Commodities | Jun 26 2012
– Base metal prices predicted to weaken in June quarter
– Minor gains expected across 2012
– Various iron ore scenarios explored
– Goldman Sachs adjusts commodity models
– Credit Suisse initiates on Evolution Mining
– Chinese growth expected to improve
By Chris Shaw
As noted by National Australia Bank, aggregate base metal prices fell by 4% in May and are now 19% lower than the levels seen a year ago. While the price falls primarily are due to ongoing concerns regarding the European economic outlook and growth worries for both China and the US, NAB notes there have also been sharp declines in speculative demand for the likes of copper in recent weeks.
Looking ahead, NAB suggests speculation over potential coordinated central bank action including a further round of quantitative easing may lend support to metal prices in the near-term, but the ongoing global growth risks imply heightened volatility for commodities for some time.
Weak demand has not helped in this regard, though NAB suggests some metals appear to be approaching resistance levels where marginal production capacity is becoming unprofitable. Any positive demand impact from an economic recovery in the US is yet to materialise and while this could emerge in the second half, NAB cautions it won't be as robust as previously thought.
Given the still clouded outlook for the global economy and as a result for base metal demand, NAB sees scope for prices to remain at current low levels in the near-term. This leads to a forecast for the NAB Base Metals Price Index falling by 7.4% in the June quarter after an increase of 7.7% for the March quarter of this year. Looking at 2012 as a whole, NAB expects base metal prices should rise by around 1.75%.
Similar economic concerns have impacted on oil prices in recent weeks, while NAB notes the global crude market has loosened as demand weakens and supply disruptions have dissipated. Despite this, market fundamentals continue to point to higher prices in the bank's view.
Looking to the future, NAB suggests the demand side still supports growth in oil prices, which implies current prices are factoring in the worst with respect to the situation in Europe. A gradual recovery in the oil price is expected, with Brent crude tipped to average around US$109 per barrel by the December quarter of this year.
NAB's quarterly average price forecasts for Brent crude stand at US$111 per barrel for the June quarter, US$108 per barrel in September and US$109 per barrel in December, rising to US$115 per barrel by the December quarter of 2013. Brent's premium to West Texas Intermediate (WTI) is expected to narrow significantly over that time, closing to around US$6 per barrel by the end of next year compared to around US$17 per barrel in the June quarter this year.
In the natural gas market, NAB expects gradual Henry Hub price strength through 2012 as the market begins the process of gradually tightening. Asian LNG prices should also stay strong thanks largely to Japan's energy needs, which should offset a weakening in regional demand from the combination of falling global trade and a slowing in industrial production for other key Asian importers.
Forecasts for Henry Hub prices in quarterly average terms stand at US$2.28/mmbtu for June, rising to US$2.72 in September and US$3.03 in December. By the end of 2013 NAB is forecasting Henry Hub prices of US$4.05/mmbtu.
Macquarie has again reviewed the Australian iron ore sector to contrast valuations to prices implied by current trading levels. The analysis is based on four potential outcomes for the market – Cast Iron, Pig iron, Ironed Out and Iron Man Competition.
The Cast Iron scenario implies continued growth in Chinese demand and a falling behind in seaborne supply, while the Iron Man competition scenario also implies a falling behind in seaborne supply but a contraction in Chinese demand. The Pig Iron scenario is based on growing Chinese demand but a catching up of seaborne supply, while the Ironed Out scenario implies both weaker Chinese demand and a catching up of seaborne supply.
Macquarie's view is the Cast iron scenario will prevail in the medium-term at least. Under such a scenario Fortescue ((FMG)) is Macquarie's top pick in the sector, this due to less demanding forward multiples given nearer-dated expansion plans.
Macquarie acknowledges the probability of Iron Man Competition being the outcome for the market has increased as the demand destruction flag in China has been raised slightly given Chinese steel production has been reducing and inventories are increasing. If demand slows further the Iron Man scenario comes more into play.
If the Iron Man scenario were to prevail Macquarie suggests Atlas Iron ((AGO)) could be better positioned given an ungeared balance sheet and lower capital commitments. At the smaller end of the market, Macquarie sees Northern Iron ((NFE)) and Grange Resources ((GRR)) as best positioned for a Cast Iron scenario, while BC Iron ((BCI)) is well placed for an Iron Man scenario.
