Material Matters: Aluminum Vs Silver, Ag Commodities And Bulks

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By Chris Shaw

According to RBS the top commodity trade for 2011 is to be long aluminium and short silver, as the aluminium:silver ratio has moved to a level where silver is at its most expensive for the past 23 years.

Looking at each metal, RBS notes aluminium prices have been left behind by the recent gains in copper but this hides improving fundamentals for the metal. World demand growth for aluminium should be more than 15% this year, with year-on-year growth to be the best for 30 years.

The potential launch of some physically-backed Exchange Traded Funds (ETFs) for aluminium and the fact a number of high cost smelters in Europe in particular could close due to high power costs should also support prices, RBS seeing scope for the metal to play catch up with copper going forward.

Since the 1970s, RBS notes, copper prices have traded at around 1.5 times those of aluminium but this ratio has blown out to about 3.7 times now, so on a risk-reward basis aluminium now looks attractive in the broker's view.

Silver has enjoyed strong gains this year, even outperforming gold year-to-date. Back in February one ounce of gold would buy 70 ounces of silver but now the ratio has fallen to just 50 ounces of silver, as silver has risen to 30-year highs in nominal terms.

But the gains are partly reflected glory from rising gold prices and with RBS expecting gold to trade lower in 2011, and with the silver trade being crowded as shown by high ETF holdings, the broker has some concerns and sees lower prices ahead.

Turning to agricultural commodities, Barclays Capital points out while much attention has been paid to the demand side of the equation thanks to growing emerging market buying, the supply side has been somewhat ignored.

Given demand growth has lifted domestic consumption levels, emerging economies have increasingly looked to curb exports to ensure domestic supply. As Barclays notes, this has had the impact of tightening global balances in a number of commodities such as sugar and cotton.

Weather has also played a role, Barclays pointing out poor conditions in Russia have forced a banning of grain exports until the 2011 harvest, while the Ukraine has also imposed a grain export quota. The overall impact has been that while production has risen in emerging markets, and strongly in some cases, there has not been similar increases in export levels.

For Barclays this implies trends in emerging market agricultural policy and export trends in agricultural commodities are increasingly worth watching closely.

With respect to coal, UBS notes last week power generator Eskom and the South African government agreed a proposal to restrict thermal coal exports. The move reflects Eskom's inability to secure sufficient domestic supply for its generators.

Given Eskom uses around 120 million tonnes of South African production of 250 million tonnes of coal products, UBS estimates South Africa needs to lift coal supply by about 4% annually to meet expected demand growth.

Given the government appears unprepared to pay seaborne prices for new coal supply there is little incentive for domestic producers to deliver the additional product South Africa requires. This will threaten exports and so is bullish for ex-African coal producers in UBS's view.

Currently UBS is forecasting thermal coal prices of US$120 per tonne FOB for Japanese financial year 2011, which would be an increase of 22% in year-on-year terms.

Risk to this forecast is to the upside in UBS's view and among Australian producers the broker suggests Coal and Allied ((CNA)) is well placed to be a beneficiary of potentially higher thermal coal prices. Coal and Allied is rated as Buy by UBS, while the other three brokers in the FNArena database covering the stock rate it as a Hold.

Goldman Sachs is also turning more positive on coal, raising its price forecasts following meetings with industry participants in both China and Australia. The broker has also lifted its iron ore price estimates.

Even allowing for modest cuts to Chinese coal demand estimates, seaborne markets are expected to tighten further in 2011. Goldman Sachs expects this will push average annual prices in 2011 above those seen this year.

The largest increases are for hard coking coal, where Goldman Sachs sees a structurally tight market for some time. To reflect this the broker has lifted its forecast to US$240 per tonne for 2011 and 2012, which compares to previous estimates of US$226 per tonne and US$204 per tonne respectively. The broker's long-term forecast of US$160 per tonne is unchanged.

For thermal coal Goldman Sachs has lifted its average annual price forecast to US$111 per tonne for both 2011 and 2012, which compares to previous forecasts of US$103 and US$101 per tonne respectively. A long-term price forecast of US$80 per tonne is unchanged.

Similarly in iron ore Goldman Sachs has revised estimates higher, its average annual price forecasts now standing at U$153 per tonne for 2011 and US$140 per tonne for 2012, up from US$146 and US$124 per tonne previously. There is no change to the broker's long-term price forecast of US$75 per tonne.

The changes to forecasts for the bulk commodities means changes in earnings estimates for Australian companies operating in these markets, which has generally resulted in modest increases to price targets. In terms of an order of preference for companies exposed to the bulk commodities, Goldman Sachs favours BHP Billiton ((BHP)) as a Conviction Buy, Rio Tinto ((RIO)), Fortescue Metals ((FMG)) and Macarthur Coal ((MCC)). The latter three also are rated as Buys by the broker.

The FNArena database shows Sentiment Indicator readings for the four stocks of 1.0 for Rio Tinto, 0.8 for BHP, 0.4 for Fortescue and 0.1 for Macarthur.

The final word on commodities comes from Standard Bank in relation to oil futures. The bank suggests commercial hedgers currently are absent from the futures market, as the latest CFTC Commitment of Traders report showed a 23% drop in net long positions week-on-week.

When commercial hedgers are absent Standard Bank notes the oil market tends to trade in a more volatile fashion. This suggests some potential price swings in coming weeks, though the bank expects prices will remain in a trading range of US$75-$US$86 per barrel heading into the end of the year.

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