Material Matters: The Outlook For Commodities

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A glance through the latest expert views and predictions about commodities: broker outlooks for the commodity sector, iron ore, lithium and gold.

-Broker outlooks for the commodities sector
-Recent ratings changes for ASX-listed iron ore stocks
-Divergent broker views on the lithium sector
-Preferred stocks in the gold sector

By Mark Woodruff

The outlook for commodities

Looking beyond a global economic slowdown sometime in 2023, Longview Economics sees an increasingly positive longer-term outlook for commodity prices. 

This view is based upon a lack of capital expenditure from producers and suppliers across a range of key commodities, which is likely to spur the next commodity super-cycle. Also, a large volume of commodities will be required for decarbonisation and the ‘greenification’ of economies.

After a period of weakness in 2023, Longview expects metal prices will return to high levels.

Currently, Morgan Stanley points out commodities markets are caught in the crossfire between the potential for recession in most developed markets in 2023 and ongoing reopening momentum in China.

In November, when the Chinese government started to ease covid restrictions and announced more meaningful property stimulus, UBS felt the macro backdrop for commodities improved meaningfully. 

These developments triggered a short squeeze/rotation leading to a 37% lift in iron ore and copper prices, a 24% increase for nickel, while copper and aluminium bounced 10%, and a significant rally in mining stocks ensued.

While the China reopening may result in pent-up demand and possible restocking, the market has priced in a faster improvement than UBS expected, even when risks remain from a Europe/US recession, a likely uneven exit from covid and structural issues within the Chinese property sector.

JP Morgan agrees and suggests the recent rally in commodity share prices has already priced in a China reopening. It’s felt the market could pivot back to global recession concerns in early 2023 or begin to worry about an interrupted or less aggressive China reopening. 

Citi lends even more support to this view by suggesting China’s reopening presents risks around expectations, and on a 12-month view sees more downside than upside for commodity prices.

Regarding commodity preferences, UBS leans toward thermal coal, zinc and aluminium which should benefit from the energy crisis, while lithium, copper and nickel are favoured for an attractive medium-term outlook.

Morgan Stanley believes the risk reward ratio still looks generally favourable for iron ore, oil copper, aluminium and gold, though is wary of the lithium sector.

Longview Economics expects an economic slowdown will weigh on oil demand through to mid-2023, if not beyond. It’s felt in that a decline in global oil demand will be the key driver of ongoing supply surpluses and further weakness in oil prices in the first half of next year.

Europe will struggle to rebuild gas inventories ahead of winter 2023/24 without Russian supply and with China reopening, according to UBS, which will result in high gas and coal prices.

Within the coal sector, the broker likes Whitehaven Coal ((WHC)) from a total returns perspective. Citi agrees and this week upgraded its rating to Buy from Neutral for both Whitehaven and New Hope Corp ((NHC)).

Recent broker views on iron ore

The spot iron-ore price has rebounded and is trading above US$100/t.

Macquarie still envisages upside momentum for iron ore miners, with Fortescue Metals Group ((FMG)) having the most potential for significant earnings upside.

The analysts continue to prefer BHP Group ((BHP)) over Rio Tinto ((RIO)) and Fortescue, due to a strong balance sheet and multiple growth options, both organic and inorganic.

The most notable change to the broker’s recent commodity forecasts is near-term upgrades to iron ore prices on improved market sentiment, despite the absence of “fundamental backing”. 

Citi also expects iron ore pricing will remain strong in the near term and this week raised its 2023 forecast to US$109/t from US$96/t. An even higher price could result in the case of a major China credit easing during the first quarter of 2023 and/or an accelerated China reopening plan.

Taking a counter view, UBS believes the risk/reward balance for iron ore has worsened, and this week downgraded its ratings for BHP Group and Rio Tinto to Sell. Both stocks were considered expensive and trading ahead of fundamentals. A Sell rating was retained for Fortescue Metals Group.

While China’s reopening appears to be a reality, the broker points out the dangers of adhering to this consensus view. It’s felt fatigue on this trade for iron ore miners could soon become apparent, given both strong recent performance and 2023 recession concerns.

JP Morgan also believes several of the iron ore miners have run too hard, noting that BHP, Rio and Fortescue have risen by 25%, 14%and 5%, respectively, this year. A Neutral rating is retained for BHP, while both Rio and Fortescue are downgraded to an Underweight rating from Neutral.

