Material Matters: Commodity Price Forecasts Revised

This story features SANDFIRE RESOURCES LIMITED. For more info SHARE ANALYSIS: SFR

 – Further revisions to commodity price forecasts
 – Copper fundamentals remain tight
 – Consensus Chinese steel assumptions may be too high
 – Base metal prices suggest further volume cuts

By Chris Shaw

With oil prices over the past few weeks softening on eurozone worries before strengthening on geopolitical concerns, National Australia Bank notes the market continues to be torn between the risks of Europe and Iran.

NAB expects Iranian sanctions are likely to impact the global market more than first thought as China won't be acting as a buyer of last resort. This should see the market stay relatively tight as the deteriorating macro environment is offset by ongoing near-term supply risks. Prices are expected to remain volatile.

Factoring in current market conditions, NAB remains of the view current prices for oil are a little low given ongoing outages and geopoliticial risk. Prices should gradually lift through the remainder of this year as the US recovery gathers pace and as Chinese economic growth picks up.

In quarterly terms NAB is forecasting Brent crude prices of US$108 per barrel for September, rising to US$109 per barrel in December and US$113 per barrel by June next year. For West Texas Intermediate forecasts stand at US$95 per barrel in September, US$98 per barrel in December and US$106 per barrel in the June quarter of 2013.

For the base metals, NAB notes prices fell by 5% in June and were more than 22% lower than year-ago levels. This reflects an erosion of confidence given uncertainty with respect to the eurozone outlook and further volatility in financial markets as well as weakening activity levels.

Aluminium and nickel prices are among the largest falls over the past year, which reflects oversupply in the former and rising production levels in the latter. In contrast, the performance of copper has been better given still tight market fundamentals.

In NAB's view the near-term outlook for global metal prices remains highly correlated to the demand outlook. With the demand outlook appearing likely to remain restrained, prices may remain at low levels near-term in the bank's view.

The NAB Base Metals Price Index is forecast to fall by 1.5% over the September quarter but should still record a rise of around 1.0% for 2012 overall. A further gain of about 4.0% is expected in 2013.

Canada's Dundee Capital Markets has similarly offered its outlook for base metal and coal prices, taking the view global economic growth will trough in the third quarter of this year. This implies base metal and coal prices are already in the bottoming phase, especially given the potential for economic activity to improve as easier monetary policies are implemented.

China in particular may see a speeding up of economic stimulus measures once new political leadership is in place in the next few months, so Dundee Capital sees the global economy bottoming before more positive data emerges in 2013.

Assuming a view of generally modest economic growth with periods of more rapid acceleration leads Dundee Capital to suggest over the medium-term commodities may act more like they did in the 1990s than in the period 2000-2008. This implies commodity price rallies of 12-18 months rather than the longer-term rally seen between 2000-2008.

A stronger US dollar will also impact on commodity prices, Dundee Capital taking the view global currencies at present are in general misaligned against the greenback. This offers scope for a weaker US dollar going forward, especially relative to many of the Asian currencies. Any fall in the US dollar would be a positive for commodity prices.

While LME inventories are high at present, Dundee Capital suggests inventory levels appear close to the top. Inventories are expected to fall given ongoing structural issues faced by miners, which include declining grades, increasing depth of discoveries and increases in sovereign risk and consistent supply disruptions. There is also a lack of infrastructure in both new and old geographies, which is adding to the challenges being faced by miners in the view of Dundee Capital.

Taking a long-term view, Dundee Capital expects Chinese and Indian demand will deliver, even if the strength of emerging market demand in the next few years is masked by debt and growth issues elsewhere in the global economy.

Supply will be the key theme going forward and here Dundee Capital expects most projects will on average be one-to-two quarters late in development and will face significant increases in capital costs. This will continue to put pressure on increasingly complex and lower grade projects, as capital costs of projects have tripled over the past decade.

