Material Matters: China, Base Metals, Tin, Mineral Sands And Resource Equities

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-Base metal outlook marginally better than steel
-Supply cuts making little dent in prices
-Yet fundamentals difficult to ignore
-Refined tin production down sharply
-Supply driving mineral sands deterioration
-Can Oz resources hitch ride on EM rally?

By Eva Brocklehurst

China

After visiting Beijing and Shanghai, Macquarie observes the main concern among metal specialists is sluggish demand. Steel continues to suffer from a lack of production discipline and few players in the market that the broker met expect government stimulus will materially change circumstances.

Some believe there may be a cyclical upturn in demand among end-users in the next six months but confidence is low. Others looking at the macro outlook point out a worsening in structural problems.

Base metals appear to have a better outlook than steel, but the broker notes further production cuts are still needed. Zinc and nickel look in better shape to Macquarie, as producers have been willing to contemplate production cuts.

The outlook for copper is generally bearish, with the market expected to remain in surplus next year as a result of continued deceleration in Chinese demand and an increase in global supply. Meanwhile, the general view on aluminium is negative, as investors appear to have lost confidence in the cost curve as price support.

Base Metals

In terms of base metals, 2015 marks the fourth consecutive year of price declines and Macquarie notes, since 1970, annual average prices have never fallen for more than five years in a row. So, while 2016 is likely to be challenging, the broker suspects the bottom of the cycle may be approaching.

What will happen next? Supply cuts driving a rebound may be wishful thinking, Macquarie suspects. This is because in prior recoveries it has been demand that has led the way while supply has simply reacted. Without a structural growth driver in terms of demand, mining commodities might have to wait for a global economic recovery.

ANZ analysts are also noting that despite supply reductions, base metals are struggling. Zinc has found some support recently with news of reductions in supply but the market has discounted similar news in aluminium.

The analysts expect the global aluminium market will remain in surplus, despite the closure of Alcoa's North American smelting and Chalco's smelters in China. What has been overlooked is increased capacity in China, with the analysts noting growth of 5mtpa over the last year and a further 4mtpa to added next year.

In zinc, closures have included Glencore's recent reductions, and the cessation of Century, Lisheen and two Nystar mines. Ten zinc smelters in China have now announced curtailments, representing around 7.0% of China's refined zinc production. The analysts observe the market has tightened and in 2016 the zinc market is forecasts to be in deficit of 200,000 tonnes.

Nonetheless, the analysts observe any benefit of supply reduction announcements appears to be fleeting. The market remains focused on the slowdown in manufacturing activity in China. The main positive, the analysts concede, is that the markets are setting a base whereby, if the macro outlook does improve, a rally could eventuate. Also, they suspect it will become increasingly difficult to ignore the fundamentals for too much longer.

Tin

While expecting all metals will be under the pump, Macquarie observes tin has been the worst performer among base metals this year. Prices are not trading as far into the cost curve as for other base metals, but headwinds remain and deflation pressure in the industry continues. Support comes in the form of refined tin production being down almost 8.0% year on year.

Chinese, Indonesian and Peruvian mine production have all fallen significantly, with a partial offset coming from Myanmar to China, which Macquarie notes is hard to estimate. Secondary tin supply, the main source being electronics and accounting for just under 20% of total metal production, is also described as under pressure.

When compared with other base metal markets the tin industry appears more healthy, Macquarie acknowledges, given over 50% of aluminium and nickel production is negative in terms of cash flow. On further analysis, when looking at how deep into the cost curve tin prices need to trade for downside support to be found, the broker becomes more negative.

Mineral Sands

Credit Suisse has extended its current forecasts for depressed pricing in mineral sands to the end of the decade. For zircon, the analysts do not expect any major increase in demand despite the disappearance of the supply overhang held by Tronox and Rio Tinto ((RIO)). The analysts do not expect a repeat of the industrial output boom in China, or the housing bubble, so further demand growth is expected to be modest.

Titanium dioxide looks most grim as feedstocks are being sold into a profitless pigment market, Credit Suisse observes, much like the 1990's. While the boom of 2011-12 is fading into memory, the analysts believe this is not the time for new mines beyond those ones ramping up, as prices are far below what is required to stimulate new supply. Moreover, those attempting to ramp up are facing challenges and the broker does not rule out insolvencies in the industry.

Supply and not demand is driving the deterioration in price, Credit Suisse contends. The broker's sources suggest Chinese exports have taken market share in low-end applications and driven oversupply.

Ilmenite prices are hardest hit, as this is the main feedstock for China and China's pigment industry is in a distressed state because of slow construction and soft industrial production. The broker does not expect China to cease exporting pigments. Western pigment capacity has been curtailed and Credit Suisse suspects it may need to stay that way until the market grows to absorb capacity.

Resource Stocks

Analyst sentiment towards the miners has hit a five-year low, Deutsche Bank observes. At first blush this may suggest a contrarian opportunity but the broker notes the knotty problem is earnings have fallen even more than share prices. A better performance in the share price will require earnings to improve, yet demand has been soft.

While demand is improving slightly, Deutsche Bank observes supply remains robust as lower costs have allowed production to keep growing in key areas. The broker senses the difficulty is that while cash flows are strong and dividends attractive, for these to increase over time there has to be some earnings growth.

Deutsche Bank mulls the question as to whether, given emerging market equities appear oversold, a rally could ensue with the stabilising of Chinese data. If that were to happen, could Australian resources hitch a ride? Again, a problem. Australian resource stocks do not share the same cheap valuations.

Moreover, there is potential for capital to drain away further as the US Federal Reserve hikes rates and the US dollar strengthens. This is offset to some extent in that Asian central banks are in an easing cycle. Further afield, the broker affords some hope in that development can accelerate quickly when countries get the balance right.

Deutsche Bank remains underweight on resources but is more positive about energy and, at the stock level, favours Oil Search ((OSH)), Santos ((STO)), Rio Tinto and South32 ((S32)).
 

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