Commodities | Aug 03 2010
By Chris Shaw
Metal prices hit an eight month low early in June but since then prices have rallied, to the extent both copper and alumininum have broken above key technical levels at 100 and 200-day moving averages.
In the view of RBS this suggests that despite fears over the global economic outlook, commodity demand has not fallen away sharply. By looking at the bulk commodity markets, the broker suggests it is possible to get a better indication of underlying physical market conditions as these markets are less influenced by speculative investors than the more easily traded base metal counterparts.
Here the news is relatively positive, as RBS points out the recent improvement in Chinese spot iron ore and steel prices along with a stabilisation in global freight indices suggests Chinese demand is actually improving.
With a rebound in construction activity expected in the December quarter, RBS sees a seasonal pickup in commodity consumption in that period. This should deliver more sustainable price gains towards the end of the year in the broker's view.
Natixis Commodity Markets agrees a positive stance on the base metals sector is justified, the group's latest quarterly review supporting the view the price falls in the June quarter mean much of the bad news is now priced into the market.
Western markets are continuing to recover from a low base, a recovery Natixis suggests reflects the combination of fiscal and monetary stimuli, demand growth from developing economies and capital spending from the corporate sector.
While the first of these factors is expected to fade over the remainder of this year, Natixis takes the view the very low interest rate environment in the US at present should sustain the recovery in that economy.
With respect to developing economies Natixis notes these are responsible for a greater portion of global growth now than was the case a few years ago, a trend unlikely to be reversed anytime soon. Stronger capital spending by corporates is also unlikely to be reversed as cash flows and profits are good at present. Natixis expects the corporate sector will be a leader of the economic recovery through investment in restocking inventories and replacement of capital stock.
With respect to China, Natixis notes demand is undergoing a temporary slowdown but the fact the Chinese currency is again on a revaluation path is positive for both the global economy and commodity prices as a stronger renminbi will boost dollar denominated prices.
As the Chinese economy slows in coming months Natixis suggests policymakers may become more tolerant with respect to domestic growth. The other plan is to consolidate a majority of output in the hands of a few large producers, which implies the closure of outdated and inefficient facilities.
These changes imply some production capacity targets, Natixis noting suggested targets for 2015 imply little production growth from current levels. While the actual outcome of such policies remains unknown, the group suggests the end result is likely to be less resource intensive growth where higher quality and higher value products are produced.
According to Natixis this could prove a negative for products such as basic steel but is likely to be beneficial for the base metals required for the production of higher performance steel or steel products. This includes the likes of nickel, molybdenum, cobalt and possibly zinc.
What is also a positive for commodities longer-term according to Natixis is there are limited increases to Western supply given increasing political and environmental risks and ongoing issues such as labour disputes.
Looking at each of the base metals, Natixis expects the copper market will return to a deficit in 2011 for the first time since 2007 as consumption catches up with supply. Tightness at the concentrate stage will help in tightening the market in the group's view, though it is likely to be later this year before prices begin to move higher.
More substantial gains are expected in 2011 and Natixis is forecasting copper prices to end the year above US$8,000 per tonne, implying an annual average of US$7,230 per tonne In 2011 this is expected to increase to an average of US$8.300 per tonne.
In aluminium, Natixis sees the market moving to a broad balance in 2011, which it sees as supportive of prices for the metal. This is especially the case as Chinese production costs are rising, something that could limit growth in output going forward. Prices are forecast to average US$2,148 per tonne this year, rising to US$2,400 per tonne in 2011.
Lead market fundamentals have been largely unchanged in recent months, Natixis noting inventory accumulation remains relatively small and a modest surplus expected this year before a deficit in 2011. To reflect this the group expects an average price this year of US$2,041 per tonne, rising to US$2,250 per tonne next year.
While nickel prices forecasts have been scaled back, Natixis remains of the view further downside is fairly limited from current levels as the ongoing market deficit erodes stocks at exchange warehouses. With the metal expected to be in deficit next year as well the group sees prices averaging US$23,000 per tonne in 2011, up from an expected average of US$20,995 per tonne this year.
Ongoing issues at Indonesian smelters is limiting any supply side recovery in tin and Natixis expects this will remain the case over the balance of this year. With scope for the market's deficit to widen next year the group expects prices will move higher, from an expected average this year of US$18,250 per tonne to around US$19,750 per tonne next year.
Recent output increases in both China and Europe have caused Natixis to lift its forecast for the zinc market surplus this year, though the market is expected to swing back into a deficit in 2011. This should be positive for prices, the group forecasting an average price in 2010 of US$2,114 per tonne and in 2011 of US$2,500 per tonne.
Given a favourable outlook for copper prices Morgan Stanley suggests Citadel Resources Group ((CGG)) is an undervalued exposure to the metal on the Australian market. The company is around a year away from its first production at the Jabil Sayid project in Saudi Arabia, while exploration results in recent months have also been positive.
Morgan Stanley rates Citadel as Overweight, setting a price target for the stock of $0.40. Supporting the broker's rating is that Citadel has completed the required equity raising to commence construction at the the Jabil Sayid project, while the broker also sees few issues arising from the associated debt raising.
Citadel has a market capitalisation of around $335 million, so it receives limited coverage in the Australian market. The FNArena database shows only GSJB Were covers the stock, rating it as a Hold with a matching price target to that of Morgan Stanley.
Shares in Citadel today are stronger and as at 1.10pm the stock was up 2c at $0.32. This compares to a range over the past year of $0.235 to $0.465 and implies 25% upside to the price targets of Were and Morgan Stanley.
