Commodities | Jun 24 2013
This story features RIO TINTO LIMITED, and other companies. For more info SHARE ANALYSIS: RIO
– Iron ore to push higher in 2H 2013
– Aluminium to remain flat
– Metals with consolidated supply to fare better
– UBS likes Rio, BHP, Iluka and Fortescue
By Andrew Nelson
Taking a look beyond the current cycle of stocking and destocking, analysts at Goldman Sachs note the current annual trend rate of growth in Chinese raw iron ore production is 2%, with year to date production up 9% year on year. This about the same growth rate as domestic Fe units, thinks the broker, who points to recent iron ore import and pig iron production data.
Looking at last year’s 2H as a guide, the broker believes that additional supply in response to low domestic prices for iron concentrate is likely. The broker notes China’s domestic market has pretty much tracked seaborne prices over the past few weeks but have found a higher support around US$128/t.
These trends support the broker’s view that iron ore should push up to an average price of US$134/t over the 2H of this year. The broker’s long term price outlook is far more conservative, Goldman Sachs pencilling in US$80/t for FY15.
The broker bases its assumption on current market dynamics, noting that while around 15% of current Chinese production is high cost and price sensitive, production will still continue to lift as the global market heads into oversupply.
Macquarie chipped in yesterday with some prognostications for aluminium, noting demand in the sector has turned quiet despite what was an encouraging start to the year on the back of improving US macroeconomic data. With US demand continuing to lag the wider economy, the broker expects overall market demand to remain flat this year, especially given the comfortable inventory levels that have been built across the sector.
There was a bright spot from Europe, as while the broker doesn’t see demand levels lifting, it does expect the decline to slow. Although, with tepid economic conditions and light order books, a rebound in aluminium is unlikely says Macquarie.
Looking at the broader sector, UBS expects to see surpluses forming in many markets, which will flow through to general short to medium-term price weakness. The broker points out spot prices for a number of metals are already trading at, or below their marginal costs of production.
In such an environment, picking materials stocks becomes that much harder. But UBS points out that thankfully, all metals markets are not the same and the differences between markets can sometimes offer opportunity. One such major differentiator is supply side consolidation. Markets with a limited number of producers tend to be able to keep tighter control over supply and pricing. This offers some protection from customers that would otherwise nickel and dime them to death.
Look at Platinum, UBS notes it is about the most consolidated metal producing industry, with 87% of the world’s total output coming from just 5 producers. The same holds true for seaborne iron ore, again with just 5 exporters delivering 75% of the world’s material.
That’s the good. The bad and the ugly are sectors where the bulk of supply is spread more evenly amongst producers. The problem with such sectors is competition, meaning price pressure, production pressure, margin pressure and combined, these can lead to fairly irrational behaviour.
UBS notes this is currently the case for gold, steel, zinc and lead, where the top-5 producers control less than 20% of the world’s total output. In good times, the inability of one or two players to control the market is a positive feature for most sector participants. It just offers little protection the other way around.
However, a consolidated sector isn’t the only key to future profits. The South Africa-centric platinum industry remains hamstrung by government policies and industry unions, which skim most of the cream off the top.
Demand side consolidation is also a factor. 70% of nickel is bought by what is a small and very tight global stainless steel industry and half of that supply is met by scrap. Even better evidence is uranium, with almost all of the world’s supply going to just 434 nuclear reactors. Aluminium supply is also highly consolidated, but the upside is offset by the fact that many producers also control the bulk of their alumina supply as well.
Sifting through all up the ups and downs, the broker has picked a couple of key markets that should continue to benefit from significant supply side consolidation. The list reads: seaborne iron ore, zircon, titanium feedstock and pigment and seaborne metallurgical coal. The broker thinks the best Australian plays on these are Rio Tinto ((RIO)), BHP Billiton ((BHP)), Iluka Resources ((ILU)) and Fortescue Metals ((FMG)).
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