Material Matters: Commodity Price And Miner Revisions, Tin, Lead And Steel

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-AUD weakness supportive
-Value in counter-cyclicals
-Questions over Indonesian tin
-Lead deficit in 2016?
-Heightened competition in steel
 

By Eva Brocklehurst

Price And Miner Revisions

Weak demand and a lack of meaningful supply reductions, amid no sign of a turnaround in China, have led to Deutsche Bank revising down forecasts for copper, aluminium, nickel and coal prices by over 10%. The broker expects no material recovery in commodity prices until 2017.

Morgan Stanley, too, stepping from its traditional end-of-year review, marks down forecasts for iron ore, alumina, copper and thermal coal substantially. Morgan Stanley remains constructive but concludes that a slower price recovery means more downgrade than upgrades to forecasts at this point in time.

Both brokers expect that in Australian dollar terms, most commodity prices will actually increase as the local currency falls further. Deutsche Bank expects US63c by 2017. Morgan Stanley's downgrade to Australian dollar forecasts more than offsets the US dollar commodity price reductions, in terms of base metals and coal. The broker's US dollar gold price forecasts are largely unchanged while Australian dollar gold price forecasts increase 7-14% over the medium to long term.

Deutsche Bank singles out several stocks which differ, as they are positioned to create value by investing counter-cyclically at this point. These stocks have strong cash flows and balance sheets. Rio Tinto ((RIO)) is one. It is buying back US$2bn in stock and should soon approve the Oyu Tolgoi underground and South Embley projects.

Iluka Resources ((ILU)) has upside pending from synergies from the Kenmare acquisition. Independence Group ((IGO)) is developing the Nova nickel deposit and spending on highly prospective exploration. Evolution Mining ((EVN)) is buying gold assets off the majors. Sandfire Resources ((SFR)) is adding value via exploration and Mineral Resources ((MIN)) is winning new crushing contracts and investing in light rail.

Deutsche Bank also likes Alumina Ltd ((AWC)) and South32 ((S32)) on valuation and strong cash flow. Both operate low-cost alumina refineries. In light of the review Deutsche Bank upgrades OceanaGold ((OGC)) to Buy from Hold and downgrades Whitehaven Coal ((WHC)) to Hold from Buy.

Morgan Stanley's preference is for Australian operations and miners which have too many negative concerns priced in. The broker downgrades South32, Iluka Resources and Alumina Ltd to Equal-weight from Overweight on a relative preference basis.

The broker's order of preference is Whitehaven Coal, Western Areas ((WSA)), Independence Group, Fortescue Metals ((FMG)), Rio Tinto and OZ Minerals ((OZL)). Morgan Stanley prefers Fortescue and Whitehaven as there is potential for their debt loads to be reduced, in contrast to market concerns regarding price and margins. Rio Tinto is also better placed to cover its progressive dividend.

Morgan Stanley makes Evolution Mining its preferred gold miner, although retains an Equal-weight rating on limited upside. The company is the largest beneficiary of the new price deck because it has substantial leverage to the AUD/USD cross rate.

On this basis Alacer Gold ((AQG)) is moved to Equal-weight from Overweight as this stock receives no benefit from a weaker Australian dollar. Medusa Mining ((MML)) and Panoramic Resources ((PAN)) are both downgraded to Underweight from Equal-weight. This is a relative call, given a lack of cushioning from FX and tight balance sheet in the case of Medusa Mining and a short mine life and weak nickel prices in the case of Panoramic Resources.

Tin

Frequently tin, the smallest of the base metals market, misses out on attention. Macquarie observes the price performance in the year to date has been poor, down 21%. There have been insufficient supply reductions in a surplus market for a re-balancing to occur. Exports have now fallen from key suppliers such as Myanmar and Indonesia and the broker has reason to believe this may not be a temporary situation.

Still, demand conditions have also softened. Macquarie has reduced 2015 global demand growth assumptions to around 1.0%. This brings into sharp focus the need for meaningful supply adjustments. Myanmar has grown to 10% of global supply in just five years and this is helping to offset any shortfalls in Chinese domestic output.

Indonesia, the largest tin exporter, has implemented new regulations which led to nothing being exported in August so total exports are now down 13% over the year to date. However, Macquarie believes the market needs a sign that actual production cuts are materialising and that illegal mining is being tackled.

Lead

Lead has experienced the least price erosion among the base metals in the year to date, down 9.4%. Lead, like iron ore, took a hit early in the commodity downturn. Still, Macquarie does not believe the outlook is particularly rosy.

Mine output has been falling in China as more stringent environmental controls are applied and the scrap battery market, a source of 53% of total refined supply, appears tighter, although this is largely because of over-capacity in the secondary smelting sector.

The broker expects lead prices should be well supported into the year end with weak mine output driving a small deficit in 2016. Still, demand is weak and prices are not expected to retain much buoyancy. The broker also expects the recent reversal of the lead-zinc spread to be short lived.

Steel

Weak global demand, excess capacity and supply remain a weight on the steel sector. The World Steel Association's crude steel production estimates for August were down 3.0% on August 2014, with declines evident among all major steel producers.

Credit Suisse believes depressed price and a flood of cheap billet from China have also weighted on ferrous scrap demand. Prices are also under extreme pressure from the low cost of substitute pig iron and continued high competition among metals recyclers.

Credit Suisse notes Arrium ((ARI)) is the worst performer in the year to date in the sector.
 

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