Material Matters: Commodity Price Views And Stock Preferences

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-Production growth, delivery key
-Copper bearishness rises
-Nickel underpinned
-Cash squeeze at China's steel mills
-Platinum rally delayed
 

By Eva Brocklehurst

March statistics for iron ore shipments from Port Hedland show a strong rebound on February, up 24%. Australian iron ore companies will furnish March quarter production numbers and tweak forecasts over the next few weeks. Bell Potter, to reflect current prices and sentiment on producer earnings and valuations, has downgraded iron ore price estimates and assumes a long-term US$80/t FOB price for 62% iron ore fines, with an Australian dollar rate of US85c. In this environment Atlas Iron ((AGO)), Fortescue Metals ((FMG)) and BC Iron ((BCI)) earnings estimates have been downgraded for FY14 and FY15.

Morgan Stanley thinks pockets of strength among select metals and bulk commodities are likely, but 2014 is too early in the cycle to be buying the sector. Supply and demand issues are more compelling from 2015. What stands out is some supportive shift in the fundamentals in base metals, particularly in nickel and aluminium/alumina. In the case of copper the recent weakness offers good entry point for those seeking value, in the broker's opinion. Gold faces too many structural headwinds to realise significant price appreciation this year, while Morgan Stanley observes the platinum group has persuasive demand fundamentals but the recent lacklustre performance is a concern. A quarter of seaborne coal producers are operating at a loss, in the broker's calculation, and prices are not expected to materially rise until production growth contracts.

Production growth and delivery is critical to the broker's views on equities. Fortescue remains the top pick among the large cap Australian miners, as at spot iron ore prices it accumulates cash rapidly. Iron ore prices are expected to to gain some momentum in the second quarter but the transition to perennial oversupply is at hand, according to the broker.

Morgan Stanley observes there are no stocks for which the broker's ratings stand out above consensus. Newcrest Mining ((NCM)) was an exception but has been moved back to Equal Weight from Overweight on the back of a strong price performance. The broker is Overweight BHP Billiton ((BHP)) given its diverse commodity exposure and potential for cash returns. Whitehaven Coal ((WHC)) has an Overweight rating too. Despite the lower coal price forecast eroding FY15 earnings, the company's production growth and expectations of thermal coal price recovery is core to the broker's valuation. Atlas Iron and Alumina ((AWC)) are rated Underweight. To Morgan Stanley, Atlas is fully capturing the existing leverage to iron ore markets and Alumina has already priced in the benefits of the current bauxite market conditions and aluminium premiums.

There is an notable increase in nickel price forecasts and the broker has reiterated an Overweight rating on Western Areas ((WSA)). Morgan Stanley's supply/demand model for nickel now shows a deterioration of the 70,000t surplus in 2014 to a 60,000t deficit by 2015. Copper remains a favoured sector exposure and PanAust ((PNA)) and OZ Minerals ((OZL)) are preferred. Unless Sandfire Resources ((SFR)) has a substantial turnaround in gold grade and recovery, Morgan Stanley expects gold production to be revised down and cost guidance to be lifted. The company's limited mine life is central to the broker's Neutral view. Perseus Mining ((PRU)) is expected to show elevated costs in the March quarter. The company is significantly leveraged to the gold price and Morgan Stanley assumes future growth projects will stay subdued until either gold prices improve or optimised mine plans can deliver effectively at the current price.

After visiting Chinese smelters, fabricators and traders, Macquarie considers most companies are positioned for the worst and any change in China's economic trajectory will likely result in an uptick in prices for most commodities. The more positive stories are where supply disruption is a bigger factor than Chinese demand. Nickel falls into this category and so, potentially, does bauxite and alumina. The nickel bullishness for 2014 and 2015 largely stems from the ore ban by Indonesia. The only Chinese company observed by Macquarie to be investing in a nickel pig iron plant in Indonesia doesn't expect much supply before 2017.

The majority of market participants were bearish on copper for this year and Macquarie notes some are even anticipating lows of US$5,500/ by the end of this year. Expectations for steel over the rest of 2014 were low. Anecdotes from the mills were quite bearish. Macquarie expects a big squeeze on cash at the mills seems to be coming, not from tighter credit conditions, but from how customers are now paying for steel. In the past they paid in cash and in advance and this provided an easy source of working capital. Now they are using bankers' acceptance bills. These typically have maturity of three to six months.

Mills generally were of a view that iron ore prices had bottomed for the short term and, while the seaborne spot prices looked cheap, there was some buying interest at these levels. Most were bearish on the longer term outlook. There was a more positive outlook for zinc. The industry participants are looking for a trading range of US$1,000-2,500t on the London Metal Exchange but think it will be some time before zinc becomes structurally tight as there is a substantial amount of inventory.

Despite ongoing strikes in South Africa the platinum price has failed to rally. Macquarie observes the amount of output lost by the three largest platinum miners in the world is just under 10,000 ozs per day and the strike has been going more than 10 weeks. The affected mines produce around 40% of global mine production. Why has the platinum price failed to reflect this? Weak demand is unlikely to be the reason, as the European car market and Chinese jewellery fabrication industry started the year positively and demand appears to be at least as strong as last year. The weakness in the price must therefore be because of high stocks. Macquarie considers the platinum producers themselves are holding large stocks and this has reduced the price impact. Unless the strike continues for much longer Macquarie is of the view that sustained gains in the platinum price will be led by demand and arrive in the second half of the year.
 

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