Material Matters: Copper, Gold & Iron Ore

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Copper price movement and its correlation with the futures market; investment demand is driving high gold prices; iron ore market likely to be in deficit through 2020-21

-Copper price drivers: Futures market and China’s growth prospects
-Gold prices may be in for a correction
-Diversified miners expected to announce strong dividends

By Angelique Thakur

Copper: It's complicated

The last four months have seen the price of copper increase by 33%. Longview Econonomics suggests being 'long' copper has become an increasingly crowded position while sentiment readings on copper are at a ten-year high.

Longview has tried to decipher what is actually driving the copper price. The obvious answer points to changes in global demand and supply. At least this is what general consensus suggests is the case.

Longview, however, thinks the price of copper is more closely correlated with the futures market.

A look at copper futures trading in 2019 shows the total volume of copper traded on major futures exchanges amounted to 1.6bn tons. This is 64 times more than the copper produced and consumed in the physical market each year, which at about 25m tons, looks measly. This, suggest the analysts, reflects the financialisation of copper in the last decades.

Another factor impacting the global bellwether’s pricing is the outlook for China's economic growth, the report suggests. In particular, the Chinese 2-year sovereign yields, Chinese equity market and the exchange rate (renminbi versus the US dollar) are factors affecting the metal's price direction.

Currently, these variables combined suggest copper prices are expected to rise in coming years.

Australian iron ore: Minimal impact from the pandemic 

Wilsons' Australian equity focus list is Overweight the materials sector, on belief the sector is in a cyclical upgrade cycle.

Iron ore prices have rallied from US$90/t in the fourth quarter of 2019 to around US$110/t currently.

The Australian mining industry has experienced minimal volume loss, reports Wilsons, as opposed to production declines of as much as -30% in other parts of the world with the pandemic unleashing its wrath on the local labour force.

The August reporting season is likely to see the diversified miners announce stronger dividends. There may even be scope for market upgrades for FY21 estimates, expects Wilsons.

Going ahead, the analysts feel the iron ore market is likely to be in supply deficit through 2020-21, with Vale continuing to deal with supply issues.

With current FY20 dividend yields at about 5%, both BHP Group ((BHP)) and Rio Tinto ((RIO)) are Wilsons' key picks in the sector.  Where Rio Tinto leads in terms of iron ore margins, BHP is well-positioned across key commodities.

Post-lockdowns will see governments pivoting policies to project/infrastructure initiatives from income support (also seen in China post-lockdown).

Farther out, most commodity forecasters see iron ore prices going back to US$65-70/t in the next 12-18 months.

Gold: Weak consumer demand to continue

Gold has continued to climb dizzy heights, reaching a record price of US$1,981/oz in the last week of July, breaking its 2011 high record.

The rise has been helped in no small measure by a deteriorating US dollar. Falling real yields and rising geopolitical tensions are also important factors in the yellow metal’s price rise.

ANZ Bank analysts feel further gains are possible but depend on investor demand rather than consumer demand, which shows no signs of recovery.

This is because the demand for physical gold remains subdued, led by weak demand from major markets like India and China, where demand was down -55% and -48% in the first half. ANZ Bank estimates gold demand in India to drop by -40% in 2020 to 414t. China will likely struggle to cross 500t (versus 849t in 2019).

This has led to a surplus in the physical gold market, estimated at 1,397t in 2020. The high prices are also not helping matters, keeping consumers away. ANZ thinks It is now up to investor demand to close this gap and push prices even higher.

The backdrop, with negative real yields helping non-yielding assets like gold, remains favourable and has prompted the analysts to revise their gold price 6-12-month target to US$2,300/oz.

On the contrary, Macquarie feels at such elevated levels, gold is in “overshoot territory”. Macquarie expects gold to trade with more volatility.

While admitting the underlying drivers remain intact, Macquarie is of the opinion gold looks susceptible to a correction at current prices. An uptick in the US treasury yields or a firming up of the US dollar could see gold pull-back towards US$1,800/oz.

Macquarie does not consider Evolution Mining’s ((EVN)) production and earnings momentum continuing into FY21 and downgrades to Underperform. It also downgrades Northern Star Resources ((NST)) to Underperform after a strong share price run.

Top picks include Resolute Mining ((RSG)), Silver Lake Resources ((SLR)) and OceanaGold Corp ((OGC)). Some other preferred stocks include Westgold Resources ((WGX)) and Bellevue Gold ((BGL)).

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