Material Matters: Gold, Aluminium & Coal

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A glance through the latest expert views and predictions about commodities. Lithium; gold; aluminium; China's emissions; and Newcastle coal.

-Lithium stocks unlikely to find support until spot prices stabilise
-Opportunity in North America for ASX-listed gold companies
-Supply, trade shocks undermine profitability in aluminium
-China lowers winter emission reduction target
-Are major coal miners exercising more pricing power out of Newcastle?
 

By Eva Brocklehurst

Lithium

JP Morgan lifts forecast for 2018 Australian exports of lithium by 6% to 1.46mt. This new supply is entering a subdued market as Chinese inventory is at record highs. Carbonate prices are also being affected by low-quality product coming online from Chinese brine assets and a shift in the market towards hydroxide.

The broker notes China's spot prices have now fallen -53% over the year to date to meet seaborne contract prices, although seaborne producers insist they are not witnessing the level of market disinterest implied by these spot price movements. JP Morgan expects battery grade prices to be -8-10% lower in 2019 and concentrate to fall by -20% year-on-year.

The broker does not expect lithium stocks to find support levels until spot pricing stabilises, which should happen in the December quarter as downstream capacity comes online and the Chinese brine supply is reduced. JP Morgan retains a preference for battery grade exposure versus concentrate and producers versus developers.

Gold

JP Morgan believes the time is right for ASX gold companies to create value through acquisitions in North America. Australian gold portfolios are now optimised and the broker forecasts three-year operating earnings (EBITDA) growth of 27% across the six leading ASX gold producers.

A disparity between ASX stocks and those listed on the Toronto Stock Exchange creates the opportunity, as North America host many large, high-grade gold systems. TSX stocks are -50% cheaper on an enterprise value/reserve basis but costs are 24% higher than ASX peers.

A number of TSX mid-caps have significantly de-rated because of ramping up issues in their core projects and JP Morgan wonders whether the problems are related to execution or fundamental flaws.

The broker calculates those ASX gold stocks it covers will generate US$4bn in excess capital over the next three years. Those most likely to make acquisitions include Newcrest Mining ((NCM)), Evolution Mining ((EVN)) and Northern Star ((NST)), as these have the greatest surplus capital.

JP Morgan prefers Newcrest for global gold exposure, Evolution Mining for defensive value and Northern Star for earnings growth. Those mid cap picks JPMorgan rates Overweight include OceanaGold ((OGC)) and St Barbara ((SBM)).

Aluminium

Macquarie observes 2018 has not been a good year for aluminium producers. A series of supply and trade shocks have progressively distorted flows of both alumina and aluminium, lifting costs for most producers. The broker notes by mid 2018 around 18% of the global industry was loss-making at a cash costs level whilst 30% were loss-making on a full operating cost basis.

The lift in the alumina price was a major factor as well as relatively high coal/power costs. The broker does point out that aluminium producers are somewhat protected from the surging spot alumina price by having part of their supply delivered on multi-year contract terms.

Subsequently, a series of trade shocks progressively distorted flows, further lifting costs for most producers. Subsequent to US tariffs on aluminium imports, US sanctions on Russian producer Rusal, and the strike by workers at Alcoa's Western Australian smelters, industry profitability appears to be substantially undermined.

Moreover, China's aluminium industry has evolved rapidly over the last decade and its smelters are now distributed across the global industry cost curve. China now maintains some of the largest, lowest-cost assets in the world and has become less exposed to a falling aluminium price.

Macquarie concludes that spot and forward contracts illustrate a tariff-related hit in the US while China's industrial reforms are ongoing cost-push factors.

Steel/Chinese Property

There is a sizeable gap between apparent demand for steel in China and property sales. The two have been fairly well correlated, with a 12-15 month lag, since 2002, Citi observes. The broker calculates, if property sales remain stable for the next eight months, demand for steel should continue to grow 5-7%. Even if property sales activity actually dips -5-8% the apparent demand for steel will continue to grow at low single digits until late 2019.

China's Production Targets

Citi has also noticed that China has lowered its winter emission reduction target to a 3% reduction, from 5%, which comes after recent guidance that local government must not order across-the-board cuts to production during the upcoming winter.

Citi suspects the -30-50% production cut requirement for targeted cities could also be removed so that local governments have more flexibility. This would be negative for sentiment in the near term, as investors could view this as stepping back from the current environmental policy.

However, the broker believes the actual impact should be relatively limited and vary across commodities. In the case of steel, the price should trade lower in the near term but recover later, as the winter reductions in Hebei should still be on a differentiated basis and construction bans may also be less stringent.

In aluminium, the broker considers the outlook marginally negative and, on a relative basis, the production cuts for alumina could be more significant. In cement the broker considers the seasonal uptrend should continue into the fourth quarter and there are upside risk to the cement prices in east China.

Newcastle Coal

Credit Suisse suggests the Newcastle coal price, which remains resilient above US$110/t, has been helped by extreme illiquidity. Around 3mt of coal is loaded at Newcastle each week, with two thirds high-energy, but globalCOAL's price discovery this year is based on average trades of just 64,000t per week.

Credit Suisse notes, since late July, trading has been reduced to 40,000t per week, or sometimes none at all. The broker acknowledges it is hard to argue that 1% of the port volumes trickling out in 25,000t parcels to an unknown entity is a representative price. Nevertheless, that is how the price is found.

Some explanations include a very tight high-energy market, while others suggest it could be intentional and an expression of the pricing power that major miners are beginning to exercise following the consolidation of producers in the Hunter Valley.

Major miners may be ensuring their own sales avoid the globalCOAL trade in order to keep visible pricing illiquid, while the price of large volumes is unknown and buried in confidential deals. Credit Suisse concludes that Glencore, the largest Hunter Valley coal producer, would prefer to win contracts at lower prices than add liquidity to the spot market.

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