Material Matters: Coal, Iron Ore, Gold

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By Chris Shaw

Recent data suggests Chinese and Indian electricity demand has continued to increase, something Deutsche Bank sees a a positive for thermal coal prices given it implies these countries will remain growing net importers of coal.

Not all this additional demand will be supplied by Australian producers as GSJB Were notes Australia has been losing some share in Chinese thermal coal import markets thanks to lower prices from Indonesian producers. This has been enough that Newcastle shipments in April were below target levels.

Despite this GSJB Were remains fundamentally bullish on the seaborne hard coking coal market given ongoing supply constraints. It notes top tier brand material is selling at US$225 per tonne for the third quarter of this year, while second tier brands are trading at US$210-$215 per tonne for the same period. For the second tier brands this is an increase of around 12.5% over second quarter prices.

As the demand increases from Asia are accompanied by not only ongoing infrastructure constraints but rising cost inflation as well Deutsche has lifted its price forecasts for thermal coal through to 2013. In 2011 its forecast increases by 10% to US$110 per tonne, its 2012 forecast rises by 26% to US$120 per tonne and in 2013 it increases by 11% to US$100 per tonne.

From a corporate profit perspective, the fact thermal coal prices have remained relatively stable this year despite significant volatility in commodity markets generally is good for visibility on cash flows for mining companies according to Deutsche.

This, plus some increases to earnings estimates to reflect the lift to its thermal coal forecasts, sees Deutsche lift its price targets on both BHP Billiton ((BHP)) and Rio Tinto ((RIO)). For BHP the target increases to $48.00 from $47.00 previously, while for Rio Tinto its target increases to $96.50 from $93.50.

The changes reflect increases to earnings estimates for both companies, with Deutsche retaining its Buy rating on both stocks. The FNArena database shows Sentiment Indicator readings of 0.8 for BHP and 0.9 for Rio Tinto.

In iron ore Citi notes 62% iron spot is currently trading at US$145 per tonne, which is US$14 per tonne below third quarter contract prices. It suggests if spot prices stay at this level or fall further, then customers have incentive to avoid taking any volume in the third quarter except where contracts are in place.

Higher iron ore prices and higher coal prices will increase the margin squeeze for those steel producers without raw materials integration in Citi's view, as steel prices have risen by around US$125 per tonne so far this year against the required US$200 per tonne increase needed to cover raw material inflation.

These higher costs should eventually be passed through to customers, but for this to occur Citi suggests there may be an adjustment period where volumes come down to create some improvement in producer pricing power.

Citi notes this process is underway in China, which has helped push spot prices down to US$145 per tonne from US$180 per tonne. But Citi continues to expect global steel demand will be strong enough over the next two to three years for iron ore prices to settle between US$150-$200 per tonne.

Recent news has also been positive for the gold price, Credit Suisse noting World Gold Council numbers for the March quarter showed a strong recovery in demand from the two largest consuming nations – India and China.

This drove physical gold demand to its highest March quarter level for the past three years, though Credit Suisse notes this strength in physical volumes was more than offset by the second lowest Exchange Traded Fund (ETF) inflow level since the middle of 2005.

Credit Suisse expects June quarter jewellery volumes will soften given recent record prices, as physical demand is a greater function of value than of volume. This means as gold prices increase the value of metal bought also rises but actual tonnes purchased decreases.

What should continue to support the metal according to Standard Bank is elevated levels of risk aversion, as the bank notes the latest CFTC data shows speculative length in gold remains acceptable despite the recent rally in gold prices.

Given this Standard Bank suggests dips in the price of the metal are buying opportunities, with gold in euro terms favoured relative to gold in dollar terms. From a technical perspective the bank sees support for gold at US$1,213 per ounce and then US$1,205, while resistance is at US$1,226 per ounce and then US$1,231.

Relative to gold Standard Bank suggests silver appears overbought, as speculative length is currently well above the average of 24.6% seen over the past 12 months. In contrast platinum appears to have seen the worst of its sell-off, the bank expecting prices will consolidate above US$1,500 per ounce.

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