Material Matters: Copper, Aluminium, Gold And Steel

This story features BLUESCOPE STEEL LIMITED, and other companies. For more info SHARE ANALYSIS: BSL

By Chris Shaw

Having been range bound for some time commodity markets are now showing more life, Barclays Capital pointing out in recent sessions both gold and tin have set fresh nominal highs and copper has pushed through the US$8,000 per tonne level.

According to Barclays there remains scope for further upside for commodities through the end of this year and through 2011, with the strength of emerging economies, their rising global market share and strong growth potential likely drivers of prices.

As well, Barclays points out an analysis of commodity performance from a business cycle perspective offers some reasons in support of stronger prices going forward. Historically commodities have performed better in late expansion phases of business cycles than in the early expansion phase.

National Bureau of Economic Research (NBER) data shows business cycle expansions tend to last around 42 months, while the current cycle has currently been in place for only about 15 months.

While prices have rebounded more strongly than in previous cycles, Barclays notes they also fell more sharply in the last downturn and so remain close to the bottom of the range of where markets have been at this stage of past business cycles.

This suggests further upside to Barclays, with the potential for this cycle to be even stronger than previous cycles given the current combination of longer-term positive factors for commodity markets.

As Barclays notes, copper prices have pushed through the US$8,000 per tonne level in recent trading sessions, but some in the market see this as only the beginning of any move higher. According to Goldman Sachs, copper has the potential to trade as high as US$11,000 per tonne by the end of 2011.

Such a move is supported by a number of factors according to Goldman Sachs, these including economic policy uncertainty, ongoing sovereign debt risks and significant supply constraints for the metal. Supporting the latter is the view emerging markets will bid away scarce commodities from developed economies.

Macroeconomic realignments are also likely according to Goldman Sachs, which suggests commodity prices will become increasingly relevant as correlations between the macro economy and commodities markets grow.

As well as copper, Goldman Sachs is bullish on crude oil, corn and platinum, as each market faces significant supply constraints. Driving these supply constraints is a fall in investment, which has been a by-product of weaker corporate returns thanks to the global financial crisis.

As the broker sees sovereign risk as an ongoing issue for probably another 18-24 months it remains positive on gold as well.

With gold now trading above US$1,300 per ounce the metal does face some headwinds, Commerzbank noting current record high prices have dampened jewellery demand. As an example, the bank notes India, the world's largest gold consumer, imported 32.6 tonnes of gold in September, down from 39.7 tonnes for the same month last year.

As well, Standard Bank notes at current levels more scrap gold is coming onto the physical market, and the bank suggests the pace of the recent rally means gold is now outpacing its long-term drivers, especially global liquidity.

On Standard Bank's numbers global liquidity has risen 10% year-to-date, while the gold price over the same time frame has risen by 18%. This in itself is not inconsistent with past behaviour, but with speculative length in the market also rising Standard Bank is more cautious with gold at current levels. A pull-back remains possible, with a move back towards US$1,300 per ounce quite possible in the bank's view.

Elsewhere in commodities, Commonwealth Bank notes aluminium stockpiles according to both London Metal Exchange and Shanghai Futures Exchange figures have trended lower in recent months. Total stocks have fallen by around 13% from 12-month highs.

While higher aluminium prices are partly a function of the weaker US dollar, this downward trend in exchange stocks is a sign demand may be recovering in CBA's view. The big test is if higher prices result in a jump in refinery restarts, so the bank wants to see ongoing and sustained falls in aluminium inventory levels while production is increasing before turning more positive on the metal.

Turning to steel, JP Morgan points out if the Australian dollar was to reach parity with the US currency by the first half of FY12 as it now forecasts, there would be a significant negative impact on Australian steel company earnings.

Of the Australian steel plays JP Morgan sees BlueScope ((BSL)) as the most exposed to a stronger Australian dollar, thanks to offshore US dollar-denominated earnings from US and Asian businesses and US dollar-denominated export revenue from the Australian crude steel making business.

To reflect the expectations of parity in FY12 between the Australian and US dollars, JP Morgan has cut its earnings forecasts for BlueScope by 13-23% for FY11-FY13. Despite these cuts the stock remains its preferred exposure in the sector, as JP Morgan estimates the shares are trading at a near 40% discount to valuation at present.

JP Morgan has an Overweight rating on BlueScope, while the FNArena database shows a Sentiment Indicator rating for the company of 0.9.

In contrast the broker rates OneSteel as Underweight, as import competition is expected to limit the company's domestic pricing power and so limit any recovery in margins. As well, the stronger Australian dollar will impact, which has seen cuts to earnings estimates of 5-13% for FY11-FY13. The database shows a Sentiment Indicator reading for OneSteel of 0.4.

JP Morgan rates Sims Metal Management ((SGM)) as Neutral, as earnings cuts from a stronger Australian dollar are more modest for this company than its sector peers. As evidence of this, JP Morgan has trimmed its estimates by 4-6% through FY13. The broker's Neutral rating compares to a Sentiment Indicator reading according to FNArena's database of 0.3.

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