Material Matters: China, Transition Metals, Aluminium & Gold

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Nuanced policy support in China; base metals/energy transition metals verus bulks; lows are in for aluminium in 2023 & the outlook for gold.

-Nuanced policy support in China rather than big stimulus
-Base metals/energy transition materials versus bulks
-Have aluminium prices already hit lows?
-Gold supported in second half of 2023

By Mark Woodruff 

Nuanced policy support in China

There are no quick policy fixes for China's challenges, so Oxford Economics approves of the current approach of not ‘going big’ on stimulus and adopting prudent variants of policy easing.

None of Oxford’s contacts on the ground in China are expecting a return to the old stimulus playbook of large-scale infrastructure spending or unorthodox stimulus, like direct cash support.

Effectively, the government is ‘buying time’ to resolve the bigger structural issues of property sector overcapacity, rising debt risks and the headwind posed by ageing demographics, suggests Oxford.

The regulatory environment has turned decidedly easier in recent weeks, points out Oxford, and more easing is expected for housing, including support for high-profile developers in distress, especially when it comes to delivering on pre-sale commitments.

Despite the risk of a negative deflationary loop between weak inflation and weak industrial output, Oxford believes its 5.1% forecast for annual growth is politically acceptable.

It’s believed sequential growth reached a nadir in the second quarter, due to the more supportive policy environment and fast-fading destocking pressures, which offset weaker external demand.

Nonetheless, higher-for-longer interest rate policies by major central banks outside China are not helping the country’s growth. Oxford notes China’s export underperformance year-to-date has been due to the relative and sustained weakness of global goods and industry, compared to services.

Moreover, US foreign policy could potentially turn more hawkish on China with 2024 elections looming in both the US and Taiwan, though Oxford doesn’t envisage a resumption of the 2018-2019 trade war in a time of feeble global growth.

Encouragingly, Oxford notes some buoyancy in the trend growth of 'new economy' sectors and points out China's leading edge in global renewables manufacturing, which plays to the government’s wish for high-quality growth.

By way of example, the country has made significant advances in solar and wind capacity, and, according to Oxford Economics, looks on track to surpass its target of supplying a third of its power consumption through renewable sources by 2030.

UBS prefers base metals and energy transition materials over bulks

UBS currently favours exposure to base metals as well as energy transition materials, such as copper, lithium, aluminium, zinc and rare earths, in preference to bulks like iron ore, based on a gradual improvement in Chinese consumption, instead of a strong lift for construction.

The broker still awaits significant direct spending/subsidy measures from the Chinese government, and early indications are consumer activity is likely to be favoured over broad construction. 

At a local level, governments are already providing partial support for property with some cities utilising the Housing Provident Fund (HPF) to lower the down payment required and raise the upper loan limit.

To align with its base metal/energy transition materials preference, UBS is currently Buy-rated on IGO ((IGO)), South32 ((S32)) and Sandfire Resources ((SFR)), while holding Neutral recommendations for Pilbara Minerals ((PLS)), Liontown Resources ((LTR)) and Lynas Rare Earths ((LYC)).

Meanwhile, the broker currently has Sell ratings for BHP Group ((BHP)), Rio Tinto ((RIO)), Fortescue Metals ((FMG)), Mineral Resources ((MIN)), Iluka Resources ((ILU)) and Chalice Mining ((CHN)).

By way of portfolio insurance, UBS suggests gold exposure via Buy-rated De Grey Mining ((DEG)), SSR Mining ((SSR)) and Gold Road Resources ((GOR)).

Regarding lithium, the broker still expects the market to remain tight despite the emergence of new supply, principally from Africa and China.

The broker pares back its supply forecast from other regions, particularly in Australia. On a company-specific basis, forecast output from Core Lithium ((CXO)) is reduced, while production growth at Mineral Resources is lowered, in line with tempered news flow from management over the course of 2023.

On the subject of copper, UBS doesn’t envisage protracted oversupply and considers the outlook over two-to-three years is compelling, despite near-term risks from weak demand in Europe/US and increased refined supply.

For coal, the analysts expect prices will remain supported in the near-term despite downside risks from the subdued demand outlook. Looking further out, prices are expected to trend lower to the broker’s long-term price of US$180/t as demand headwinds pick up and supply normalises.

Buy-rated Coronado Global Resources ((CRN)) is the broker’s key pick (unchanged after this week’s first half results) for exposure to currently high prices, and because of management’s M&A discipline.

Should investors be seeking a diversified option to gain exposure to coal, UBS prefers South32 over BHP Group.

Have aluminium prices already hit 2023 lows?

Despite soft fundamentals, the aluminium price had its strongest month since January, rising by 6.6% month-on-month in July, and demand indicators in China are also looking positive, according to Morgan Stanley research.

Metals were in general supported by hopes of China stimulus and early signs of softening US inflation, explains the broker.

For aluminium, global production reached a record high in June as China output jumped by 4.5% month-on-month, while ex-China demand remains lacklustre, leading the broker to ponder: has this bad news on fundamentals already been allowed for in the aluminium price?

While there is pricing upside into winter if China curtailments return and destocking comes to an end, Morgan Stanley prefers to wait a month or two before becoming too confident and will see how the market digests the elevated production out of China.

The uptick in Chinese aluminium output was largely driven by rebounds in the provinces of Shandong and Yunnan in particular, explain the analysts. In Yunnan, seasonal improvements in hydropower drove restarts, while smelter margins have also been healthy, explains the broker.

Hydro-related curtailments are expected to return with the dry season this winter in China, which could tighten supply again.

Moreover, there is little risk of smelters restarting in Europe at current prices, as Morgan Stanley sees upside risks for both coal and gas prices into winter.

For the fourth quarter of 2023, the broker currently forecasts an aluminium price of US$2350/t.

Ignoring a brief foray below US$2,200/t in early-July, Morgan Stanley suggests this level probably represented the likely nadir for aluminium prices this year.

World Gold Council sees near term support for the metal

Gold will remain supported on the back of economic uncertainty and a weaker dollar in the second half of 2023, according to the World Gold Council (WGC), despite likely weakness in the current month.

The precious metal (USD) has provided an 8.7% year-to date return and gained 3.1% in July due to a weaker dollar and a spike in breakeven rates, notes the WGC.

It was the rebounding gold price in July which offset outflows for month of -US$2.3bn for the physically backed exchange traded fund (ETF) market, explains the WGC, resulting in a 2% month-on-month rise for total assets under management to US$215bn.

The WGC suggests risk factors were the primary drivers of gold’s gain in July, largely due a sharp rise in breakeven rates on the back of stronger-than-expected economic data.

Breakeven inflation is the difference between the nominal yield on a fixed-rate investment and the real yield (fixed spread) on an inflation-linked investment of similar maturity and credit quality. (Nominal yield minus Inflation-protected yield = Breakeven inflation rate).

However, the WGC notes there is an anomaly. 

Growth data have been stronger and inflation data have been weaker, yet the rise in breakevens was the result of stronger nominal yields – not real yields – suggesting the bond market sees ‘good’ data merely as inflationary rather than growth-inducing.

This contradiction helps explain the rift between the equity market narrative of a soft landing, suggests the WGC, and the bond market expectation for an eventual hard landing.

The organisation points out sentiment and valuation still appear elevated on stock markets, while economic risks remain. The US debt ratings downgrade, alongside the announcement of a huge extension to government borrowing is the latest in a slew of troubling data points including bankruptcy filings and credit spreads.

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