A Pig Iron scenario would favour Grange given its production of high grade pellets as well as Northern Iron given it produces high grade concentrate. Atlas wold be at a relative disadvantage under such a scenario. Under an ironed Out scenario Macquarie sees Mount Gibson Iron ((MGX)) as well placed thanks to a solid balance sheet and high grades.
Overall, Macquarie rates Fortescue, Atlas, Grange, Northern iron and BC Iron as Outperform, while Mount Gibson Iron is rated as Neutral. These positive views across most of the sector reflect the fact there is valuation upside even if current spot prices prevail, given the market is currently pricing in lower than spot prices.
With commodity prices underperforming expectations in the June quarter, Goldman Sachs has made mark-to-market downgrades for most commodities. The changes have impacted on annual average price forecasts both this year and in 2013.
In the view of Goldman Sachs, much of the recent price weakness in commodities is due to negative sentiment around the European debt issue and concerns of a hard landing in China. A stronger US dollar is also playing on sentiment.
At the same time fundamentals have also shifted, with the demand outlook softening slightly and many companies reconsidering previous capex plans. This has caused Goldman Sachs to adjust expected supply/demand balances, which has generated changes to medium-term price forecasts for alumina, aluminium, iron ore, mineral sands, rare earths and gold.
What hasn't changed is the broker's order of preference, as most preferred are TiO2 feedstocks, iron ore, thermal coal and gold. The next tier includes copper, met coal, zircon and the platinum group metals. The least preferred tier is made up of alumina, aluminium, nickel, zinc and uranium.
With respect to the impact on companies under coverage from Goldman Sachs, the revised commodity prices forecasts mean significant changes in earnings estimates and price targets in some cases. The most significant are for Lynas Corp ((LYC)), Alkane Resources ((ALK)) and Aditya Birla ((ABY)).
For Lynas, Goldman Sachs's price target falls to $1.50 from $1.75 as rare earth price expectations have been lowered. The stock continues to offer significant value and so a Buy rating is retained, but any re-rating is unlikely prior to start-up of the LAMP project in Malaysia in the broker's view.
Also in the rare earth sector, Alkane's price target has been reduced to $1.05 from $1.45 and Goldman Sachs retains a Hold rating on the stock. This is primarily a reflection of the fact the company is years away form first production at its flagship zirconium project.
Target for Aditya Birla falls to $0.60 from $0.73 given the fact lower price expectations for copper don't mesh well with the company being the highest cost producer under coverage by Goldman Sachs. There is no change to the broker's Hold rating.
As part of its global gold coverage, Credit Suisse has initiated coverage on Australian play Evolution Mining ((EVN)) with a Neutral rating and $1.70 price target. Evolution's appeal according to Credit Suisse is what the company can become rather than what it is today, as there remains work to be done to extend short reserve lives.
Evolution was created last year through the merger of Catalpa Resources and Conquest Mining and has four operating mines – Edna May, Pajingo, Cracow and Mt Rawdon. In Credit Suisse's view each of the mines had been starved of capital and attention before Evolution was created, but now management are investing capital and increasing exploration.
Credit Suisse expects this will see an extension to mine life beyond that implied by existing reserves, but the fact the timing of any such success is unknown supports the broker's Neutral rating. The FNArena database shows three ratings for Evolution in total, with both Macquarie and RBS Australia rating the stock as Buy. The consensus target for Evolution is $1.98.
While concerns over the growth outlook for China have played a part in influencing commodity prices in recent months, the view of Citi is a growth rebound in that economy can be expected in the second half of 2012.
In Citi's view growth has now stabilised at a low level, so the fact inflation is likely to remain low will offer scope for further policy easing in coming months. This should facilitate a growth rebound in the March quarter, though Citi's annual growth forecast for China for 2012 has been trimmed to 7.8% from 8.1%. Growth is forecast to increase to 7.9% in 2013.
Medium-term, Citi's view is growth may settle around the 7% level annually, while the correction of over-investment and government policies to lift consumption are likely to see investment slow more than consumption does. This is likely to result in the investment-to-GDP ratio declining as early as 2013-2014.
Citi analysts do warn there remains scope for an escalation of the European debt crisis to cause a hard landing for China, especially in the absence of any additional policy support.
