Material Matters: Oil, Steel, Gold And Fertilisers

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By Chris Shaw

Some short-term factors appear to be driving oil prices at present and given this distortion Barclays Capital has looked instead at what it sees as some key long-term themes for the market.

One of these is demand, Barclays noting demand estimates in 2010 have been consistently revised up to the point global demand growth for the year could be the strongest for the past 30 years. With non-OPEC oil demand continuing to dominate, the group suggests it is reasonable to question whether consensus long-term demand estimates are now somewhat too low.

As an example, Barclays points out current International Energy Agency (IEA) forecasts are for Chinese oil demand to reach 14.3mb/d (million barrels per day) by 2015, which would constitute a cumulative increase of only 4.95mb/d for the period 2010 to 2030. By way of comparison, demand growth in 2010 alone was 0.94mb/d.

One implication of such forecasts, according to Barclays, is that for these existing demand growth assumptions to be correct sharply higher prices would be required, as this would keep demand growth in check. The other implication is while there has been an increase in investment on the supply side, the supply-demand balance in the global oil market continues to move into a more precarious position.

To Barclays this means oil has become scarce, so implying a need to shift ever larger shares of total economic resources into oil exploration and recovery.

Over in the steel market, Macquarie notes prices have enjoyed a strong start to 2011, with prices for hot rolled coil pushing above US$800 per tonne in many regions. While increases to raw material prices have contributed, Macquarie attributes the rise primarily to margin expansion.

According to Macquarie, apparent demand growth and a lack of raw materials have combined to improve market fundamentals, as at present steel production is not enough to meet demand. This has given steelmakers some pricing power and allowed for an expansion in producer margins.

The market may well see further price gains shorter term in Macquarie's view, as key inputs such as coal and iron ore have seen price gains, in the case of the former these stemming from significant supply constrains due to the flooding in Queensland. As well, Chinese steel production has picked up and there are signs of some re-stocking in that market.

Macquarie expects that in coming weeks hot rolled coil prices outside the US, which have lagged to date, will start to play catch-up. This should drive steel prices higher shorter term, though the broker notes such periods of steel shortage tend to not be long-lasting.

By mid-year conditions are expected to have deteriorated such that steelmakers should be using high priced raw materials at the same time as steel prices themselves are undergoing something of a correction. This implies the current strong margins being enjoyed by steel producers will also head lower.

Gold has come under some pressure in recent weeks and Deutsche Bank sees scope for the price to fall below US$1,300 per ounce in coming sessions. Such a fall is likely to prove short-lived in the broker's view, as positive structural trends remain in place that could push the metal potentially as high as US$2,000 per ounce over the next two years.

From an economic perspective, Deutsche notes confidence levels in general and in the US in particular have improved of late creating an expectation tighter monetary policies are likely to become an objective. This implies deflation fears have been extinguished and inflation will then be addressed. Such a scenario implies lower investment demand for gold and so lower prices.

But Deutsche points out a counter argument is the fiscal imbalance that has become more significant over the past 25 years won't be quickly reversed. This in part reflects the view it has been accommodative monetary policy that has been a key driver of global growth and this easy policy trend will be difficult to reverse.

Commonwealth Bank takes a different view, suggesting the US dollar will in fact firm from around the middle of 2011. This trend, plus improving world growth prospects and improving returns on alternative assets, will combine to put downward pressure on gold prices through the end of this year and into 2011.

There is some evidence this view is gaining weight in the market, as Commonwealth Bank notes in recent weeks net long gold futures positions held by money managers have been reduced. The bank suggests this indicates such investors are lightening their bet on whether gold prices can continue to move higher.

Deutsche's analysis shows gold equities have weakened more than the gold price in recent weeks, so given the broker remains positive on the gold price outlook medium-term the broker also remains positive on the sector overall.

Preferred gold plays listed in Australia for Deutsche are Newcrest Mining ((NCM)) and Avoca Resources ((AVO)), both of which the broker rates as Buys. For Newcrest, Deutsche is attracted to the company's stable and diverse operational portfolio, as well as a number of growth options available to management.

The company is also enjoying falling costs per ounce and rising associated copper output and this continues to imply value at current levels in Deutsche's view. The broker has a price target on the stock of $51.50, which compares to a consensus price target according to the FNArena database of $46.68. The Sentiment Indicator for Newcrest according to the database is 0.8.

With respect to Avoca, Deutsche expects some positive news flow following the group's completion of the Anatolia merger. This includes a pre-feasibility study for the project, resource upgrades and potentially positive exploration results.

Combined, these catalysts should deliver short-term outperformance, so supporting Deutsche's Buy rating. The broker's target is $4.50, which compares to a consensus price target according to the FNArena database of $3.87. The database shows a sentiment indicator reading on Avoca of 0.3.

Credit Suisse's focus has been on the global fertiliser market, this following a better than expected December quarter report from Potash of the US. The company reported both its phosphates and nitrogen divisions performed well in the period, reflective of an improving volume and pricing outlook.

In Credit Suisse's view this positive price momentum in the fertiliser segment will continue, thanks to a combination of limited Chinese export supply through the first half of this year and rising raw material costs.

Other positives for prices according to Credit Suisse are delays at proposed projects such as Ma'aden and rising soft commodity prices in lower inventory levels in the market. This has positive implications for earnings for Incitec Pivot ((IPL)), the broker estimating for every US$10 per tonne change in urea prices there is a $4.8 million impact on group earnings in earnings before interest and tax (EBIT) terms.

DAP (Di-Ammonium Phosphate) prices have an even greater impact on earnings for Incitec Pivot, Credit Suisse estimating for every US$10 per tonne move there is an $11.5 million impact on EBIT. Credit Suisse is currently 9.7% above market consensus with its earnings forecasts for Incitec Pivot in FY11, so it expects upgrades to market estimates in coming months.

Credit Suisse rates Incitec Pivot as Outperform with a price target of $5.10, which compares to a consensus price target according to the FNArena database of $4.33. The database shows Incitec Pivot is rated as Buy six times, Hold once and Sell once.

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