If miners choose to look after shareholders and pay dividends rather than invest capital in new projects, Dundee Capital sees a situation where mine supply will be unable to keep up with demand, even assuming modest global economic growth.

With respect to price forecasts, Dundee Capital suggests ongoing supply deficits mean the copper price has essentially bottomed for the cycle in the US$3.00-$3.40 per pound range, while nickel prices appear to be trying to bottom in a range of US$7.50-$8.00 per pound. In coming months lead prices are forecast to trade in a range of US$0.80-$0.95 per pound, while zinc prices of US$0.80-$0.90 may represent the bottom for the cycle.

For coal, Dundee Capital is forecasting metallurgical coal prices of US$220 per tonne in the June and September quarters, before increases to US$245 per tonne in the December quarter and a 2013 average of US$260 per tonne. Thermal coal prices are expected to bottom this year before delivering slow gains through 2013 and beyond.

Having reviewed the global copper market, Macquarie's conclusion is mine supply growth continues to underperform thanks to declining grades, lower than expected recoveries and adverse weather conditions.

Macquarie also sees evidence of Chinese copper demand increasing into the second half of 2012 as government stimulus measures are implemented. Inventory levels in the Chinese market are declining rapidly and capacity utilisation rates for fabricators are moving to 80-90% levels from 50-60% in the first quarter of this year.

This combination leads Macquarie to suggest the fundamentals for copper will remain tight in 2012. Any improvement in sentiment should boost Australian copper producers, as Macquarie notes these stocks are leveraged to market sentiment.

Among copper stocks under coverage, Macquarie rates PanAust ((PNA)), OZ Minerals ((OZL)), Discovery Metals ((DML)) and Blackthorn Resources ((BTR)) as Outperform, while Sandfire Resources ((SFR)) is rated as Neutral.

For PanAust and OZ Minerals, current share prices are trading at levels implying significant discounts to the spot copper price according to Macquarie. PanAust is trading at a larger discount and has the greater leverage in the broker's view. Among the developing producers, Macquarie suggests both Sandfire and Discovery are trading at levels implying copper prices closer to spot levels.

By way of comparison, the FNArena database shows Sentiment Indicator readings for the copper plays of 1.0 for Blackthorn, 0.8 for PanAust, 0.4 for OZ Minerals, 0.2 for Discovery and 0.1 for Sandfire.

Turning to China, Citi notes consensus expectations are for Chinese steel production of greater than one billion tonnes by 2025. Citi's forecast stands at 820 million tonnes by 2020.As China represents 45% of world steel demand, any adjustment in the intensity of the investment profile in that economy will have ramifications for the global steel market.

Attempting to assess a sustainable level of steel consumption in China, Citi suggests the total should trend to maintenance levels by the end of this decade. This implies a best case outcome of 670 million tonnes of consumption, which suggests the consensus for production of more than one billion tonnes in 2025 is too high.

Assuming this, Citi suggests the implication is between 4-15% of global capacity would need to close. While some of this may occur in China, Citi's view is the brunt of closures could fall on western companies given the expectation of a continued erosion in pricing power and ongoing margin pressure.

This suggests the possibility of a secular period of earnings downgrades for steel companies that is not currently priced in, this as consensus numbers at present continue to build in an earnings recovery.

Further on China, Macquarie has reviewed 1H12 commodity output on the back of the release of Chinese production and trade data for June. While output has risen for many commodities this has come at a time of weak demand, leading Macquarie to suggest current price weakness is likely to increase pressure on domestic producers to cut volumes in coming months.

For this to happen prices will likely need trade to levels where capacity is forced offline, though as Macquarie notes the aluminium market in particular continues to ignore price signals as output has hit another record high.

In zinc as well production appears too high for current pricing and demand, leading Macquarie to suggest there is further downside pressure likely in both metal markets in coming months. While copper output also rose, weak international mine output means this metal doesn't face the same pressures in the view of Macquarie.

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