bank a recent example.

Gold will not remain in a bear market, Citi believes. The money printing and currency debasing of the past few years could eventually induce inflation once the impact of the oil price slump has filtered through. Gold has recently resisted the strengthening US dollar, detaching from other metals which are still clustered closely to the US dollar index, Citi maintains.

The broker looks back to 2008-12 and notes certain forecasters had then maintained that systemic risk and money printing over that period warranted gold trading above US$2,000/oz. While not Citi’s take at the time, the broker considers such a view is not irrational. Analysis of gold over the long term indicates it is correlated with the quantum of money in circulation. Why it may be different at present is because the historical connection is via inflation.

Money printing has almost always resulted in inflation but with today’s excess of global production capacity, and the collapse in the oil price, inflation has been deferred. The long-term principle still holds, Citi believes, and it may be the case that investors are happy to accumulate gold at these levels in anticipation off the correlation between money supply and gold returning in 2016-2020.
 

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