UBS Positive on Resources Outlook

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 By Chris Shaw

As coordinated global fiscal stimulus programs helped stabilise global economic growth in 2009, there was a recovery in market values and in investor risk appetite, an outcome UBS notes was instrumental in providing support to commodity prices after the global financial crisis-driven weakness of 2008.

The price changes were of different magnitude among the different commodities however, UBS noting base metal prices generally recovered to close to pre-correction levels with copper, aluminium and zinc particularly strong, while coal and iron ore prices were weaker in Japanese financial year 2009 than was the case in 2008 given the contract system and the timing of agreements. For gold, prices in 2009 first returned to then pushed well above the highs seen in 2008.

As noted, timing played a big role in the pricing outcomes for various commodities, as UBS points out both coal and iron ore prices have improved as 2009 has gone on, coal largely as China has emerged as a large buyer of metallurgical coal for the first time thus reducing the pressure on thermal coal prices from weaker global demand. In iron ore, the pick up in steel market activity has seen demand increase enough to push up spot prices by better than 30% year-to-date, leaving them around 75% above benchmark levels.

The price activity has been reflected in the share price performance of resource equities, as in broad terms UBS notes base metal companies have enjoyed 100% plus gains year-to-date and iron ore stocks gains of better than 150% year-to-date. Australian gold shares have performed relatively poorly through 2009 however, as the stronger gold price benefits have been offset by a stronger Australian dollar to the extent both Lihir ((LGL)) and Newcrest ((NCM)) have gained only around 10% year-to-date, while coal stocks have been mixed with Macarthur ((MCC)) and Whitehaven Coal ((WHC)) gaining more than 200% year-to-date but Coal & Allied ((CNA)) losing 9%.

Iron ore stocks generally enjoyed good gains through 2009 with Fortescue ((FMG)) rising by around 124%, Murchison Metals ((MMX)) and Mount Gibson Iron ((MGX)) rising by better than 200% and Gindalbie Metals ((GBG)) gaining more than 50%, reflecting the strength in spot prices over the course of the year.

Among the base metal plays UBS note Oz Minerals ((OZL)) and PanAust Resources ((PNA)) were both able to deal with refinancing issues and so were re-rated over the course of 2009, while the likes of Western Areas ((WSA)) and Alumina ((AWC)) underperformed.

For Western Areas it was production issues of lower output and higher costs that dragged on the share price to the extent UBS prefers Panoramic Resources ((PAN)) on valuation grounds, while it suggests the underperformance makes Alumina undervalued given upside risk to consensus earnings forecasts as spot prices remain above consensus estimates at present.

In mineral sands, UBS notes Iluka ((ILU)) had a tough year as demand for its products was weak at the same time as the company spent a lot on capex, this combination creating some balance sheet concerns. While demand is showing signs of improvement there is still not much evidence of re-stocking in the broker’s view.

Looking to 2010, UBS expects the next 12 months will show a restocking across the base metals spectrum, not only by the BRIC nations but in the US and Europe as well. In the broker’s view this means the risk to prices remains to the upside given the existence of depleted supply lines to end users.

This sets the scene for what UBS suggests may be the most resource intensive recovery since the early 1970s, so rather than accept the consensus view of a somewhat soggy resources market plagued by lacklustre demand and industrial overcapacity its view is of a world of scarcity in the months and years ahead that will be supportive for further price gains.

In terms of forecasts for the bulks, UBS expects the price gains of recent months should also flow through to higher contract prices for Japanese FY10 and in iron ore it notes consensus forecasts are for an increase of 18% over the JFY09 settlement prices. The coal price outlook is similarly positive, UBS forecasting contract prices of US$170 per tonne for hard coking coal and US$90 per tonne for thermal coal, which compare to benchmark prices for JFY09 of US$129 per tonne and US$71 per tonne respectively.

While it is positive going into next year UBS, cautions there are risks to its view and it sees these risks as rising going into the second half of the year as it expects resource utilisation rates will rise in both the US and China through 2010. There is also the growing likelihood of some policy tightening in nations such as the US and it suggests this may see some loss in macroeconomic momentum in the third quarter as restocking draws to a close.

UBS expects this may create something of a tradeable correction in commodity markets but it takes the view the scarcity factor is likely to reassert itself beyond the second half of 2010. This will generate strategic challenges across the commodities landscape and so help push prices higher longer-term in its view.

In terms of the Australian resource stocks UBS covers, the broker notes it has Buy rating on two-thirds of the companies in its universe and only Kagara ((KZL)) is currently rated as a Sell.

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