Material Matters: Silver And Coal Plus China And India

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– Silver production continues at record levels
– Production among other commodities also strong
– Chinese commodity demand expected to remain solid
– Indian demand growing but from a small base
– Some coal contracts settled

By Chris Shaw

Silver recorded a seventh consecutive year of record mine supply in 2010 and Barclays Capital expects 2011 will be another record. With production at the San Christobal mine, the world's 3rd largest, to resume after a 12-day strike ended this week, Barclays expects global mine production will increase by around 500 tonnes this year.

Such an increase should be enough to keep the silver market in a slight surplus position. Barclays expects an excess of around 3,000 tonnes as new mines and expansions offset any closures and contractions.

With prices hitting 31-year highs there has been fresh investment in the silver industry, Barclays also noting there has been increased producer hedging to take advantage of current prices. The move makes sense given production costs for primary producers are below US$10 per ounce, while those for marginal primary producers are below US$15 per ounce.

Given the new investment, Barclays expects the silver market will remain in surplus even if there are some supply disruptions. Investor interest is the key driver of prices at present and this needs to move from centre stage in the group's view for changes in the market balance to have a greater impact on silver prices.

Increases to production are unlikely to be limited to just silver, RBS Australia noting across the commodities spectrum producers are moving ahead with plans to lift output. This suggests increasing supply volume will be a key theme in the sector throughout 2011.

As RBS notes, this comes at the same time as commodity inventories ended the March quarter at high levels. Aluminium inventories are at a record high, lead and zinc are at more than 16-year highs and copper is at a nine-month high. 

A key in RBS's view will be upcoming Chinese commodity import data for March, as improved numbers will be needed to show the weakness in February numbers was simply a reflection of a slowdown over the Chinese New Year period. 

Macquarie takes the view there is already evidence of a slowing in China, this coming via the latest Purchasing Managers Index (PMI) numbers. These showed weak numbers even in the context of normal seasonal volatility. In contrast, both US and European PMIs remained at relatively solid levels. 

The PMI data out of China showed both bad news in terms of a rise in inventories and good news in terms of a slight weakening in prices. Credit availability remains tight, this mattering much more than a benchmark level of interest rates in Macquarie's view.

A further point made by Macquarie in relation to the data is China's slowdown is a policy decision and not an external shock, so it remains up to the policymakers when they decide to release this current constraint. Once released, activity levels are expected to turn around as quickly as they have slowed in recent months.

Overall, Macquarie expects a slight slowing in global Industrial Production (IP) growth in coming months, though this will be from what has been a strong start to 2011. For the year as a whole IP growth is expected to remain at solid levels.

Still on China but also including India, Goldman Sachs has just returned from a tour of both countries with some feedback it sees as relevant for the commodity companies under its coverage universe.

In China, Goldman Sachs notes meetings with industry and government officials were upbeat, suggesting the government's current policy response is a measured approach and inflationary pressures are starting to show signs of easing.

While the target for growth in 2012 may be only 7%, down from 7.5% previously, the actual outcome should still exceed this level, with the more important point for Goldman Sachs the quality of growth achieved. This implies slower but still impressive consumption growth for commodities generally. 

Over in India, Goldman Sachs continues to forecast GDP growth of 7-9%, while demand for key commodities such as steel, copper and aluminium is growing at 8-10% per annum from a relatively small base.

As Goldman Sachs notes, its commodity models already assume significantly lower consumption growth for 2011 compared to 2010. The visit to China and India has not only allayed concerns a further trimming of numbers would be needed, it has led the broker to take the view its forecasts may now be too conservative.

In terms of China and specific commodities, Goldman Sachs notes industry contacts expect aluminium consumption in China could rise by as much as 17-18% this year, well above the current forecast of an 11.5% increase. Copper consumption growth is likely to be more modest at 7-12%, which again implies some upside to the broker's current forecasts.

Given China still needs to import a significant portion of its iron ore requirements, Goldman Sachs sees good price support, with a likely floor for spot prices of around US$120-$140 per tonne. China is also struggling to achieve the goal of self-sufficiency in metallurgical coal, which implies imports will continue to grow. The story is similar in the thermal coal market.

With respect to coal, BA Merrill Lynch notes Xstrata and Japan's Chugoku Electric have agreed a JFY11 thermal coal contract price of US$129.50 per tonne. This was better than the US$125 per tonne BA-ML had forecast and market consensus estimates of US$120 per tonne.

While Chugoku is not normally a price setter in the market, the fact the company has signed a deal when others had stepped back from negotiations is viewed as a positive by BA-ML. On the news the broker retains a JFY12 forecast price of US$130 per tonne, which implies some upside to market consensus estimates of US$115 per tonne.

For commodities in general BA-ML notes there are some newly emerging tailwinds, including solid prices for iron ore, coal and Ti02, further Australian dollar gains and corporate activity in the sector. The proposed bid for Equinox ((EQN)) is evidence of the latter.

In the view of BA-ML, a stronger Aussie dollar may underpin offshore fund flows into Australian resource stocks, this despite the obvious impost on earnings for the Australian producers. Least impacted stocks in terms of higher Australian dollar expectations would be BHP Billiton ((BHP)), Rio Tinto ((RIO)), PanAust ((PNA)) and Fortescue ((FMG)).

BA-ML also updated on uranium, remaining of the view the issues at the Fukushima plant in Japan are unlikely to lead to a glut of supply and sustained price weakness in the sector. While demand may be impacted as countries re-assess uranium requirements, BA-ML also sees as likely some supply side issues.

This should limit any potential oversupply, so keeping a rising price profile for uranium. What will also help in the view of BA-ML is the decision of Kazakhstan, the world's leading supplier, to limit production growth to just 2% in 2012.

Kazakhstan's actions are important, as BA-ML notes the nation is expected to account for 35% of global mine supply in 2011, up from just 18% in 2008. As sources of secondary supply become harder to find, BA-ML sees scope for an increase in corporate activity in the sector. This is likely to be driven by the likes of China and Korea attempting to secure long-term supplies.

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