Chinese Stimulus Package Won’t Rescue Commodity Prices

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By Chris Shaw

China’s stimulus package of more than US$500 billion is to target infrastructure projects in particular, which as Standard Chartered notes implies increased demand for commodities used in the construction of items used in such projects. But while this is a positive the group cautions investors against getting carried away with the potential for commodity prices to return to pre global financial crisis levels.

With infrastructure projects to be major beneficiaries of the stimulus, Standard Chartered sees copper, alumiminum and the construction steel materials as the major beneficiaries, but the demand story remains a question mark and this will only become clearer when the scale of any projects stemming from the package is known.

As of yet there are no indications of any projects related to the package having gotten underway, so in the group’s view the impact on metals markets is unlikely to be felt prior to the second half of the current calendar year. As a result Standard Chartered expects the current surpluses in the aluminium, zinc and steel markets will remain over the course of this year, while the deficit in copper should also remain but is likely to shrink in coming months.

In terms of the kinds of projects expected under the Chinese package, Standard Chartered sees extending the nation’s power grid as likely, which would boost demand for both copper and aluminium. On its numbers these projects alone could generate additional demand for as much as 450,000 tonnes of copper and 900,000 tonnes of aluminium. This equates to around 9% and 7% of annual consumption respectively.

The issue is demand elsewhere remains weak, with the construction and whitegoods sectors good examples. This leads the group to forecast while both copper and aluminium consumption will increase this year, the rate of increase will actually be lower than was the case in 2008.

The situation is similar in the steel materials sector, as while Standard Chartered expects steel consumption to benefit from the infrastructure package, the weakness elsewhere will hold back the market to a large extent. As an example the group expects steel usage in roads, highways and power grids to increase to between 70-147 million tonnes this year, up from 28 million tonnes last year.

At the same time weak construction demand means steel inventories will remain elevated, causing steel producers to institute production cuts over the course of the year in an attempt to sustain prices.

Standard Chartered is not alone in taking the view any recovery in commodity prices will take some time, as Deutsche Bank is forecasting something of a “W” shaped price outlook with firmer numbers in the June quarter to be followed by weakness in the September quarter and a further recovery in the final three months of the current calendar year.

In terms of specific metals, the broker sees further gains in the gold price being dependent on further weakness in the US dollar. It expects a peak in the metal’s price in coming months at around US$990 per ounce.

While contract prices have been set in coal, volumes remain at risk and so the broker remains cautious, while it notes in iron ore the Chinese are continuing to try and talk down the price before contracts are finalised. In contrast the outlook for uranium remains positive in the broker’s view as the supply side is faltering so there will be a need for utilities to secure reliable supply, an outcome Deutsche Bank expects will push prices up to around US$80 per pound next year.

Among the industrial metals, the broker has lifted its forecast for copper prices in 2009 to US$1.49 per pound from US$1.28 previously, which reflects a marking to market of prices so far this year. Despite the increase the broker continues to forecast a fall in prices from current levels later in the year given the metal is expensive relative to its marginal cost of production and so Deutsche remains cautious on copper stocks.

Having factored in recent coal contract price settlements and revised forecasts for other metals and iron ore, where it now expects contract prices to be down 40% from last year against a 30% decline previously, the broker has adjusted its earnings estimates for companies it covers in the mining sector.

The resultant changes lead the broker to suggest the share price versus net present value gap that had opened up given the market’s weakness has now started to close, meaning opportunities in the sector are now more limited.

Having said that there are still some attractive choices with the best in its view being in uranium and gold, the former reflected in its Buy rating for Paladin ((PDN)) and the latter by Buys on Lihir ((LHG)) and St Barbara ((SBM)). The broker also continues to see better relative value in Rio Tinto ((RIO)) compared to BHP Billiton ((BHP)) and consequently rates the two stocks as Buy and Hold (downgraded from Buy) respectively.

From a bottom up view the broker likes nickel play Mirabella ((MBN)), while it also sees value in Alumina Ltd ((AWC)), mineral sands play Iluka ((ILU)) and Centennial Coal ((CEY)). Deutsche Bank does point out the existence of either negative earnings momentum or other risks should keep any share price gains constrained in the medium-term among these stocks.

This is reflected by the ratings, as Alumina is rated Hold, Iluka has been downgraded to Hold from Buy following the broker’s latest review and it continues to rate Centennial as a Sell. Similarly cautious on copper the broker rates Equinox Mining ((EQN)) as a Sell as well.

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