Material Matters: The QE2 Bull Market, Plus Coal, Gold, Copper, Aluminium

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By Chris Shaw

With global economic growth already above 4.0%, driven by growth in emerging economies of better than 6.0% and accelerating, Macquarie sees a positive environment for global liquidity and commodity prices.

Add in a new round of quantitative easing measures, evidence of an acceleration in Chinese economic growth and tight conditions in the iron ore, coal and copper markets and the broker is confident in its expectation of a strong ongoing bull market for resources.

On Macquarie's analysis, there remains reasonable value among Australian resource stocks at present, as cumulative earnings per share growth expectations for FY11 and FY12 stand at a little more than 75%. This compares to expected earnings growth for the market ex-resources over the same period of around 20%.

To reflect this strong growth outlook, Macquarie has adjusted its model portfolio, extending its overweight position to the resources and mining services sectors. This has come via the addition of PanAust ((PNA)) and Boart Longyear ((BLY)), the former given a strong balance sheet and solid net cash position and the latter to add exposure to the fast growing mining services and construction sector.

Macquarie has also increased its weighting to Woodside Petroleum ((WPL)) to reflect its view there remains significant upside potential for oil prices as the global economy recovers over the next year. To make way for the new additions Macquarie has removed David Jones ((DJS)), AGL Energy ((AGK)) and CFS Retail Property Trust ((CFX)) from its model portfolio.

The resource related stocks in Macquarie's recommended portfolio are now Origin Energy ((ORG)), WorleyParsons ((WOR)), Woodside, Rio Tinto ((RIO)), BHP Billiton ((BHP)), Oz Minerals ((OZL)), Mount Gibson ((MGX)), Equinox ((EQN)), PanAust and Boart Longyear.

RBS Australia is similarly positive on the potential for quantitative easing to offer a boost for equity markets, given the policy is a reflationary action and equities and commodities typically outperform cash in such periods.

To reflect its positive view on equities, RBS Australia has also re-weighted its portfolio, adding a position in Boart Longyear to reflect the view there is operational leverage on offer that is not being fully priced in at current levels.

RBS Australia has also added to its Materials exposure by increasing its Rio Tinto position, the broker pointing out it retains a preference for bulks compared to base metals given the producers of bulks currently trade at a discount to net present value. A recent visit to China also has the broker confident in continued steel capacity additions in that market, which is supportive for the bulk plays.

With respect to base metals exposure, RBS Australia remains reluctant to chase stocks at present as in its view those commodities that have over-discounted the US dollar decline could be vulnerable. As well, RBS notes copper prices are current 19% above its own forecast for this year and 6% above its forecast for 2011.

Resource exposure in RBS Australia's model portfolio consists of Origin, Santos ((STO)) and WorleyParsons among energy plays, Boart Longyear among cyclicals and BHP, Rio Tinto, Fortescue Metals ((FMG)) and Newcrest Mining ((NCM)) among the materials and mining plays.

Elsewhere, Citi has revised its coal price forecasts to reflect both recent exchange rate movements and lower than expected price settlements in the September and December quarters.

The changes see Citi lift its thermal coal forecasts by 3-7% in 2011-2012 to as much as US$110 per tonne, while coking coal price forecasts for 2011 have been trimmed 5% to an average of US$238 per tonne.

The changes have been more significant for PCI and semi-soft coal prices, Citi cutting is numbers for both by around 20% next year to US$155 per tonne and US$150 per tonne respectively.

The changes mean cuts to earnings forecasts for the coal producers covered by Citi, the biggest hit being taken by Coal and Allied ((CNA)) thanks to its twin exposures to semi-soft coal and a stronger Australian dollar.

In Citi's view, the established Australian coal producers are fully valued at current levels, so the stockbroker continues to focus on the emerging producers. Citi rates both Cockatoo Coal ((COK)) and White Energy ((WEC)) as Buy, High Risk, with respective price targets of $0.70 and $5.55, the latter down from $6.00 previously. Citi rates Resource Generation ((RES)) as Buy, Speculative, though the broker's price target on the stock has fallen to $0.95 from $1.00 previously.

The only change in ratings made by Citi is to downgrade Whitehaven Coal ((WHC)) to Hold, Medium Risk from Buy. The change is a valuation call and reflects recent share price gains. Macarthur Coal ((MCC)) is rated as Sell, Medium Risk, with a price target of $11.50. This is well below the current share price of around $12.50.

With respect to the broader market, the FNArena database shows Sentiment Indicator readings for the Australian coal plays of 1.0 for Cockatoo, White Energy and Resource Generation, 0.5 for Coal and Allied, 0.3 for New Haven and Whitehaven, 0.2 for Riversdale and 0.0 for Northern Energy and Macarthur Coal.

With gold trading near the US$1,400 per ounce level there is clearly a lot of interest in the market, but as Commerzbank notes interest has further risen on the back of an article by World Bank president Robert Zoellick.

Zoellick has called for leading economies to consider re-adopting a modified global gold standard as a way to counter currency movements. In Zoellick's view, the system should include the US dollar, the euro, the British pound, the yen and the Chinese renminbi, while he suggests gold should be used as a reference point for inflation, deflation and currency value expectations.

Commerzbank's view is any such plan is a long way from being close to being realised, but psychologically such arguments are likely to offer some support to gold prices in the current environment.

Turning to the base metals, Commonwealth Bank notes the Shanghai to London Metals Exchange copper and aluminium price arbitrage levels have increased to a point that normally suggests China will look to cut its imports of both metals in coming months.

September trade data show no evidence of this trend emerging just yet, especially as Chinese production of a number of metals has slowed on the back of power cuts. This leads Commonwealth Bank to suggest Chinese buyers will keep importing metal despite this unfavourable arbitrage at present.

Under such conditions, Commonwealth Bank suggests both copper and aluminium prices on both the LME and the Shanghai exchange should continue to see good support.

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