Material Matters: Iron Ore, Gold And Energy Plays This Reporting Season

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– Iron Ore prices to remain supported at current levels
– UBS sees US$120/t as a reasonable price
– Gold to remain range bound
– Oil prices expected to soften a little
– JP Morgan makes energy play predictions ahead of reporting season

By Andrew Nelson

Over the last few weeks commodities have joined in on the equities rally, albeit not quite as enthusiastically. Much of it has to do with a slowing down of the constant stream of gloom and doom economic talk on the topics of the US, Europe and China, which has tempered the still significant levels of uncertainty about the global outlook.

One need look no further than the recent hiccup in prices, which has come hand in hand with renewed European fears that have emerged over the last week or so. If anything, this shows quite clearly just how vulnerable commodity markets remain to the little ups and downs in market confidence.

Thus while it is evident financial and commodity markets have improved since November, ongoing performance remains closely tied to the macroeconomic environment and changes in sentiment. Commodity analysts from National Australia Bank expect, if anything, prices will remain volatile in the near term. Looking a little further out and the bank still expects prices to soften, but at least they should remain a little firmer than historical averages, thinks NAB.

One commodity that specifically interests the bank is iron ore. Prices have run significantly higher since mid December, pushing as high as US$158.5 per tonne before coming back off a little bit. NAB notes there have been a few temporary factors helping out, like the lift in demand from Chinese restocking in anticipation of continued improvement in economic activity. Chinese industrial and construction activity is already showing some early signs of improvement, while ongoing issues with Indian export bans and cold weather in China have also helped to support the higher prices.

More generally, NAB does see the recent pick up in global optimism as a good sign for commodity prices in the near term, while temporary drivers like weather and floods are also boosting near-term prices. The bank thus sees the continued prospect of upside risk to the near-term outlook. However, on a mid to longer-term horizon, the bank expects most markets will once again start to soften as production begins to ramp up in response to the higher pricing environment.

Last week, a few analysts from UBS took a trip out to China, more specifically Shandong and Shanxi provinces, to take a closer look at what has changed since the last trip in November. The broker had a sit down with a number of companies ranging from upstream coal producers to downstream aluminium and cement producers, steelmakers and truck manufacturers.

The good news is the broker continues to see clear signs of a demand recovery. Cement sales are rising on last year’s levels, steelmakers are cutting losses and even truck manufacturers are expecting positive growth in 2013. The outlook for coal is a little less certain, but this is because contract prices are still under negotiation. However, UBS notes that at least one coal company it met with believes there is limited downside to current prices, as production is ultimately controlled by local governments. 

Steel prices are also on the rise, yet while prices have rebounded from the trough in August 2012, the broker notes steelmakers still have to deal with squeezed margins given the high iron ore price. The steelmakers UBS spoke with see US$120/t as a more reasonable price. Still, those the broker spoke with are guiding for continued expansion despite overcapacity in a push to steal some market share from the smaller mills.

However, UBS expects that the overcapacity situation will continue to keep a lid on any price upside for steel, cement and aluminium. For coal, the broker expects to start seeing stronger prices through 2H13, with long-term price support to come from supply discipline.

Meanwhile, analysts from Standard Bank point out that gold remains range-bound, caught between the real economy and the monetary economy. Increasing economic confidence is further capping upside for the metal, while conversely, easing monetary conditions continue to provide support.

Standard expects US$1700/oz will provide resistance and 1660 will continue to provide support. However, were gold able to break through 1700, then 1720 is about as high as Standard thinks it will go. Thus, the broker prefers a long position in gold, targeting an average price of US$1720/oz for this year.

The bank also expects iron ore markets to continue on the road higher, with the price pushing back towards US$160/t. The bank notes that Shanghai Rebar Futures remain strong and by last week the May contract was significantly higher.

However, the bank thought China’s January PMI releases were mixed at best, while the official steel PMIs showed a move back into contraction. Yet despite these latest data, low warehouse stock levels, especially for rebar, mean the broker isn’t really concerned about the latest reads and believes that further re-stocking will be necessary to meet construction demand in March.

Standard also took a look at Brent crude and notes that based on the premise of continued supply growth and persistently weak demand, we should see a quarterly average of $109/bbl for Brent. However, the bank does note that while it is still happy with this forecast as a 1Q baseline, the geopolitical risks currently at play in the world certainly could see prices overshooting this forecast.

And to put it all into perspective, analysts at JP Morgan have put together a reporting season hit list of Australian energy plays. The broker predicts Woodside ((WPL)) will come in a bit ahead of consensus on the net profit line, with a US67cps dividend for the 2H. Santos ((STO)) should be in-line with consensus, with a US67cps dividend falling a penny short. Oil Search ((OSH)) should also pip consensus by 1%, with dividends in-line. Beach’s ((BPT)) dividend should also be in-line with the last six at 0.75c

Aurora Oil & Gas ((AUT)) is expected to fall 10-14% below consensus, with no dividend foreseen for some time, as the company’s field development program is not yet self funding. AWE ((AWE)) will probably deliver an in-line outcome, but still no dividend given there is some substantial capex to fund. Senex ((SXY)) is also unlikely to pay a dividend given current funding requirements, while Buru ((BRU)) is expected to post a small loss. Lastly, the broker expects Roc Oil ((ROC)) will fall well short of the market, also paying no dividend because of capex requirements.
 

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