Last week, Morgans downgraded its rating for both BHP and Rio to Hold from Add on limited valuation upside, while also alluding to the premature pricing-in of a China growth recovery. As Sell rating was maintained for Fortescue.

Divergent broker views of the lithium sector

Prior to very-recent share price falls for lithium names, the sector had been undergoing a price correction since mid-November

Last week Macquarie highlighted strong underlying lithium prices and felt the near-term demand outlook continues to brighten with the easing of covid policies in China, further supported by various stimulus policies.

The broker’s preferred Australian producers are Mineral Resources ((MIN)) and IGO ((IGO)), while Pilbara Minerals ((PLS)) offers full lithium exposure through its Pilgangoora operation. 

The analysts also see value in Allkem ((AKE)) which offers unique exposure to both lithium brine in South America and spodumene production in Australia. Goldman Sachs agrees on the valuation proposition, and initiated coverage with a Buy rating last week.

Macquarie also has an Outperform rating for Liontown Resources((LTR)), which should gain valuation support as construction at Kathleen Valley de-risks the project. Global Lithium Resources ((GL1)) is thought to offer the greatest near-term exploration upside.

Morgan Stanley has an opposing view on the lithium sector and last week downgraded its rating to underweight on near-term caution around battery over-production in China, subsidies being partly phased out and consumer caution impacting electric vehicle demand.

This week, Citi also updated its commodity price forecasts. On a 12-month view the broker sees more than -20% downside for lithium, along with thermal coal, rutile/zircon and nickel.

Morgan Stanley downgraded its rating for Allkem to Underweight from Equal-weight on a potential delay to the Stage 2 expansion at the Olaroz Lithium Facility. An Underweight rating was maintained for IGO ((IGO)) on pressure from both lower nickel and lithium prices, 

While Morgan Stanley’s Equal-weight rating was maintained for Mineral Resources ((MIN)), its target increased to $83.40 from $78.80 on a positive outlook for iron ore. 

UBS, on the other hand, believes iron ore fundamentals are weak and preferred to focus upon a fragile macroeconomic backdrop and China's reopening challenge. While this broker’s target for Mineral Resources was increased to $93 from $83.30, its rating was downgraded to Neutral from Buy after a very strong recent share price.

Allkem is now the analyst's sole Buy in the Lithium sector, with IGO rated as Neutral and Pilbara Minerals ((PLS)) a Sell.

Meanwhile, JP Morgan has lowered its 2023 and 2024 lithium forecasts by around -10% and -15%, respectively, which allows for lower battery growth and more long-term supply.

Despite these changes, the broker anticipates modest year-on-year growth in pricing across the complex, which supports material EPS growth via contract lags heading into 2023.

IGO and Allkem are preferred by JP Morgan over Pilbara Minerals and Liontown Resources.

The outlook for gold stocks

Gold enjoyed an around 11% recovery from its early November lows to December 9.

Macquarie attributes this rise to a broad-based relief rally based on the prospect for an accelerated Chinese reopening and increasing signs of a peak in developed-market inflation.

UBS still favours gold in 2023, as it is well-placed to benefit from a pivot by the US central bank, with prices poised to rally as real rates decline and the US dollar weakens against G10 currencies. The broker holds this view despite noting the risk reward of gold miners has recently worsened.

Morgan Stanley agrees the turning point for gold should be when the last of the rate hikes come through and, after some initial downside, the price should pick up in the second half of 2023.

According to Macquarie, the precious metal is expected to bottom at US$1,550/oz in mid-2023 (quarterly average), up from their previous assumption of US$1,500/oz. 

The analysts continue to prefer Northern Star Resources ((NST)) from among the larger-cap gold names, while the smaller-cap top pick is West African Resources ((WAF)) via the development of the Kiaka project in Burkina Faso. The exploration and development potential for De Grey Mining ((DEG)) is also noted.

While this broker retains its relatively bearish outlook, some upgrades were made to the near-term outlook this week. Within its large cap gold coverage, Newcrest Mining ((NCM)) received the largest earnings per share increase at 27% for FY23, with Evolution Mining ((EVN)) and Northern Star Resources up 21% and 24% respectively.

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