Rudi's View | Jun 14 2007
(This story was sent out as an email to paying subscribers of FNArena on Tuesday.)
By Rudi Filapek-Vandyck
Commodity prices have continued to surprise most experts across the globe and securities analysts at ABN Amro, Citi, GSJB Were and Macquarie -to name just a few- have recently again increased their price forecasts as the gap between daily spot prices, listed commodity futures and analyst forecasts remains firmly in place.
Over the past four years, such a wave of price increases steadfastly pushed up share prices of commodity producers as their earnings forecasts, and often valuations too, receive a boost from increased product price forecasts. As mid-year approaches more securities experts are expected to increase their commodity price forecasts. Whether this will lead to further rises for shares of BHP Billiton (BHP), Rio Tinto (RIO), Newcrest Mining (NCM) and others remains yet to be seen with at least one of the leading experts in the Australian share market calling for a broadly based correction.
The mining and metals research team led by Vicky Binns at Merrill Lynch said on Tuesday a broadly based price correction in share prices of leveraged companies in the sector is likely to occur in the next 3.5 months. The prediction is based upon the assumption that traded metal prices, such as nickel and copper, will correct in the short period ahead.
The higher than forecast spot prices for most metals so far in 2007 has again opened up the public debate among economists and resources analysts whether speculative funds rather than underlying market fundamentals are driving spot prices these days. Vicky Binns & Co at Merrill Lynch, while remaining firm advocates of the Super Cycle theory, weigh in by stating traded base metals are still dominated by “too much hype and speculation”. However, as underlying market fundamentals in the form of rising inventories are anticipated to come to the surface more prominently in the months ahead, the speculative bubble is believed to be ready to burst, and lower prices should follow.
Lower prices for base metals lead to lower share prices for companies with leverage, Merrill Lynch states, even if it could be argued the market never priced in the elevated spot prices in the first place.
Merrill Lynch firmly believes resources companies continue to deserve investors’ attention, but preferably through exposure to bulk commodities such as iron ore and coal (coking and thermal), as well as uranium, platinum and gold. If anything the broker believes selling out of nickel exposure seems but the right thing to do with the anticipated pending price correction estimated in the order of 50% from recent record levels.
Spot nickel retraced more than 13% last week.
Merrill Lynch is far from the only one who believes nickel is ready for a significant price fall. Commodity specialists at GSJB Were, for instance, reported this week nickel is their least preferred metal:
“Fundamentally, we believe that the outlook for nickel has weakened appreciably, because of a modest softening in demand for nickel from stainless steel in the short-term, and the rapid build in Chinese ferronickel production in the medium term.”
The case for bulk commodities is build on the expectation that this year’s tighter than expected markets for iron ore and coal are likely to last two more years, if not three, and most securities analysts have so far only adjusted their price forecasts for the upcoming Japanese fiscal year. Merrill Lynch anticipates that current consensus forecasts for price falls in the years beyond 2008 will gradually shift north, almost securing a constant stream of support for producers of these products.
A similar scenario should develop in the uranium sector. At the last quoted weekly price indicator of US$138/lb, spot uranium is already significantly above average price forecasts for the whole year by most brokerages in Australia. So far there have been no indications of any price falls anytime soon. Merrill Lynch has now lifted its price forecast for this year to US$105/lb from US$85/lb previously, but this is likely to be raised again shortly.
The mining and metals team has decided to conduct another in-depth sector study and expects to update its current forecasts shortly. There can be no doubt regarding the direction of current price forecasts: “Not surprisingly, the [current] outlook carries upside risk.”
Last week, resources specialists at Macquarie completed their update on the uranium industry. Not only did the analysts significantly raise previous price forecasts, Macquarie now also believes spot uranium could surge as high as US$200/lb over the next sixteen months.
The investment case for gold and silver is partly based on eroding producer margins. Apart from supportive factors, such as anticipated lower central bank sales, ongoing de-hedging by producers and continuing growth in investment demand Merrill Lynch analysts have observed how operating costs for most major producers are rising, and the trend is unlikely to reverse, the analysts believe.
The broker says it is obvious the large global gold producers need to increase their reserves of low cost ounces. They will do so through buying smaller fish. Mergers and acquisitions will soon become the dominant theme in the sector, the analysts believe, and it will affect share prices of Australian gold producers as much as those abroad.
The broker believes likely targets in Australia include Newcrest, Lihir (LGL) and China based Sino Gold (SGX).
While the silver story is pretty much considered to be similar to gold’s, underestimation and not consolidation will drive share prices for producers of platinum, palladium and rhodium, the broker believes. The analysts lifted their product price forecasts following Platinum Week in London four weeks ago. Merrill Lynch has buy recommendations on all PGM stocks under coverage: Anglo Platinum, Aquarius Platinum, Impala, Lonmin and Northam.
Vicky Binns and her team have been bearish on copper since the final quarter of last year, but they had to admit this week this proved to be incorrect. A significant increase to copper price forecasts was the result. However, Merrill Lynch remains of the view that copper prices will correct substantially sometime in the second half of the current year.
This view is not shared by the analysts at GSJB Were who remain copper bulls and recently further increased their already top of the market price forecasts.
Merrill Lynch suggests that any sizeable correction in share prices of resources companies should be treated as a buying opportunity, even if it involves nickel leverage.