Material Matters: Mineral Sands, Zinc, Oil And Iron Ore

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-Mineral sands re-stocking subdued
-Slow response from China's zinc smelters
-OPEC production cut unlikely this year
-Citi contemplates iron ore at US$50/t
 

By Eva Brocklehurst

Reports of an impending rebound in mineral sands demand has instigated a review of prices by Commonwealth Bank analysts. They predict zircon and titanium dioxide supply will lift noticeably in the years to 2017 as recently commissioned projects reach full capacity. Nevertheless, the chances of strong re-stocking activity of titanium dioxide appears increasingly unlikely, as pigment manufacturer inventories are normalised.

In the case of zircon, re-stocking is also unlikely. Chinese trade data suggests imports have risen to record levels over the past year despite subdued pricing. Both these products are susceptible to substitution as they are non-essential quality additives to manufacturing. The substitution issue may have run its course but the analysts highlight the cyclical nature of demand, with growth higher than GDP possible in good years and lower than GDP in bad years. They expect both markets to be in surplus for the rest of this decade, with the peak surplus in 2016 and a slow move to deficit by 2020.

A recovery in zinc prices has sparked investor interest, with Macquarie noting the bullish tone at the recent Antaike conference is based on the slow response to price rises by Chinese zinc smelters. The changes in financing conditions and a shift in the supply curve has lifted the incentive price for refined zinc supply. Small zinc smelters in China have been struggling to make a profit over the past two years, given high cost inflation and credit rationing. Hence, rising zinc prices have failed to bring some idled capacity back on line, or lift utilisation, eliciting a sluggish supply response. Forecasts are for Chinese refined zinc supply growth of 5% in 2015, with the main contribution coming from ramp up of new capacity and re-starts during 2014.

Macquarie observes, if the zinc prices rallies towards RMB17,000/tonne and Chinese smelters are able to make good margins, there could be another 100,000t of supply in the offing. The broker believes the break-even threshold for Chinese refined zinc supply is around RMB16,550/t. Macquarie observes few at the Antaike conference were worried about zinc demand in 2015. Antaike estimates demand will grow at 5% this year, driven by the galvanising sector. Robust infrastructure construction and a solid automobile sector, as well as export demand for galvanised steel, are considered the pillars for zinc consumption.

Meanwhile, the zinc concentrate market remains under pressure and the import arbitrage ratio implies it is a buyer's market for imported zinc concentrates at present. For the first time since 2013, imported zinc concentrate is cheaper than that of Chinese domestic counterparts and Macquarie expects this situation should bolster imports. 

Citi suspects the latest official selling prices for oil from Saudi Arabia are an indication of earlier efforts to stake out a larger role in China and Asia rather than an aggressive marketing move aimed at the US market. The country's stake in China has been challenged by sales from other areas of the Middle East and Central Asia as well as Russia and Venezuela. Citi believes Saudi Arabia has accepted it will have to lose deliveries to the US, amid US growth and competitive Canadian crude reaching the refining system on the US Gulf of Mexico.

Saudi Arabia may be signalling a willingness to cut production but Citi contends that in a lesson learned from the 1980s, Saudi Arabia will not cut output on its own, fearing a loss of market share. Hence, a production cut is only likely to ensue if other producers are feeling the pain too. Citi does not believe agreement on cutting output at the November 27 OPEC meeting is likely. A better opportunity could emerge early in 2015, after the northern winter.

Citi has become even more bearish on iron ore, downgrading forecasts yet again. Forecasts are now set at US$78/t in the current quarter and US$65/t for 2015 and 2016. Demand remains weak and supply is surging. High cost capacity is being driven out of the market but, the broker observes, this is happening at a lower-than-expected price because of barriers to exit, exchange rates and other factors which are lowering costs.

Of the Australian pure-play iron ore miners, Citi observes Fortescue Metals ((FMG)) is the fittest, able to withstand a long downturn in iron ore prices. Mt Gibson ((MGX)) may be the fittest small-cap thanks to a healthy cash backing but is now burning cash at Koolan Island at a greater rate. Atlas Iron ((AGO)) is the most at risk, now envisaged as net debt and unlikely, on Citi's price forecasts, to be able to repay its US$270m facility in 2017 from cash flow. Meanwhile, the acquisition of Iron Ore Holdings by BC Iron ((BCI)) is looking more and more ill-timed. The broker observes there is little value at current prices.

But wait, there's more. Citi expects iron ore prices will fall briefly into the US$50/t range next year. The broker believes only modest cut-backs to production are likely if the price remains in the US$70/t region. During the Chinese winter Citi expects many mines that shut down will simply not re-start in the new year but the scope of such reductions is likely to be insufficient to stem the downward spiral. As a result, prices will need to fall further to prompt additional closures. Moreover, Chinese steel demand is expected to weaken early next year. Measures relating to pollution are currently negatively impacting demand for steel and a further deterioration in steel demand is expected on the back of tight credit conditions, slowing manufacturing export growth and the Chinese government prioritising reform over short-term growth.
 

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