Material Matters: Commodities And Growth, The Value Of New Projects

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 – Deutsche remains overweight the commodity sector
 – Barclays expects mixed performances in commodity markets
 – Goldman Sachs updates metal consumption growth and met coal market outlooks
 – Not all copper projects add value
 – NAB updates commodity market views

By Chris Shaw

In recent months risk assets in general have performed strongly, yet as Deutsche Bank notes share prices for Australian resource stocks have been relatively subdued. This reflects concerns about the growth outlook for China, but these concerns appear overdone in Deutsche's view. An overweight call on the sector is retained.

Such a positive view is supported by key indicators of commodities demand being stronger than they appear. As Deutsche notes, while indicators such as global steel production and Chinese Industrial Production are showing few signs of life, these indicators tend to lag at turning points.

The data suggest measures such as Chinese steel production actually bottomed late last year and are now improving. As well, Deutsche's analysis suggests Chinese property is on track for a soft landing, especially given lower inflation should allow for further policy easing in China this year.

Commodities demand therefore appears to be strengthening rather than weakening, meaning it is only a matter of time until year-on-year growth rates turn higher. Once this improving demand trend becomes more evident, Deutsche expects mining share prices will outperform the market, this given mining share prices appear priced for a worse outcome than should actually occur.

While Deutsche remains positive on commodities in general, Barclays Capital continues to expect a wide range of performance in the sector throughout the June quarter. While precious and base metals should record the biggest gains, oil and gas prices are expected to be flat to down and agricultural commodity prices should generally move lower.

As Barclays notes, the sell-off in commodity prices in the final quarter of last year was heavily overdone, so the relatively modest improvement in business confidence and economic growth prospects has translated into strong leverage over prices. 

In recent weeks momentum in commodity markets has slowed, so for Barclays the way forward now appears far more complex. While economic growth prospects are positive indicators are now no longer surprising to the upside, so most of the good news appears priced into commodity markets at present.

One positive factor according to Barclays is investor positioning has only started recovering to the long-side and markets don't appear overstretched. Measures of spare capacity in a number of markets are also thin, so even a modest improvement in global growth should be enough to put some pressure on the supply side in many markets.

In terms of China specifically Barclays remains relatively positive, even allowing for a widely expected soft-landing for the economy in general. Data support a positive view, as Barclays notes several PMI components with relevance for metal markets have delivered some very large increases. These include the backlog of manufacturing orders, new export orders and new orders of manufacturing goods. A higher order book and and falling raw material stocks imply higher expected purchasing of raw materials.

At the same time a lot of bad news has already been heavily discounted by the market. This means while there is small further downside potential in the very short-term, Barclays sees reason to be positive on the prospects for metals demand growth.

Goldman Sachs notes base metal prices have risen year-to-date, with copper and zinc prices both up by around 10% and aluminium about 9% higher. The price action of the past few months has prompted the broker to review its expectations for base metal markets.

In aluminium, Goldman Sachs has been forecasting global consumption growth this year of 4.4%, down from 9.3% in 2011, and remains very comfortable with this estimate. Data for the quarter to date is supportive, showing growth of 4.2% despite the issues in the European economy.

Copper remains the strongest of the base metals but Goldman Sachs cautions there are some potentially misleading signals in the market at present with respect to the strength of demand in different regional markets.

Record copper imports into China in recent months have boosted apparent consumption but Goldman Sachs suggests recent data elsewhere suggest semis producers in that market are operating well below capacity at present.

Outside of China the falls in LME stocks and higher premiums in markets such as North America suggest demand is healthier than Goldman Sachs believes, particularly as the fall in LME stocks has been more than offset by increases in SFE inventories. Given this, the broker continues to forecast full year copper consumption growth of 2.3%.

In nickel, Goldman Sachs continues to forecast global consumption growth of 3.4%. China will be the driver of the increase, while other markets are likely to record small single digit falls. In recent weeks falling prices have deterred buyers from building inventory ahead of traditionally stronger seasonal demand according to Goldman Sachs.

While US zinc consumption is quite strong at present, European consumption is lower and Chinese consumption is little changed. Based on these figures Goldman Sachs continues to expect global zinc consumption growth this year of 2.9%.

