Material Matters: Copper And Gold, Nickel And Steel

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By Chris Shaw

The copper market has been quite tight in recent months and precious metals research and consultancy group GFMS sees scope for this trend to remain in place for much of the next three years. This should be enough to generate record prices, GFMS expecting a copper price peak of well above US$11,000 per tonne in 2013.

GFMS expects the overall copper market balance will be in negative territory this year, prior to a brief return to a market surplus in the first half of 2011 on the back of an economic slowdown. Deficit conditions are expected to re-emerge in the second half of next year, driven by supply growth struggling to keep pace with consumption.

GFMS's forecasts allow for some production growth, as producers are expected to lift output to take advantage of higher prices where possible. Supply from secondary sources should also grow, but structural constraints will continue to limit output growth overall. GFMS is forecasting refined production growth of an average of 3.4% annually for 2011 to 2013.

An increase in substitution is also factored into the estimates, but increases in demand should offset this as Chinese copper consumption growth is forecast to average 6% annually through 2013. China should account for about two-thirds of the increase in global copper consumption over 2010-2013.

Increasing interest from investors should also boost copper prices according to GFMS, while also supporting ongoing high levels of price volatility. The combination of bullish fundamentals for copper and an expectation of a growing investor base in commodities generally should see further inflows into copper and so support prices in the view of GFMS.

Turning to gold, Macquarie is similarly positive on the yellow metal in that it expects prices will continue to rise into 2011. Gains in the metal in 2010 have followed two different periods, rising at one point in response to the sovereign debt crisis in Europe and more recently returning to its more common relationship with the US dollar.

A key to the gains in both periods, according to Macquarie, is that Asian growth ex Japan has been relatively robust and real long run yields have mostly been declining through 2010. These factors have generated strong liquidity growth, so allowing investors to continue to buy gold even at higher prices. Both factors should remain supportive in the near-term in Macquarie's view.

For buying interest to continue to ramp up from current levels Macquarie suggests a key will be the existence of a convincing investment thesis for margin buyers. At present there are some topical issues with sovereign debt problems in Europe still in play, along with geopolitical uncertainty thanks to North Korea and rising inflationary expectations.

These factors and ongoing strong global liquidity growth lead Macquarie to suggest gold will continue to gain, but the broker doesn't see it as the strongest performing commodity going forward. This leads the broker to suggest a better exposure to the metal may come via companies leveraged to rising production profiles.

With respect to nickel, Macquarie attended the fourth New Caledonia nickel conference last week, coming away with the view the region continues to offer lots of promise, but it has its share of challenges as well.

New Caledonia will have a global nickel market share of around 7.5% this year but should see strong growth in production in coming years as new projects come on-stream thanks to significant investment from global mining group Vale in particular. A global market share of around 12% by 2015 is seen as possible.

What could hold back or delay this growth is project delays, skilled labour shortages, declining ore grades and what Macquarie notes is a complex political environment for outsiders. Longer-term production growth is likely to come from the Koniambo deposits in the north and the Prony and Pernod Creek deposits in the south.

Macquarie has not been the only broker looking more closely at nickel, as BA Merrill Lynch has today initiated coverage on two nickel stocks listed on the Australian market and reinstated coverage on another company.

The two initiations are on Western Areas ((WSA)) and Independence Group ((IGO)), while coverage has been picked up again on Minara Resources ((MRE). Western Areas is rated as a Buy, Independence as Neutral and Minara as Underperform.

BA-ML's general view on nickel is for a more balanced market, as nickel production continues to increase while demand growth is slowing. Significant oversupply remains unlikely in the broker's view as there remains scope for nickel production to underperform expectations.

What makes Western Areas the pick of the bunch, in the view of BA-ML, is the company offers the combination of high grade mines, production growth potential and low costs. Production is expected to increase from around 9,600 tonnes in FY10 to 23-25,000 tonnes in FY11, thanks to the Flying Fox mine expanding, the Spotted Quoll mine coming online and an upgrade to group production facilities.

There remains scope for production to increase further to 30,000 tonnes or more per year in BA-ML's view, which offers additional upside to its numbers. The stock is currently trading at a discount to peers on the broker's numbers and this offers the potential for a share price re-rating. BA-ML's price target for Western Areas is $7.10, while the FNArena database shows a Sentiment Indicator reading for the stock of minus 0.3.

For Independence, BA-ML sees a steady nickel producer with the benefit of some gold output as well via a 30% stake in the Tropicana project. Independence currently produces nickel at around 10,000 tonnes per year and this rate of output should be sustainable for some time. Current mine life is five years but this is likely to be extended.

While the Tropicana stake offers some valuation upside BA-ML sees this as somewhat offset by the risks it sees to nickel prices and the fact much of this upside potential is already priced into the stock. BA-ML has a target on Independence of $7.80, while the stock's Sentiment Indicator reading according to the FNArena database stands at 0.7.

Minara is a laterite nickel producer and in the view of BA-ML this makes it a stock to own when there is a strong view nickel prices are expected to increase. This is not currently the case in the broker's view.

While group production is improving, it remains below required levels and issues continue to arise in the broker's view. BA-ML has a price target on Minara of $0.70, while the stock's Sentiment Indicator according to FNArena's database is 0.0.

The final word on commodities today comes via steel industry consultant MEPS, the group reviewing November market results for steel producers across the world and concluding despite weaker numbers for the month a steel price recovery should still be expected.

US producers have lifted December prices by US$30-$40 per tonne but even allowing for this, transaction figures for flat products have continued to drift lower as year-end demand weakness has become more apparent.

On the plus side, MEPS notes business activity in the US steel market is starting to pick up and delivery lead times are extending as customers place orders ahead of the expected price increases. Imports are not a factor in the US market at present as offers are yet to become competitive.

Canadian orders remain at poor levels and service centre inventories have risen, though MEPS suggests fewer imports and a potential lock-out at US Steel may limit supply by enough to prevent prices drifting lower.

As the Chinese government continues to try and curb energy use there is growing pressure on steelmakers to scale back their operations. This has helped prices rally in recent weeks, but MEPS suggests there are now signs of market sentiment again wavering. Local demand is softening and inventory levels overloaded, while the outlook for export sales appears relatively poor according to MEPS.

Japanese demand from the construction sector remains very weak, while auto output is also falling. On the plus side, exports have been strong and MEPS notes domestic inventories have again strengthened. While consumption is not great in South Korea, producers have been able to maintain transaction prices and export quantities are at record levels.

Final quarter consumption in Taiwan is currently below the forecast of MEPS, while domestic sales have been hit by competitive imports from China and South Korea in particular. This has seen market prices fall in recent weeks.

While Polish demand has contracted leading into the end of the year, MEPS expects an improvement early next year. Inventories are currently under control and there should soon be a need for some replenishment, but MEPS notes mills have been unable to maintain price gains achieved in October. Elsewhere in eastern Europe MEPS notes the price tendency remains negative as sales volumes are low and steel product turnover is poor.

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