Material Matters: Oil, Thermal Coal, Copper, Gold And Platinum

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-OPEC counters US oil production
– Chinese thermal coal exports unlikely
-Future in copper ex Chile
-Gold seen challenging lower levels
-Platinum seen subdued long term
 

By Eva Brocklehurst

Commodities

Citi suspects there may be some short-term pain for commodity markets but a turnaround could be on the horizon. Citi forecasts modest upside for the US dollar as markets defer expectations of a Fed hike to the end of the year. Looser global monetary policies, ex US, structurally lower oil prices, and an eventual supply response should all help to drive a further recovery in prices for the broader market.

Crude Oil

Inventories in the US grew by 5.3mmbbl in the latest reporting week, a return to trend rates of inventory building after the smallest build-up since early January in the prior week. Deutsche Bank does not find this encouraging and continues to expect a decline in US production in May based on the extent of reductions to oil rigs. A larger change in the build-up of inventory in the short term is likely to come from higher refinery availability.

The broker expects worries over inventory capacity are likely to subside over the US summer and then renew as maintenance comes to the fore in September, unless a more constructive market emerges by then. Meanwhile, OPEC production rose substantially in March from Iraq and Saudi Arabia, which has the potential to offset the price-supportive influence of the US production decline if surpluses remain high in coming months.

Thermal Coal

Markets are speculating about China becoming a net exporter of thermal coal after announcements by Shenhua and Datong that they would be exploring the opportunity of offshore sales. Macquarie discounts the possibility of any dramatic increase in in exports in the near future, given a price disadvantage in Chinese coal and a lack of explicit policy support. Longer term, stronger-than-expected demand in India or in South East Asia may lead to rising Chinese thermal exports.

That said, the idea entails a continued contraction in Chinese imports. Macquarie believes it is important to make certain distinctions in this regard. China’s south east region accounts for more than half of the total imports in recent years and this area has the stickiest demand for thermal coal. A reduction in imports, if any, is expected to take place first in the central north and central east. The central north is a region rich in thermal coal, with Inner Mongolia the second largest producer. Central east is the most developed region and, while not having much in the way of resources, is close to the northern ports from which the central north coal is transported.

Macquarie also does not expect a significant increase in Chines exports because arbitrage analysis suggests thermal coal exports are not competitive. In the past these exports have found a home in east Asia, particularly Japan. Exports to Japan are currently at a negligible level, the broker observes. Similarly, exports to the Indian market do not look competitive. A dramatic increase in China’s thermal coal exports requires the seaborne market to be much tighter than the domestic market, which is not the current reality.

China Policy

Citi observes the preliminary HSBC manufacturing PMI for China has fallen to a one-year low in April, worse than expected. Sub indices weakened across the board. Citi’s economists believe the official PMI, to be released May 1, will be flat in the absence of strong re-stocking incentives, given lacklustre domestic demand and production. The broker believes the Chinese policy stance has shifted towards more decisive easing as the base line of growth is under threat. The economists expect two additional policy rate cuts this year to further trim the real cost of capital and revive demand.

Copper

In terms of copper supply the key may lie outside of Chile, in Citi’s view. Freeport McMoRan is on track to supersede Codelco as the world’s biggest producer in 2016. The broker observes the miner continues to expand operations in Peru and the US, diversifying away from Chile despite price pressure. Codelco has been also facing hurdles with regard to recovering profitable ore from the Atacama Desert and its ageing mines may struggle to keep up with demand growth, in the broker’s view.

Citi notes Rio Tinto‘s ((RIO)) mined copper production was up 12% in the March quarter while BHP Billiton ((BHP)) production of 160,000t was in line with estimates. BHP’s FY15 guidance was cut, nonetheless, because of the Olympic Dam mill outage.

US Dollar/Gold

The US dollar has been rising since mid 2014 and Citi notes, if it rises above the DXY Dollar Index level of 100 soon, charts suggest it will tackle parity with the euro. Citi’s economists, having examined fundamentals as well, believe the euro will weaken against the US dollar by the end of the year and may even end up below parity. Citi observes, if that becomes the case, the historical relationship with gold suggests the yellow metal could be challenging the US$1000/oz level this year.

In terms of medium-term demand the trends relative to purchases of gold items seem intact but will provide a steady rather than spectacular improvement, in the broker’s opinion. Nevertheless, in the short term, the peak season for gold demand has passed  and the next surge only comes in September when manufacturing jewellers begin to acquire gold for Christmas. Gold has also not been helped by ongoing US dollar strength, or by the fact the market remains little concerned by conflicts or the Greek financial situation.

Platinum

That other precious metal, platinum, hit a new six-year low in the March quarter and Macquarie suspects there is worse to come. The broker envisages smaller deficits in the market and a significantly lower long-term price. Gold, which pulled platinum up in 2011 and down again in 2013, is not to blame. Macquarie notes platinum has moved to a substantial discount to gold this year and, for now, the gold price looks more like a ceiling to platinum rather than a floor.

Macquarie suggests all three levers of rising prices are broken: curbing supply, increasing consumption and stockpiling. Mine production is expected to rise in South Africa over the next few years, while demand is subdued and stocks are plentiful in China. There is a better news story in the form of European car production, with the second half expected to be stronger. The economy is improving and, most importantly, unemployment is falling, a key instigator of car sales and perceived platinum demand.

In the medium term, however, Macquarie is not overly bullish on European demand as the economy will not grow at a rapid pace and upside for car sales will be capped by reduced need for car ownership in Europe. Recycling of vehicle catalysts will continue apace and present a headwind for platinum over the rest of the decade and the broker suspects the ultimate outlook might, therefore, depend on the Chinese jewellery sector.
 

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