Commodities | Jun 29 2012
– Commodity price forecasts revised
– Recent LME copper stock builds may reverse
– Aluminium demand remains weak
– Gold price may pick up into end of year
– Bulk and PGM market views updated
By Chris Shaw
As Morgan Stanley notes, in recent months commodities as an asset class have struggled under the weight of weakening growth, heightened risk aversion, a stronger US dollar and mixed supply responses.
Given the uncertain market conditions, Morgan Stanley continues to suggest exposure should only be to those metals or bulk commodities where there are the benefits of tight supply conditions and some residual demand strength. For the broker this means copper, tin, gold, iron ore and hard coking coal.
In the base metals Morgan Stanley notes copper continues to benefit from supply constraints significant enough to outweigh demand weakness, while there is also demand upside from increased infrastructure spending in China.
The tin market is more balanced and is likely to stay so given increased supply issues, while Morgan Stanley points out supply continues to exceed demand for aluminium, alumina, lead, nickel and zinc. To factor in recent market conditions price forecasts have been lowered by a weighted average of 6.4% for the base metals this year and by an average of 8.5% in 2013.
On the same basis price forecasts for the precious metals have also been lowered, reflecting a marking to market of prices of recent months and the revised assessment from Morgan Stanley of demand risks from both the industrial and investment sectors. Gold remains the preferred exposure.
In the bulks the changes to forecasts have been minor in iron ore, at 3% for both 2012 and 2013, but Morgan Stanley has made more significant cuts of 12-13% to thermal coal forecasts to reflect both weaker demand and excess supply stemming from the shale gas revolution in the US.
The new forecasts leave Morgan Stanley slightly below consensus with respect to the base and precious metals and broadly in line with respect to bulk price estimates.
Taking a broad view of commodity markets, Morgan Stanley's forecasts reflect the fact the risk to the global growth outlook remains skewed to the downside given any resolution to Europe's issues is likely to take some time.
A weaker trend in leading indicators for manufacturing and industrial output also suggest growth risks are to the downside, leading Morgan Stanley to trim its global growth estimates through 2013. This also accounts for the potential for a hard landing in China, though this is not the expected outcome for that economy.
Chinese copper imports for May surprised to the upside but in the view of Barclays Capital the figures shouldn't have been such a shock given daily volumes of copper contracts traded on the SHFE had been moving higher. These traded volumes typically have a positive correlation with copper import volumes, with a lag of one to two months.
Moving into June, Barclays notes the SHFE-LME arbitrage has become more attractive as domestic physical premiums have risen, as this has offered more support for spot transactions. If the driver of this has been sustained improvement in end-demand conditions, Barclays sees scope for imports to be driven higher and for recent LME stock builds to be reversed.
In aluminium, Commonwealth Bank notes for the period from March 1 to June 26 the 3-month futures price on the SHFE has fallen 6.7% to US$2,400 per tonne while 3-month LME prices declined 21% to US$1,827 per tonne.
The fall in prices reflects a worsening demand environment, a trend CBA sees as consistent with falling manufacturing PMIs around the world. The lack of demand has induced some supply rationing, as higher cost and less efficient smelters have closed.
In coming months CBA expects an increase in Chinese aluminium imports as buyers take advantage of the favourable arbitrage in place. This should help narrow the current differential in prices and so provide some support for LME aluminium prices.
Following last week's announcement by the FOMC that stymied hopes for further quantitative easing, gold prices have weakened, falling and staying below the US$1,600 per ounce level.
But as Standard Bank notes, the lower prices have prompted a pick-up in physical demand from the Far East in particular. This has helped offset still weak Indian demand, while a lack of scrap selling, despite prices trading above the levels of this time last year, has also been supportive.
Standard Bank's view is the physical gold market should remain a point of mild support rather than resistance. The Indian wedding season should see a ramp-up in buying from August and this supports the expectation gold will trade higher towards the final quarter of this year.
With respect to the Platinum Group Metals (PGMs), Barclays sees recycling as an increasingly important factor in the market given in the current environment this offers the main capacity for supply growth.
High PGM prices have generated an improved collection process for spent auto-catalysts and the retrieval of PGMs contained has become very efficient. But collection of scrapped auto-catalysts remains quite low, Barclays noting recovery rates are around 50% for palladium and 60% for platinum given increasing lifespan of vehicles.
The current levels of retrieval rates are unlikely to be enough to push the palladium market into substantial surplus in the view of Barclays, but the recycling process is likely to become increasingly important to the market in coming years, rising to as much as 17% of platinum supply and 20% of palladium supply over the next five years.
In terms of shorter-term market factors, Barclays notes fundamentals for PGMs are likely to tighten in coming months as end-user buying picks up, to the extent the palladium market swings into deficit this year. This leaves palladium as the preferred exposure for Barclays at present.
The key market dynamics for coming months in the view of Barclays are expected to be price sensitivity and response from the scrap market, potential production cuts, stability of demand and Russian state stock releases.
With respect to the bulks, Goldman Sachs suggests while market sentiment remains bearish, demand fundamentals in China are still quite strong. Import growth for the bulks continues to outpace underlying demand for steel and electricity, which is seen as evidence of China's growing reliance on imports.
Goldman Sachs notes at present iron ore prices are close to the US$140 per tonne cost support levels set by high cost producers in the Chinese market. The discrepancy between crude ore production and supply of domestic units indicates an ongoing deterioration of ore grades and or an increase in strip ratios.
For Goldman Sachs this is consistent with the thesis of high cost domestic supply in China, which is expected to continue to support prices until seaborne supply growth can displace domestic Chinese supply.
This may take some time, as Citi notes the New Orders to Inventory ratio in the Chinese steel market fell further in May, this indicator having a strong correlation to steel production levels. The fact the indicator fell means there is risk weak orders could see iron ore demand stay stagnant in coming months.
In the thermal coal market, Goldman Sachs notes Chinese demand remains strong and over time this is expected to address the market's oversupply situation. This should support prices and underpins the broker's expectation thermal coal price risk on a 12-month basis is skewed to the upside.
Indian supply could play a role in determining coal prices, RBS noting the Indian Meteorological Department last week revised its forecasts for the southwest monsoon rainfall to 96% of the long period average. This is down from 99% previously. Given this forecast is for a key coal producing region, Coal India's production could gain relative to last year thanks to fewer weather related issues.
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