Further on copper, BA Merrill Lynch has examined the market and key growth projects in particular to assess which add production tonnes and which also add value to the company involved. Such analysis suggests many of the world's best emerging projects are outside of the Australian copper sector, with the DeGrussa project of Sandfire Resources ((SFR)) an exception.

Projects such as Oyu Tolgoi, Cadia East and Wafi-Golpu add the most value for every copper tonne produced, while projects such as the Olympic Dam expansion and PanAust's ((PNA)) Phonsavan and Inca de Oro projects appear less attractive.

When measured by return on capex the DeGrussa project ranks quite highly, followed by Oyu Tolgoi, Golpu and Cadia East. Under such a measure BA-ML notes the Olympic Dam expansion generates among the lowest returns. DeGrussa also screens highly in terms of risk and return, followed by Golpu and Oyu Tolgoi. Olympic Dam screens the worst on this measure. 

As BA-ML notes, the key takeaway is the Australian market lacks tier-1 pure play copper options, as while DeGrussa screens well, the project is relatively small and is being fully priced by the market. While PanAust is viewed as a growth play, BA-ML argues this is due more to an increase in tonnage rather than an increase in value from new projects.

Among smaller projects, the Carrapateena project of Oz Minerals ((OZL)) screens well on most metrics according to BA-ML. Value per tonne of ore in the ground and net present value of production screens give particularly positive results, while the project also screens well on a cash cost basis.

In terms of Australia's listed copper plays, BA-ML suggests the Carrapateena project is being priced in as a free option for Oz Minerals at current levels, while for PanAust the recent fall in share price has not changed the view the stock remains relatively fully priced. Sandfire is also fully priced and needs find another deposit, while country risk continues to impact on market value for Intrepid Mines ((IAU)). 

In the bulks, Goldman Sachs suggests following a decline of almost 40% relative to year ago levels given concerns of lower Chinese steel production this year, met coal prices appear to have found a support level around US$210 per tonne for premium grade material.

Goldman Sachs has a neutral view on the outlook for the met coal price, suggesting while downside risk from current levels is limited there needs be a significant change in the outlook for steel production and/or a significant supply disruption for prices to climb substantially higher.

A dispute between BHP Mitsubishi Alliance (BMA) and the unions is another factor that could impact on supply, largely as Goldman Sachs notes BMA is the significant player in the seaborne market given it producers about 18% of such supply.

Given the dispute appears to be based on questions of principle rather than issues of remuneration, Goldman Sachs sees potential for the dispute to linger, so triggering further supply disruptions. Such an outcome could influence market sentiment in coming months.

Finally, National Australia Bank has updated its commodity market views to account for February market activity. The bank notes prices increased by 3.5% for the month, but remain 19% lower than was the case at the same time last year. 

While prices have held most of their gains since the start of the year there has been some pressure in recent weeks from Chinese growth concerns. As NAB notes, near-term there continue to be concerns emerging market demand won't be enough to offset supply increases, though longer-term the scenario appears more positive.

In copper, NAB suggests despite some weakness in China's property sector and slowing industrial activity global supply conditions should remain tight. There should be some similar headwinds for the nickel market in coming months.

Base metals less tied in with construction could face fewer headwinds in the view of NAB, but slowing Asian economies and moderate global growth should limit the extent of any price upside. NAB expects relatively favourable conditions should support base metal prices close to or a little below current levels, so the bank continues to forecast an 8% increase in the NAB Base Metals Price Index in the March quarter and a 7% increase for 2012 overall.

In the oil market, NAB notes prices remain steady as the market continues to be balanced by ongoing geopolitical tensions and weak demand. While the US market has weakened Asian markets are still very tight, so while prices may ease any falls are unlikely to be significant in the bank's view.

One point made by NAB is managed money remains long oil, so any easing in the situation in Iran or any release of emergency stocks could generate a significant sell-off given the former alone is likely adding a US$10-$15 per barrel premium to prices at present.

In general, NAB expects the global oil market will remain tight this year despite the weak macro environment. This suggests while prices are likely to ease from current levels they should remain above US$100 per barrel (WTI) over the course of the year.

 

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