Material Matters: Mixed Fundamentals

This story features BHP GROUP LIMITED. For more info SHARE ANALYSIS: BHP

By Chris Shaw

Trading in base metals remains nervous given ongoing concerns over Chinese growth and the European sovereign debt crisis, so GSJB Were has looked at industry cost curves to gauge where there may be levels of cost support for the various metals.

Such an analysis shows a split among the metals, GSJB Were noting both aluminium and zinc are already trading at prices below the ninth deciles of their respective cost curves. For aluminium this ninth decile for smelter cash costs is estimated to be around US101c per pound, while for zinc it is estimated to be around US80c per pound.

Given spot prices are currently below or around these levels at US87.5c and US79.6c per pound respectively, this suggests to GSJB Were fresh production cutbacks are likely if prices continue at current levels.

Commerzbank agrees, taking the view there is now limited downside for aluminium prices given many producers are operating at a significant loss at current price levels. This should force cutbacks to production in the bank's view, meaning inventories in China may have reached their peak for the shorter-term.

In contrast, GSJB Were notes the prices for both copper and nickel continue to trade at well above their respective cost support levels, which it estimates at US165c per pound and US660c per pound. Spot prices for both metals are currently around US300c and US900c per pound respectively.

In general, for the base metals Barclays Capital notes there continues to be emerging evidence of robust demand. The latest is the Metals Bulletin report showing a jump in tin premiums given low inventories and higher consumer demand.

US tin premiums are currently around US$500-$620 per tonne, up from US$500-$575 per tonne previously. The same trend is evident in copper as premiums in the US spot market have increased to US5-6c per pound over the past week from US4.5-5.5c previously, while premiums in aluminium contracts also appear to be increasing. This appears supportive for prices once the current Chinese and European growth issues are resolved.

In copper specifically, Deutsche Bank has attempted to measure real consumption levels in China, largely because growth in Chinese exports of copper appear very strong given a rise of 48.5% year-on-year in May. This represents strong growth from the April data.

This data are somewhat misleading in Deutsche's view, as it notes Chinese copper exports come from both direct exports of copper and copper alloy semis and indirect exports of copper-containing end products.

Direct copper exports are relatively small, so the level of indirect exports is of more significance. Deutsche estimates if one million tonnes of copper was exported in finished goods this would reduce China's 2010 apparent demand by as much as 12-13%. As China also manufactures for other emerging markets, the actual figure could be increased by a further 3% or so.

This leads Deutsche to suggest apparent copper consumption in China may be inflated by as much as 15% or so if the amount of copper re-exported in finished goods is stripped out.

UBS has looked more closely at the bulk commodities, noting monthly metallurgical and thermal coal exports lifted strongly in April after the February/March seasonal downturn. In relative terms, UBS prefers thermal coal to met coal on a 6-12 month view, largely because the global steel sector is now moving into its seasonally weaker second half of the year.

In contrast, the thermal coal market is seen as remaining buoyant over the same period thanks to expected strong buying from both China and India. As well, annual and semi-annual contract prices should underpin the market in UBS's view.

In iron ore, UBS points out spot prices have fallen by about 18% in the past month, though spot prices are still about 6% higher than the April-June quarterly prices settled by BHP Billiton ((BHP)) in previous contract settlements.

Late last month it was reported Vale of Brazil would lift iron ore prices by 35% in July, its contracts being based on the average index-based spot prices reported for the period of March 1st to May 31st. As these data are now available, UBS estimates Vale's average March-May price would be around US$128.3 per tonne for fob fines.

UBS suggests this can be used to get an indication on BHP's prices for the next quarter as BHP calculates its prices somewhat differently. Its July-September quarterly contract price is reported to be based on the average price for April-June.

If prices for the rest of June remain at current levels, UBS estimates BHP is likely to lift prices in the July-September period by about 23%. This is significant as the broker's earnings forecasts for the company currently incorporate a 5% quarter-on-quarter lift, which implies some upside to current estimates.

UBS currently rates BHP Billiton as Buy with a price target of $53.50, while the FNArena database shows the stock is rated as Buy six times, Accumulate once and Neutral twice with an average price target of $48.87.

In the oil market, Barclays Capital continues to argue fundamentals warrant higher prices as there remains strong growth momentum in demand in both OECD and non-OECD nations. While non-OECD supply has been strong, Barclays notes the medium-term supply picture in general is getting gloomier, largely given the impact of the BP spill in the Gulf of Mexico.

Barclays sees this issue as likely to have profound effects for the oil exploration industry, as the end result is likely that oil becomes slower onstream, more expensive to produce, a more political industry and there will be less product available.

Applying this to the current end of the oil curve leads Barclays to suggest oil remains undervalued at just below US$100 per barrel. The group sees US$70 per barrel as having emerged as a strong floor level for the oil price.

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