Commodities | Aug 16 2012
– Further volatility expected for commodity prices
– CBA revises forecasts lower
– Iron ore prices could rebound
– Coal price risk remains to downside
– Chinese inventories a headwind for copper prices
By Chris Shaw
In the view of ANZ Banking Group, commodity prices are likely to remain volatile over the coming month as markets react to both sagging fundamentals, ongoing economic growth concerns and the direction of government policy.
Any sustained recovery in prices appears to be a month or more away, as ANZ suggests recent stimulatory initiatives will take a few weeks to start to materialise in economic data. This will increase the market's focus on policy direction, something ANZ sees as adding to price volatility.
In terms of specific markets, ANZ sees the base metals as being hamstrung by near-term Chinese demand worries. This sees the bank adopt a neutral view overall, with fundamentals for aluminium justifying a more bearish view.
ANZ is just on the bearish side of neutral with respect to precious metals, as the focus of Chinese policymakers on reserve ratio requirements rather than interest rates suggests an immediate return to the negative real interest rate trade that boosted demand last year is unlikely.
Oil markets appear overpriced for this stage of the economic cycle in the view of ANZ, as much of the demand upside appears to be front-running of expected US and European policy injections. Potential for tighter supply in the short-term should limit downside risk in the bank's view but a slightly bearish view is maintained.
ANZ is neutral on the bulks, noting iron ore and coking coal markets remain leveraged to moves in steel prices. Seasonal demand is also soft but ANZ suggests the end of the Indian monsoon season could see an increase in buying interest.
ANZ has developed a China Commodity Index (ANZ CCI) and has looked at the relationship of this index to Chinese PMIs. Results show a strong relationship between Chinese PMI and the ANZ CCI, so given the possibility of seasonal improvement in Chinese PMIs in August and September there is scope for the ANZ CCI to also move higher.
To account for recent price movements and a deteriorating growth outlook for both China and the global economy, Commonwealth Bank has revised down commodity price forecasts. All metal price forecasts have been trimmed, with coking coal estimates cut 1-8% through FY14, base metal prices lowered 3-8% in FY13 and gold 3-4% through FY14. Iron ore has seen the most significant cuts, with price forecasts lowered 16% in FY13 and 8% in FY14.
For CBA the changes were necessary as the global economy is expected to record sub-trend growth this year and next even allowing for the potential for further policy stimulus. As well, CBA notes the Australian dollar has remained firm as commodity prices have fallen, which is leaving Australian commodity producers with spot forex exposure vulnerable to the combined impact of lower commodity prices and a strong dollar.
Economic data for China for July leads CBA to suggest a bottoming of activity levels will be a little more delayed than previously thought. This is likely to mean a deeper and more protracted turning point, something expected to weigh on commodity prices shorter-term.
A cyclical recovery in the Chinese economy should become apparent late this year and into 2013, which CBA sees as supporting a recovery in commodity demand. Prices should also recover as the supply and demand sides of the various markets adjust.
Iron ore prices are currently trading around their lowest level for two and a half years but in Macquarie's view a rebound back to cost support levels of around US$130 per tonne is likely in the near-term. This expectation is based on low inventory levels at mills, stabilisation in domestic prices and some improvement in steel market fundamentals.
As Macquarie notes, smaller mills have been aggressive in destocking iron ore over the past four weeks, as inventory has dropped to 21 days of use from 29 days previously. Macquarie views this destocking as the key driver of recent iron ore price weakness.
Price patterns in the market are very similar to what was seen in October of 2011, when just over 20 days of inventory acted as a floor for the market and mills quickly re-stocked, pushing up prices. Now, even if mills were to simply stop destocking, Macquarie suggests this would be enough for iron ore prices to tick higher. The fact prices in China stabilised over the past week suggests mills may be coming to the end of the current round of destocking.
Domestic iron ore is more attractive in a weak market given shorter delivery times and the ability to purchase smaller volumes at a time. At present an arbitrage has opened up between seaborne and imported material, but Macquarie suggests this will close as once mills return to the market these incremental purchases will be on the seaborne market.
In the steel market Macquarie suggests there are signs a two-speed market is emerging, as long product demand from the construction sector remains solid and flat product demand weak. As orders from the construction sector have increased, trader inventory of rebar has fallen. Rebar is a benchmark construction product.
This implies current production of rebar is undershooting demand, which would be a positive for prices. As spot rebar prices increase Macquarie expects a rebound in iron ore prices will follow as destocking comes to an end.
Commonwealth Bank is less bullish and has revised iron ore price targets lower in coming years. The changes reflect a weaker world growth outlook, a more protracted slowing in the Chinese economy and strong supply growth ex the Pilbara region.
CBA's revised forecasts suggest Chinese crude steel output will now growth by 1% this year, down from a previous forecast of 3% growth. This will act to delay a widely-expected recovery by a quarter or two. As a result, CBA's forecasts now stand at US$128 per tonne in FY13, US$134 per tonne in FY14 and US$126 per tonne in FY15.
The changes don't impact on CBA's central view marginal Chinese supply will set prices for seaborne iron ore. Estimates suggest the 95th percentile price support level is US$106 per tonne and CBA suggests for prices to remain around this level world steel output would need to fall by 5%.
Global 80th percentile cost support lies at US$87 per tonne but CBA suggests for iron ore prices to remain at these levels, world steel output would have to fall by 20% in both 2012 and 2013. With Chinese domestic mine cost inflation having run at 10-15% in recent years, this inflation should support pricing for iron ore even as incremental Chinese supply is displaced.
Still on the bulks, UBS has met with Chinese coal producers and suppliers and notes there are as yet no signs of any demand recovery. At the same time, large producers have given no indication of cutting production even while demand remains weak.
This leads UBS to suggest there is little scope for any rebound in coal prices in 2012, with prices more likely to fall further after the summer peak season. This is because producers are under pressure to maintain market share despite weak demand, which implies further price cuts in coming months.
For UBS there is greater downside risk for coking coal when compared to thermal coal as prices for the former are still 40% higher than production costs and Chinese steel mills only began to cut production in July.
Turning to the base metals, Standard Chartered's recent trip to China showed copper inventories have continued to increase, reflected in a lift in estimated bonded warehouse inventory of around 100,000 tonnes to 500,000 tonnes.
This supports the view Chinese copper stocks have again reached one million tonnes, with further gains expected over the coming month before an improvement in demand stems the recent gains. This copper inventory will act as a headwind for copper prices in the September quarter in the view of Standard Chartered, though prices are still expected to recover towards the final quarter of 2012 on the back of a possible demand pick up as monetary policy eases.
In price terms, Standard Chartered notes since the start of July 3-month LME copper has traded in a range of US$7,320-$7,819 per tonne. For the past three weeks prices have seen overhead resistance at US$7.600 per tonne, with immediate downside support standing at US$7.200 per tonne.
This level will attract buyers in the view of Standard Chartered and leads to the suggestion consumers should buy copper on dips towards US$7,220 per tonne to take advantage of an expected rally back towards US$8,000 per tonne.
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