Material Matters: Potash, Iron Ore, Copper, Gold And Aluminium

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-Potash producer position weakens
-Fears iron ore price following cost curve
-Next 12-24 months critical for Oz copper
-ANZ analysts initiate short gold position
-Morgan Stanley Underweight gold equities
-Deutsche Bank positive on aluminium

By Eva Brocklehurst

Potash

Potash markets are quiet, as March has arrived without any sign of first half import contract price agreements from China and India. Macquarie observes an increased likelihood the benchmark contract system may not survive 2015. The market outlook from both parties has diverged and the broker is not surprised agreement is yet to be reached. Producers have the most to lose in this scenario. In an oversupplied environment the battle for market share accelerates and earnings certainty goes out the door. Macquarie suspects producers will push for contract pricing to persist in order to retain market discipline and this may necessitate acceptance of lower prices.

Macquarie suspects that for every day a decision is delayed, the position of potash producers weakens. The broker also believes potash demand will ease across major markets in the US, Brazil and Asia and a further de-stocking will take place given stocks were replenished last year. Of note, Chinese buyers are sitting on high stock levels and, with the current contract price set well above the cost curve, which is moving lower, Macquarie suspects the risks are skewed to the downside.

Iron Ore

Iron ore has had a weak start to 2015 with the price down 16%, to US$59.73/t currently, because of weak steel consumption in China, a late Chinese New Year holiday and an unrelenting surge in seaborne supply. That is the backdrop UBS observes for iron ore equities and Fortescue Metals ((FMG)) has been the worst performer of the Australian iron ore miners while Grange Resources ((GRR)) has been the best. The broker's analysis suggest an average implied price of US$59/t, – in line with spot – is currently factored into the market. While the miners have exceeded expectations in cutting costs, and this has minimised cash burn, UBS remains concerned that the price may follow the cost curve as it flattens. The broker remains highly concerned about further asset write-downs, which could ultimately impact on mine life and debt covenants.

Copper

Expansion of new copper opportunities remains an increasingly important proposition, with less than a decade of reserves remaining. JP Morgan notes key projects being considered, such as PanAust's ((PNA)) Frieda River, Sandfire Resources' ((SFR)) Black Butte and OZ Minerals' ((OZL)) Carrapateena are slated for production later this decade and, under base case assumptions and a generally bullish copper outlook, would deliver acceptable returns.

With feasibility studies underway at Frieda River and Black Butte, the next 12-24 month are considered critical in terms of de-risking and finessing project economics. JP Morgan notes all projects face challenges and the immediate future of Carrapateena is uncertain following suspension of the sale process, but further options are being investigated which could enhance the value proposition. The broker maintains an Overweight rating for Sandfire Resources and Neutral for OZ Minerals and PanAust.

Gold

ANZ analysts are initiating a short position on gold, with a view that prices will test US$1,100/oz in the short term. They acknowledge the long-run appeal is intact but expect gold will trade lower on the back of a stronger US dollar and weaker euro. The upside break-out of the US dollar has led to a reassessment of the near-term view and gold has a negative correlation with the US dollar, which means it will have a positive one with the euro. The broker believes the break below US$1.10 for the euro is critical, opening up the potential for a move to parity. This will pressure the gold price and suggests a further US$80/oz move on the downside in the yellow metal is possible. The major adjustment is to the three-month outlook which pushes out the profile of a trough in prices before the gold price resumes its uptrend.

Morgan Stanley does not believe the recent fall in the gold price is fully reflected in equities. The broker's key Underweight calls – Independence Group ((IGO)), Newcrest Mining ((NCM)) and Regis Resources ((RRL)) – are pricing in premiums to spot gold. Alacer Gold ((AQG)) remains the broker's only Overweight call while Medusa Mining ((MML)) has recently been moved to Equal-weight. In an uncertain gold price environment the broker continues to recommend some gold exposure but looks for low-cost producers with strong balance sheet.

Hence, Alacer Gold fits this profile although the broker acknowledges absolute upside appears limited. Morgan Stanley also accepts that increased pessimism on the global economic outlook, heightened geopolitical risk and further delays to market expectations of US rate tightening could produce a gold price rally. This is the main risk to the broker's largely Underweight view on ASX gold producers.

Aluminium

Deutsche Bank remains positive on the outlook for aluminium even though demand has deteriorated in China. The outlook for the next two years is now more balanced and the broker downgrades forecasts for aluminium prices by an average of 8.0% over the next few years. While factoring in falling premiums the broker expects the annual all-in price appreciation to be low single digits. However, with Rio Tinto ((RIO)) and BHP Billiton ((BHP)) dropping unit cost and Alumina's ((AWC)) exposure to the aluminium price reduced, margins are expected to improve for all three in 2015 and beyond.

Rio Tinto's average aluminium costs have declined to US81c/lb in 2014 and Deutsche Bank expects these to drop further, to US69c/lb by 2016. Rio Tinto has closed or sold 10 smelters since 2007, representing 1mtpa of production or 25% of capacity since buying Alcan. BHP Billiton's costs have dropped to US74c/lb, reflecting the closure of Bayside and Alumar smelters and the benefit from the weakening South African rand. Deutsche Bank factors in a further US5c/lb reduction to BHP's unit costs. Alumina Ltd has only 25% of alumina contracts still linked to the aluminium price. The broker reduces earnings estimates by 7.0% over the next two years but valuation has reduced only slightly.
 

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