Commodities | Jul 05 2011
This story features SANDFIRE RESOURCES LIMITED. For more info SHARE ANALYSIS: SFR
– Japanese copper market to normalise from third quarter
– Social housing market to boost copper and iron ore
– Increase in Chinese raw material demand to support commodity prices
– More evidence needed before bullish approach on copper
By Chris Shaw
The earthquake and tsunami that devastated parts of northern Japan in March was expected to have a negative impact on base metals demand, an expectation that proved correct given only lead demand across March-April was positive according to Japanese commodities data for the period.
Barclays Capital notes the average size of the demand decline across the base metals in Japan for March-April was 6.7% in year-on-year terms. This is actually a better result than had been expected, as after the disaster Barclays had factored a 10% decline in demand into its model.
The headline figures show a clear split between end-demand sectors in terms of consumption trends. Shipments of copper and wire cable rose 18% year-on-year for the construction sector in May, while the auto sector experienced a 21% decline on the same basis.
Looking ahead, Barclays expects the second half of 2011 will show stronger Japanese demand growth across the base metals, though potential power shortages in summer remain something of a risk. This positive view is supported by expectations of stronger performance from the Japanese auto sector, where progress in restoring supply chains has been faster than anticipated.
To Barclays this suggests a normalisation of activity from the third quarter, especially given the boost provided by a stepping up in reconstruction activity in the second half of the calendar year.
Still on Asia, Macquarie suggests a stronger outlook for social housing in China over the second half of 2011 and through 2012 will prove supportive of the broker's bullish outlook on both copper and iron ore.
Macquarie suggests the coming months are likely to see some announcements to overcome current cash constraints, including bigger transfers from Beijing, easier access to bond markets and some kind of procurement platform for social housing.
In Macquarie's view this will result in more meaningful construction in the December quarter and across 2012. This implies some upside risk to current demand numbers for a variety of commodities.
The Chinese government is currently targeting 10 million social housing units this year, which compares to a target of 5.8 million in 2010. Given the 2010 target was exceeded, Macquarie sees scope for a similar outcome this year.
The key is determining how much of the planned 10 million in starts is incremental construction beyond what would have been built regardless of any target. Macquarie suggests the breakdown of the plan is for four million starts to be in the renovation of run-down areas, 2.2 million will be for capped price housing and 3.8 million will be public and low-rent housing.
Construction activity going into public and low rent housing is not recorded in commodity building floor space numbers that are closely followed. This leads Macquarie to suggest demand for commodities from construction could start to outperform such indicators in the second half of this year.
Further on iron ore, Citi notes while Chinese steel production remains near record levels and Japanese steel production has help at reasonable levels given the impact of the earthquake and tsunami, exports from India, Brazil and Australia have been lower.
Despite this, iron ore prices have failed to move higher, something Citi suggests is due to de-stocking in the Chinese market and a gap between domestic and international prices. Given a threat of power-related capital constraints in China at present, Citi expects prices will stay range bound in the short-term.
Once demand picks up as reconstruction in Japan gathers momentum later in the year, and as Chinese de-stocking runs its course, Citi expects prices will start to pick up by the final quarter of this year. Citi is forecasting average iron ore fines prices of US$165 per tonne this year and US$149 per tonne in 2012 and spot prices of US$176 per tonne and US$153 per tonne respectively.
Still in China, Macquarie has examined year-to-date apparent demand data across various commodities, which shows significant variation in performance. Copper stands out in terms of apparent demand has fallen by 8.5% in year-on-year terms before allowing for unreported stock changes.
In contrast, Chinese lead demand growth suggests some restocking, while the data for nickel suggests real consumption growth has slowed in recent months.
According to Macquarie, the implication of the data is while some headline activity indicators may weaken given the monetary tightening in the first half of this year, Chinese raw material demand is still expected to increase given the degree of de-stocking year-to-date.
To Macquarie, this suggests even a slowing in the pace of growth of end-use sectors in China should not act as a barrier to higher prices for commodities such as copper, where de-stocking has been most intense.
UBS has also looked more closely at China and copper, noting May production and trade data indicated total copper inventories in that market are at critically low levels. At the same time production rates of semi-manufactured material are rising strongly, UBS attributing this to Chinese copper traders and consumers not having enough credit to buy their raw materials. A strong copper price is also deterring buyers.
While China's position as dependent on copper imports would in theory be bullish for global copper stocks, UBS suggests there are three reasons for caution. The first is the expectation of further monetary tightening in China, which may impact on demand.
The second is with QE2 now rolling off, there is the potential for a bearish reversal of capital flows to the US. Finally, UBS notes copper-bearing goods inventories-to-sales ratios are back at relative highs.
For the broker, this is enough to suggest waiting for these risks to play out before looking to buy into copper equities.
Bullish signals would include China boosting credit liquidity, markets being fully positioned ex QE2 and some stability in copper-bearing goods inventories and an associated lift in sales. In terms of forecasts, UBS expects copper prices will average US$4.00 per pound this year, before easing to an average of US$3.70 per pound in 2012.
Among global copper stocks likely to respond to any recovery in Chinese trade, UBS suggests the Australian plays of interest are PanAust ((PNA)), Sandfire ((SFR)) and Discovery Metals ((DML)). UBS rates all three companies as Buys, while the FNArena database shows respective Sentiment Indicator readings for the three stocks of 0.7, 1.0 and 0.5.
As a warning, UBS cautions there is scope for a bearish short-term scenario for copper if there is no change in China's inflation-targeting policies. If inflation remains a threat there will continue to be constraints on economic growth, so delivering continued weakness in China's copper trade. UBS suggests this could see copper trade sideways or even lower through the remainder of 2011, something that would weigh on the value of copper equities.
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