Material Matters: Bulks, Zinc, Gold And Miners’ Cash

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-Renewed optimism boosts prices
-Will the rally in bulks persist?
-Zinc production on the up and up
-Call for cash return from miners

By Eva Brocklehurst

Market mood has shifted recently. Take away the obsession with the US 'fiscal cliff' and Europe's sovereign debt, add signs of stronger activity in China, and you have the reasons for the recent surge in confidence, according to National Australia Bank analysts. While not ruling out further uncertainty, the analysts see the recent bout of optimism boding well for commodity prices in the near term. Other factors, some of which are temporary in nature, are boosting near-term prices.

Usher in metallurgical coal.

Metallurgical coal prices rose as Cyclone Oswald disrupted supply from Queensland Rail services to the Queensland port of Gladstone (which should be fully restored by February 25th). This adds, the NAB analysts note, to other supply disruptions from industrial actions and an export ban on some Mongolian operations that are likely to support seaborne prices. The benchmark price is now up 8% in the year to date, in line with BHP Billiton's ((BHP)) recent offer for March 2013 contracts, according to Goldman Sachs.

Goldman Sachs has also flagged a modest rise in Newcastle prices with the Chinese thermal coal import arbitrage moving into the negative. This points to a fall in Chinese import volumes in the current quarter. The broker believes the seaborne market is trapped in a narrow range between cost support at US$90/t and the limits of a well supplied Chinese market. The outlook on the demand side is robust and the broker suspects this will underpin a modest price recovery in 2013. This is supported by evidence of a rebound in Chinese power sector consumption and the coal share of the mix in the US power sector increasing to 42%. The risk is that continued investment in capacity in China keeps prices in check.

Iron ore's rally resumed just before China shut up shop for New Year, with prices near the 14-month high of US$159/t, Goldman Sachs notes. Meanwhile, port stocks fell 2.3mt from the previous week to their lowest level since April 2010. Although the spike in prices was larger than many anticipated, some of the factors underlying the increase appear to be temporary, such as re-stocking rather than outright demand, according to NAB analysts. This signals that prices should ease over coming months. On the flip side, the resilience in prices leading up to the Chinese New Year could be persisting on hopes of stronger demand following the week-long holiday, suggesting there is some near-term upside risks to price forecasts.

On the subject of China, the zinc miners were strong producers in 2012 and more supply is on the way, according to Macquarie. There is also no shortage of smelter capacity and  Macquarie notes a strong bounce in China's refined zinc production in December. Also, there is underlying structural demand for at least some of the imported concentrates for reasons such as quality and consistency and payment terms (domestic miners require cash payments typically). Smelters have increased charges for treatment of imported zinc and the recent rise in zinc prices will  improve the value of free metal in imported concentrates. The broker sees the upside price potential for zinc as fundamentally limited.

As for gold, prices should continue to be influenced by the mood of the markets, NAB analysts contend. Uncertainty may be helpful to the price but with improvement in the US economy and little inflation around the risks are to the downside. Central bank purchases are expected to remain a supportive factor, while the improving Indian and Chinese economies will provide physical demand. Nevertheless, NAB sees the price easing by around 11.5% through 2013 and another 10% in 2014.

The calls for miners to slow down and return surplus cash to investors are growing louder, according to Goldman Sachs. The miners appear to have heeded this to some extent by putting some large projects on hold. The broker does not believe they will listen much more, citing decades of precedence against miners returning cash. Also, heightened commodity price volatility and uncertain economic times preclude this. Moreover, there are some project that still promise returns above the cost of capital. The broker finds Rio Tinto ((RIO)) the only contender likely to return cash at the moment. 

Some statistics that were quoted look interesting. The sector has generated US$939 billion in cash flow from operations since 2005 and of that, 61% has been directed back to growth via capital expenditure. Dividends have accounted for 24% of all cash spend and acquisitions for 17%. Goldman's analysis indicates that capex spend from the mining sector peaked in 2012 at around US$117bn. Volatility in commodity prices and ongoing capex spend in 2013 does not leave significant room for surplus cash generation in the broker's view. It might be a bit better by 2014, when capex and dividends fall to around 60% of cash generation, suggesting surplus cash of around US$50bn. Then again, Goldman thinks the market may still be disappointed.
 

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