Commodities | Mar 22 2011
– Lead boosted by Japanese demand
– Elevated copper prices difficult to justify
– Potential upside for gold
– Japan and energy markets
By Chris Shaw
With the market expecting reconstruction efforts in Japan in the wake of the earthquake and tsunami to boost demand for base metals, this sector of the commodities market has largely outperformed over the past week.
Taking an overall view, Goldman Sachs points out Japan is, copper excepted, not a huge consumer of base metals. The country accounts for less than 10% of global consumption, but Japanese demand for all metals should rise as rebuilding commences.
Goldman Sachs notes the standout performer so far has been lead, the industrial metal seen as the most immediate beneficiary given strong demand for batteries to power generators as the Japanese attempt to restore power to affected areas. This is coming at the same time as an increase in emerging world demand, so expectations are for a tightening in the lead market.
Elsewhere among the base metals, Goldman Sachs notes disruptions to car manufacturing in Japan could impact on Chinese exports of aluminium and alloy products as about half of these exports go to Japanese auto manufacturers.
Short-term copper demand is also expected to fall in Japan given current power rationing, while damage to a number of Japanese semis fabricators should also impact on consumption in the view of Goldman Sachs.
There is scope for China to fill the breach in terms of copper demand shorter-term, Commonwealth Bank noting the Shanghai Futures Exchange to LME copper price arbitrage is currently more supportive of Chinese buying.
Recent falls in LME copper prices make Chinese imports of copper more attractive, especially as CBA notes Chinese demand appears to be price sensitive at US$4.50 per pound or higher.
This underpins the view of CBA that copper prices of US$5.00-$6.00 per pound are difficult to justify, as at current levels demand destruction becomes relevant and makes such prices unlikely to be sustained much beyond the next six months.
With respect to the precious metals, Standard Bank notes at present gold is encountering resistance at US$1,430 per tonne. While this may continue for some time and could push gold down as far as US$1,380 per tonne, the bank remains of the view gold will hit new highs sometime in 2011.
As Standard Bank points out, gains in oil prices are offering some support to gold prices. As well, recent falls in real interest rates as inflation expectations have risen suggests global liquidity should continue to grow.
As long as this remains the case, Standard Bank sees upside potential for gold. The target is US$1,500 per ounce in the third quarter of 2011, post a short period of weakness from seasonal factors and an increase in gold scrap volumes.
A further boost for gold is coming from safe haven and currency hedge buying, ANZ Banking Group noting ongoing geopolitical tension in Libya and the moves to weaken the yen post the Japanese earthquake have seen some buying enter the gold market.
Energy markets are also likely to see some impact from the aftermath of the disaster in Japan, UBS estimating closures to nuclear and thermal power facilities may translate to Japan requiring an additional 5mmtpa of LNG. Any increase in Japanese LNG imports should boost Asian spot LNG prices according to UBS, with Woodside ((WPL)) the most likely beneficiary among the listed Australian plays.
UBS rates Woodside as a Buy with a price target of $60.00, while the FNArena database shows a Sentiment Indicator reading of 0.1 and a consensus price target of $49.09. The market appears to prefer Santos among the major Australian energy plays, the database noting a Sentiment Indicator reading for the stock of 0.9.
On oil, UBS notes Chinese apparent oil demand rose 14% in January in year-on-year terms. This compares to demand growth of 11.6% in 2010. Global oil demand for 2010 according to International Energy Agency (IEA) estimates is now expected to have been 87.9 million barrels per day, slightly above the UBS estimate of 87.6 million barrels.
UBS is forecasting a modest increase in 2011 to global demand of 89.0 million barrels per day, while the IEA forecast stands at 89.4 million barrels. Spare capacity appears to be falling, UBS noting OPEC space capacity in February of 4.98 million barrels per day compares to 5.15 million barrels per day in January.
To better understand the potential impact of the earthquake on the Japanese oil market, Deutsche Bank looked at 2007 numbers, when an earthquake impacted on Japan's largest nuclear facility in Niigata. In the months following that quake, Tepco, the Tokyo power company, doubled its purchases of low-sulfur fuel oil and direct-burn crude oil relative to the preceding six months.
Assuming increases in demand stemming from the latest earthquake Deutsche sees positives for Asian fuel oil markets, especially given Japanese inventories are currently at very low levels and there is typically a seasonal uptick in demand in the region in the June quarter.
An even bigger impact could come in the bulk material markets where Deutsche notes Japan is a more significant player. Japanese buying accounts for about 15% of the seaborne thermal coal market and around 13% of the seaborne iron ore market. This compares to around 5% of global demand for industrial metals.
Thermal coal is one of Japan's most important sources of electric power, leading Deutsche to suggest a medium-term larger than normal increase in thermal coal imports into the Japanese market is likely in the wake of the lost nuclear capacity.
Citi agrees, expecting global thermal coal markets will tighten in response to events in Japan, with the full effects to be felt by late in the second quarter of 2011. This is bullish for thermal coal prices as this period is expected to correspond with a pick-up in demand from other regions.
Given Japan has been the only Asian buyer willing to pay high prices for coal out of Australia, Citi suggests the short-term impact of the Japanese earthquake may be a correction in the Newcastle market. This reflects the need for cargoes previously bound for Japan having to find new markets given damage to Japanese ports and utilities.
Medium-term, Citi estimates Japanese thermal coal imports could increase by as much as seven million tonnes this year, which would help tighten the market. Also supportive is the fact a number of other nations are re-examining their commitment to nuclear power generation in the wake of the Japanese crisis. This represent potentially significant additional demand.
On Citi's numbers, 56GW of nuclear capacity is equal to 183 million tonnes of coal. If it is assumed 19% of replacement capacity comes from coal-fired power generation, Citi suggests an additional 36 million tonnes of additional thermal coal needs to be sourced over the next 10 years.
This is expected to push prices higher, especially as Citi had already been forecasting a thermal coal market deficit of 13 million tonnes this year. This implies upside risk to current 6-12 month price forecasts for Newcastle FOB thermal coal of US$130 per tonne.
