Commodities | Aug 07 2014
-Supply issues plague bulks
-Steel demand revised higher
-Aluminium, zinc, lead prices elevated
-JP Morgan downgrades nickel for H214
By Eva Brocklehurst
Commodity markets are entering the second half of 2014 on a positive note but ANZ analysts expect the recovery to be far more gradual than in the past. The recovery will be tempered by lower liquidity and a stronger US dollar. The lack of a sustainable uplift in prices on the back of increased geopolitical risks recently suggests the market is complacent about the risks. The analysts expect supply-side issues will remain to the forefront of commodity markets, particularly for the bulks – coal and iron ore – while energy markets will find support from improved macro conditions and tightening US supplies. Supply-side issues are also expected to drive the base metals complex, while Chinese demand for physical gold is likely to remain weak. Improved global supply of grains appears to be priced into the market while the analysts expect cotton and sugar prices to languish. The outlook for beef prices remains strong.
National Australia Bank's non-rural commodity price index is expected to rise by around 1.7% quarter-on-quarter in September in US dollar terms, following a 7.3% decline in June. Stabilisation of prices for iron ore and metallurgical coal are the main drivers of the rise, while strong increases in some base metal prices in recent months are also making a contribution. In Australian dollar terms, commodity prices are forecast to rise a little across the remainder of 2014 and continue to edge higher in 2015, largely reflecting a depreciation of the Australian dollar as interest rates, particularly in the US, start to normalise.
Coal abounds in the market, depressing prices, and major producers are showing no sign of supply discipline. ANZ analysts observe demand is either waning or under pressure from alternative supply. The situation is not expected to improve in the near to medium term. Hence, the analysts have downgraded coal prices by an average of 10% over the next two to three years. Larger, short-term downgrades are specifically made for coking (metallurgical) coal to reflect the unsustainably strong export response from Australia while larger, longer-term downgrades are made to thermal coal as China's supply expansion continues. The ANZ analysts remain positive on the longer-term demand dynamics, as coal remains a base-load power source in China and industrial activity in India is gathering steam. Reduced capital expenditure in Australia and Indonesia should mean tightening supply in 2016 and 2017, and a price recovery.
Commonwealth Bank analysts observe coal miners seem to be tolerating short-term losses and relentlessly pursuing cost cutting, maintaining more output than previously assumed. Combined with higher mine closure thresholds, because of take-or-pay freight contracts, and expensive mine closure costs, the analysts expect supply will remain in the market for longer and prices will remain lower. CBA analysts have revised down coking coal price forecasts by 10% for FY15 and 16% for FY16. The long-run price has been revised down to US$135/t FOB Queensland. Thermal coal prices are revised down 16% for FY15 and 9% for FY16. The analysts retain a real long-run thermal coal price of US$80/t FOB Newcastle.
National Australia Bank analysts expect metallurgical coal prices will recover modestly from current lows, trending up to US$150/t for hard coking coal by the end of 2015. They note global metallurgical coal producers have cut production by around 20.8mt, with most of the reductions seen in North America. Thermal coal prices are expected to drift lower but there is limited downside in the NAB analysts' view, while increasing idle production capacity should limit any significant upside. They forecast thermal coal contract prices to ease to US$80/t in the next Japanese financial year. In addition, they observe the Australian government has approved what appears to become the largest domestic coal mine, Carmichael, forecast to produce 60mt of thermal coal per annum, which may further drive down already subdued prices.
The NAB analysts expect global steel production to increase, with profitability in China's steel sector improving in recent months because input costs have fallen more rapidly than steel prices. They expect the iron ore price will settle to around US$100/t at the end of 2014, and US$95/t at the end of 2015.
CBA analysts have downgraded iron ore prices across forecast years. Falling Chinese production costs, growth in new cheap seaborne supply and slower growth in Chinese pig iron output relative to crude steel combine to weigh on the market, even it global steel demand is being revised up. Miners around the world are commissioning new mines and reducing costs at existing mines and this should weigh more heavily than previously anticipated, in the analysts' view. They revise FY15 forecasts down 5% and FY16 down 12%. In the long run, iron ore prices are downgraded to US$85/t CFR China or US$73/t FOB Pilbara, assuming US$2/t in real freight costs. The CBA analysts have also upgraded steel demand forecasts, as a recovering global economy and strong Chinese infrastructure investment push up production. Even so, cost cutting, greater loss tolerance and new committed projects outweigh stronger demand.
Physical markets for some metals have become tighter than NAB analysts previously expected, from a combination of both demand and supply side factors. Prices for aluminium, zinc and lead in particular have risen more than previously forecast and look set to remain elevated. Consequently, price rises forecast for later in the year have been brought forward. That said, the analysts emphasise the uncertain economic and political environment poses significant risks to the outlook. Moreover, the amount of metal being held both in and outside of official warehouses is creating distortions in physical market. In aggregate, the NAB Base Metals Price Index rose 5.8% in the June quarter 2014, with large increases in nickel and smaller rises for aluminium and zinc, partly offset by a fall in copper. Following strong growth in base metals prices over 2014, prices are now forecast to grow much more gradually over 2015 and 2016.
JP Morgan has revised up price forecasts for aluminium in the second half and 2015, expecting that tight fundamentals ex China may lead to annualised price appreciation greater than 10%. The analysts remain neutral on copper and gold prices, expecting support to hold up at US$7,000/t and US$1,275/oz respectively. The analysts' nickel price forecasts are being downgraded for the second half as current fundamentals are not considered to be signalling a meaningfully tight market. Steep price appreciation is expected in 2015, as the refined nickel market moves into deficit. Zinc price forecasts are upgraded for 2015 as the global balance moves into deficit, although JP Morgan suspects the recent rally may be premature.
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