Material Matters: Gold Demand Uncertain, Base Metals And Fertiliser Improving

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By Chris Shaw

Financial issues in Greece continue to add to volatility in metal prices generally and gold in particular given that metal's safe haven status. Sharp drops were also experienced following the Goldman Sachs news on Friday.

Fundamentals are nevertheless continuing to play a role in the gold market, a point emphasised by last week's GFMS Gold Survey. UBS notes the survey showed while GFMS remains bullish for 2010 the group has a cautious medium-term view.

GFMS suggests the end of the rally in gold is in sight given net jewellery demand remains weak, though its view is this could take a year or more to play out. The other issue for GFMS is the level of investment demand, as in 2009 this was strong enough to surpass jewellery fabrication demand for the first time since 1980.

The strength in investment demand is not entirely surprising given ongoing currency and inflation concerns, as well as the recent sovereign debt issues in Europe. But as UBS notes, the issue for GFMS is unless inflation really picks up and/or there is a dollar crisis, higher real interest rates and a weakening of the safe haven story will see investment demand for gold weaken.

Assuming this, current levels of investor demand for gold are not sustainable. The GFMS view is while prices could rally to US$1,300 per ounce and beyond in the shorter-term, this likely will be the final rally of what has been a multi-year bull market.

Barclays Capital also sees ongoing strength in investment demand as a key for the gold price, as while physical demand sets the price floor for the metal it has been investor demand driving prices higher.

What could support prices if investor interest falls is stronger physical demand, and China gives some cause for optimism in this regard. GFMS notes jewellery demand for gold in that country rose by 8% last year.

With income levels rising, growing inflation fears and potential for a revaluation of the renminbi, China may well deliver further gold demand growth this year. Though as Barclays points out, the GFMS forecasts for 2010 overall imply little real growth in global jewellery fabrication demand.

What this means, according to Barclays, is if investor demand turns less supportive other buying such as from central banks would need to emerge to drive prices higher. Barclays is forecasting an average gold price of US$1,166 per ounce this year, while GFMS is forecasting an average of US$1,170 per ounce, with a range of US$1,050 to US$1,300 per ounce through the year.

Turning to the base metals, Citi notes there are some signs emerging of an improvement in demand in developed economies. In the US, copper service centre shipments are now up 9.5% in year-on-year terms, or 4% on a month-on-month basis.

While Citi points out this is coming off a low base, it remains the first positive data point since early in 2006. The news is similarly positive in the aluminium market, where orders are up 25% year-on-year and 12% month-on-month in March.

Europe continues to lag, but the improving data in the US is being matched by better figures out of Japan. In that market both copper and aluminium shipments are rising, with copper shipments of semi-manufactured products up 37% year-to-date and aluminium shipments up 34%.

The data is in line with Citi's view a recovery in OECD demand and an associated boost from re-stocking will see continued strength in base metal prices in the second half of 2010. Barclays Capital notes there are not yet any signs of re-stocking, but it sees this trend as gaining traction in coming months.

In the view of GSJB Were the outlook for copper is already improving, as not only is demand from developed countries rising but Chinese importers continue to buy the metal in large quantities whenever an opportunity to do so presents itself.

The flip side is copper supply remains constrained in Were's view, reflecting a scarcity of large-scale greenfields projects and disruptions to production globally. As well, the broker sees no reason for currently positive investment flows in commodity markets to reverse.

What could also boost metal prices according to UBS is a revaluation of the Chinese currency, as global commodities where China is a net importer should gain as a stronger renminbi makes it cheaper for the Chinese to import these commodities. This should translate to increased demand.

According to UBS base metals and iron ore are likely to be the biggest beneficiaries, as China's share of seaborne iron ore imports in 2010 is estimated at 64%, while it also consumers 25-40% of the global base metals market. Gold is another potential beneficiary in UBS's view, especially if any renminbi appreciation is interpreted as a sign the government is concerned about rising inflation.

Given the signs of improving demand, Weres has lifted its metal price forecasts, its copper estimates rising to US352c per pound this year and US375c per pound in 2011, up from US320c and US335c respectively. In aluminium, forecast prices have been increased to US97c and US90c per pound for 2010 and 2011, against US91c and US88c previously.

Increases to lead price forecasts have also been made, Weres lifting its estimates to US93c per pound this year and US88c per pound next year against previous estimates of US87c and US78c respectively. Zinc forecasts are also higher, rising to US99c and US90c per pound respectively for 2010 and 2011, up from US93c and US88c. Nickel price forecasts for Weres are unchanged at US858c per pound this year and US725c per pound.

Copper remains the number one base metal for GSJB Were and in terms of playing this story via listed Australian equities. The broker has reiterated its Buy recommendations on Pan Aust ((PNA)), Equinox ((EQN)) and Oz Minerals ((OZL)).

In the agricultural commodities sector Credit Suisse notes North American DAP (Diammonium Phosphate) inventory levels continue to come down, now standing 23% below five-year average levels. This, plus recent contract signings at US$435 per tonne, is expected to support pricing growth near-term.

This is important for Incitec Pivot ((IPL)), Credit Suisse continuing to take a favourable view on the stock given fertiliser prices remain ahead of its forecasts. Its Outperform rating is accompanied by a $4.15 price target, while the FNArena database shows four Buys, four Holds and one Sell rating.

Current spot prices are around US$460 per tonne, while Credit Suisse is forecasting prices will end FY10 (September year end) at US$390 per tonne, rising to US$400 per tonne in FY11.

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