Material Matters: Coking Coal, Iron Ore, Uranium And Gold

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-Less volatility in coking coal ahead
-Iron ore's 2012 reality check
-Uranium waiting for Japan's re-start
-Gold strength should endure

By Eva Brocklehurst

Steel makers are looking for ways to use less hard coking coal. Why? JP Morgan says it's because of the nightmares they have from when the spot coking coal price hit US$400/t back in 2011. This is more than twice what  the broker believes is the long-term marginal cost of hard coking coal – at US$150/t. The fears of a spike in coal prices have led to conservation measures which JP Morgan suspects are here to stay, adjusting its 2013 coking coal price forecast down 3% but lifting its long term forecast for benchmark low volatility coal from US$150/t to US$160/t.

Although early days, use of natural gas in steel making is gaining traction as another alternative for lowering carbon costs. Gas can be used as an alternative to PCI coal and also in direct reduction iron (DRI) making. JP Morgan cites an indication of the level of steelmaker interest in diversifying from coking coal in major US steelmaker Nucor contracting with major US energy supplier Encana for a long term gas supply that can support three DRI plants. This implies the abundance of shale gas in the US, and increased usage in steel making, could negatively affect US-focused coking coal producers. Moreover, low-vol coal reserves are limited in the US. BHP Billiton ((BHP)), in JP Morgan's view, estimates Australia holds 31 years worth of low-vol coking coal. This suggests it will remain a dominant exporter for many years.

JP Morgan expects coking coal prices to be less volatile in the next few years as steelmakers search for new technologies and thrift in coking coal usage. Chinese steel demand recovery (5% growth JPM estimates) should support stronger benchmark prices next year. JP Morgan has lowered its price expectations for the first half of 2013 but expects a pick up to a benchmark US$180/t in the second half. The broker then expects coking coal demand in coming years to be softened by steelmaker initiatives to reduce costs. Consequently, JP Morgan advises investors should hold targeted exposure to coking coal rather than hoping for a rapid return to the boom times seen during 2008/11.

RBC has dropped its 2013 coking coal price forecast by US$10/t (or 5%), to US$190/t for 2013 and to US$180/t out to 2016 while UBS makes its largest recent forecast change on metallurgical coal, which has been revised downward to reflect BHP Billiton's ((BHP)) monthly and quarterly deals with Japan. UBS' price estimate now ranges from US$168/t in 2013 to US$150/t in 2015 and 2016.

In terms of iron ore, BA-Merrill Lynch says the market received a much-needed reality check in 2012. Revenue and costs were brought to the fore in a big way. Therefore, the broker's most preferred stocks are Fortescue Metals ((FMG)), BC Iron ((BCI)) and Atlas Iron ((AGO)). Importantly, each encompasses an attractive growth profile in production and mine life, capex is relatively light and there are consistent cash flows and reasonable balance sheets. The least preferred? These are Grange Resource ((GRR)), Gindalbie Metals ((GBG)) and Mount Gibson Iron ((MGX)). Gindalbie is in the final throes of commissioning a $3bn project and BA-ML is leaving well alone until the project is both financially and operationally de-risked. Elsewhere, Grange and Mount Gibson slip down the ranks, reflecting lower operating margins and higher operating risks.

RBC has lowered 2013 and 2014 estimates for iron ore prices by US$5/t. The recovery in the iron ore spot price was strong as this year ended. However, it did not significantly surpass the US$120/t CFR level in November and RBC thinks US$130/t forecast may be difficult to achieve in 2013. The broker therefore lowered its average CFR forecast to US$125/t but remains positive on a re-rating of iron ore prices in the early part of next year.

Marginal uranium production costs are now pushing close to US$50/lb but the uranium market always looks good a couple of years out, according to BA-ML. The key drivers in the medium term are the Japanese timetable for re-starting reactors, contingent on the pending Japanese election, and supply changes such as delays at BHP's Olympic Dam. Whilst the uranium price is at or near lows, BA-ML expects that any upturn in demand will be the much-needed trigger for providing established names with the chance to perform again. Paladin Energy ((PDN)) is the leveraged producer operationally and also financially, according to the broker. Price and debt headwinds have overshadowed a turnaround in operating performance. While recently lowering its rating on the stock BA-ML plans to re-visit Paladin as the most leveraged name on a rising uranium price. Key catalysts will likely come from the Japanese elections at the end of this year and subsequent deliberations on re-firing nuclear power plants.

Uranium price forecasts have been changed by RBC. The broker has lowered its uranium price forecasts by an average of 11% through to 2016 estimates with US$75/lb now forecast in 2016. RBC maintains a longer term price estimate of US$60/lb. In base metals, RBC has moderately increased its 2012 price forecasts for aluminium, copper, zinc and lead. It has raised its estimates for the lead price profile out to 2016 by an average of 11% due to a stronger curve. Copper has been lowered by average of 9-10% for estimates to 2015 and 2016 price forecasts due to increased supply. Cobalt now has a relatively flat price profile of US$10-11/lb through to 2016 estimates. Due to a weaker carbon steel recovery forecast for the coming years, RBC also has a molybdenum forecast in the US$11-16/lb range through to its 2016 estimates.

So what about gold? As inflation is expected to rise in 2013 BA-Merrill Lynch continues to view the gold outlook positively, and expects gold equities should perform well in this environment. The broker's metal strategists see further monetary easing and rising inflation expectations lifting gold prices in 2013. They have maintained a US$2,000/oz target on gold on further monetary easing and see scope for this to rise to US$2,400/oz by end of 2014. The top stock picks are Newcrest ((NCM)), which they expect will have a transitional year as it delivers on Cadia East and the upgrade at Lihir. For Evolution Mining ((EVN)) this will mark the commissioning of its sixth operating mine (Mt Carlton). BA-ML notes here, even in the absence of acquisitions, further exploration success should drive value. The broker sees the poor performance of gold equities in 2012, despite strong gold prices, emanating from a number of factors such as missed production targets, rising costs, weak cash generation and lowered growth targets. All this should change in 2013, as BA-ML believes gold producers will focus on improving operations, organic growth and better returns on capital. BA-ML also sees potential for increased consolidation activity in the Australian junior/mid tier gold space in 2013.

Overall, earnings forecasts for RBC's mining universe have been adjusted down an average of just 4% for the 2012-2014 forecast period, with iron ore, lead and gold price forecasts having the most impact as well as expectations for a stronger euro. However, there are some big differences within that average. For example, RBC's 2013 earnings forecasts for Rio Tinto ((RIO)) are down 13%, Anglo American down 7%, and Glencore down 7%. UBS believes that 2013 will be a year which could provide meaningful upside for metals prices if China and the US provide growth supporting policies. Hence, this broker flags thermal coal, iron ore, gold and copper as beneficiaries. 

 
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