Material Matters: Copper, Gold and Thermal Coal

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By Eva Brocklehurst

Goldman Sachs is very bullish on copper. It sees a second wave of Chinese construction growth gaining momentum and this will impact on what it refers to as late cycle assets, or finishing commodities, such as copper and aluminium, in 2013. Others are bullish on copper too. UBS has increased its forecast average price by 6% to US$3.40/lb for 2013 and it also notes that China remains very short copper.

Goldman finds that the strength in Chinese building completions, with more copper consumption coming at the end of a building's construction, is the primary driver of copper prices. This should continue in 2013. Forecasting the Chinese construction cycle indicates that more completions relative to starts will continue until late 2013. Goldman says continued outperformance of copper relative to steel reflects this. However, it does see the main offsetting factor for steel being that Chinese demand is also heavily dependent on non-building construction.

Looking further ahead, the broker finds significant downside risk to copper prices in late 2013/14, caused by a sharp forecast slowdown in Chinese construction completions, together with anticipated above-trend copper mine supply growth in both 2013 and 2014. So it won't last forever. The broker says producers/investors should strongly consider medium-term hedging and taking profits, respectively, over the next 12 months, especially in the event of any strong rally in copper prices.

What are the key stocks in this regard? Well, obvious top runners are Rio Tinto ((RIO)) and BHP Billiton ((BHP)). A number of brokers have updated their outlook on these two recently. All eight brokers in the FNArena database have a Buy or equivalent on Rio. BHP attracts five Buys, with BA-ML, Credit Suisse and JP Morgan on Hold. At the other end of the scale we have Sandfire Resources ((SFR)). UBS flagged the stock as a Buy last month as the company brings its DeGrussa copper mine into production. Citi, however, is more cautious and considers a lot of upside has already been reflected in its share price. The broker maintained a Hold rating.

That's the problem, according to UBS: you've got to be quick to pick the upside potential. As the northern hemisphere winter closes in UBS has reviewed the re-stocking by power and steel companies and come up with its trump material for the quarter – thermal coal. The broker considers that this re-stocking is a reliable price-driving event and this year it is underpinned by the strong sell-off during the year. Gold looks pretty good too – why? The potential for expanding QE3 in the United States, once the presidential elections are over.

The quantitative easing undertaken in the US and eurozone have delivered 10-20 per cent price hikes across metal markets. This holds the promise of redirecting capital flows into emerging markets that are reporting materials-intensive growth. All good for the highly speculative precious metals complex. Prices for the bulk trades in iron ore and coal are not immediate beneficiaries of such speculation because these trades are predominantly physical. The exposure here comes from the resultant impact on the broader economy of the likes of QE3, which happens further down the track.

The downside for investors is that, with metals and corresponding equities prices responding quickly to QE3's announcement, there was little opportunity to take advantage of potential upside in the stocks, according to UBS. Hence, the broker's preference is restricted to bulks. Gold hangs in there with the whiff of any inflation emerging. So, upside for gold punts – for example UBS likes Perseus ((PRU)) – and bulk commodities. In iron ore UBS likes Fortescue ((FMG)) for leverage and Rio for large scale and low risk expansion. In thermal coal it's Whitehaven ((WHC)) with its Asian exposure. BHP's coal volumes in the September quarter will be of particular interest. UBS is looking for BHP's metallurgical coal production to be up at least 3% in the quarter. It's a thumbs down for aluminium prices. That puts Alumina ((AWC)) returns under pressure. The recommendations for Alumina are varied. The FNArena database shows three Buys, three Holds and two Sells.
 

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