Commodities | Apr 05 2012
This story features OZ MINERALS LIMITED, and other companies. For more info SHARE ANALYSIS: OZL
– Commodity prices not reflective of weak demand
– Markets searching for direction, further volatility expected
– June quarter seasonally positive for commodities
– NAB, Morgan Stanley update price expectations
– Deutsche Bank revises earnings and ratings for the sector
By Chris Shaw
Standard Bank has reviewed commodity price performance for the March quarter, taking the view prices in the period were not reflective of weak real demand conditions faced by most commodities.
As evidence, Standard Bank notes data from China continues to point to a slowing down of the major components of commodity demand – construction, manufacturing and exports. At the same time not much is expected from Europe in coming months, while the US recovery remains fragile at best.
Over the first quarter, net speculative length grew for most commodities reflecting the fact it has been investor interest driving commodity prices in recent weeks. This leads Standard Bank to suggest there remains downside risk for metal prices, so the advice for investors is to avoid any market euphoria.
While Europe's debt crisis is looking more under control and the gradual recovery in the US economy is bolstering market confidence, National Australia Bank expects further volatility in non-rural commodity prices in coming months.
This reflects a still uncertain global economic growth outlook, as the euro-zone appears to have entered a recession and there have been clear signs of slowing in big emerging economies such as China. This leads NAB to suggest there is little upside risk to commodity prices over the medium-term.
In oil, NAB suggests the market appears to be searching for direction at present. While supply concerns are holding up the market, global demand continues to weaken as the outlook for emerging economies in particular turns more uncertain.
While on balance NAB expects oil prices will ease from current levels, the market should remain relatively tight. Even is the Iran situation eases and oil prices fall US$10-15 per barrel, NAB still sees prices only falling to levels around US$110 (Brent) per barrel over the next six months or so.
The downside risks to base metals demand is slightly more elevated than previously thought in NAB's view, so price expectations have been revised slightly lower. While supply demand conditions are expected to loosen in coming quarters the bank sees fundamentals as solid enough to support prices at elevated levels relative to history.
In the gold market NAB suggests the recent price decline reflects a strengthening in the outlook for the US economy, as investors have moved money elsewhere as a result. Volatility in the US dollar and financial markets should continue to influence the gold price, with the price expected to moderate as general economic uncertainty dissipates and the US economic recovery picks up momentum.
NAB expects the gold price will ease from a forecast of US$1,620 per ounce in the June quarter to US$1,500 per ounce in the December quarter. Prices should decline further to US$1,300 per ounce in the March quarter of 2014 in the bank's view.
In the bulk commodities, National Australia Bank notes prices have been mixed, coal suffering from concerns over slowing Chinese demand while iron ore prices have tracked higher. Downside risk to the outlook for bulks stems from the potential for deeper problems in Europe in the bank's view.
Despite this, NAB suggests fundamentals for the bulks remain sufficiently strong to support elevated prices over the forecast horizon of the next few years. Chinese growth should remain at relatively brisk levels, meaning demand for raw materials should stay solid and sustain relatively elevated prices.
World Steel Association data indicates global steel production has risen slightly year-to-date, this despite a softening in Chinese demand for steel producing raw materials. There remains scope for policy easing in China near-term and this should prove supportive, while improving profitability in steel production should also be supportive in NAB's view.
Re-stocking in the iron ore market appears to be coming to an end, leading NAB to suggest there is little upside to current price levels. Elevated stockpiles suggest some price declines in coming quarters, but with the market largely balanced the bank expects prices will remain around current levels.
In general, NAB expects bulk commodity prices will remain largely unchanged in coming quarters, though the risks are now more heavily weighted to the downside. For iron ore NAB expects quarterly contract prices of US$130 per tonne for the June and September quarters and US$125 per tonne in the December quarter of this year. Prices should settle at US$120 per tonne through 2013 in the bank's view.
For hard coking coal prices are forecast to trade in a range of US$205-$215 per tonne through the end of next year, while semi-soft coking coal is expected to range from US$155-$165 per tonne for the same period. Quarterly thermal coal forecasts stand at US$115 per tonne through to the end of December next year.
In US dollar terms the bank's non-rural commodity price index is forecast to fall by about 8% over the course of this year before a further fall of 3.25% in 2013. In Australian dollar terms prices are forecast to fall by about 8% this year before a gain of 3% next year.
Taking a shorter-term view, Barclays Capital note commodities tend to be a standout performer in the June quarter given average price gains almost across the board. Copper and natural gas are the biggest winners, delivering median returns for the quarter of 1.23% and 2.99% respectively.
Silver is the clear loser in the period and is the only commodity asset on the list of Barclays that delivers both negative mean and median returns. Barclays gives silver just a 42% chance of price gains in the June quarter, which compares to odds of an advance for gold of more than 53%.
Morgan Stanley has also reviewed commodity markets post the March quarter and for oil suggest barring a supply shock upside is limited from current levels. This reflects both weak demand and the scope for increased production as OPEC producers in particular take advantage of high prices.
Price risk is skewed to the downside in the view of Morgan Stanley, particularly if outages are resolved, geopolitical tensions ease or special reserves are released. Similarly, natural gas prices are expected to remain under pressure until the market can work through what is currently a significant level of excess supply.
Morgan Stanley remains bullish on gold given an expectation of a further round of quantitative easing in the US later this year and constrained new gold supply. Prices for the metal are forecast to rise through the final quarter of 2013, Morgan Stanley expecting prices will push through the US$2,000 per ounce level over the course of next year.
Silver prices should remain volatile as traditional links to gold prices come under increasing pressure but Morgan Stanley expects recent price weakness should attract bargain hunters to the metal. A lengthy period of negative real interest rates in the US should reignite investment demand, leading to the expectation prices will rise through the end of next year. The silver price is expected to trade above US$40 per ounce through 2013.
Morgan Stanley has turned less positive towards aluminium given a large supply overhang and the ongoing growth in Chinese smelting capacity. Chinese production growth will need to slow to bring the market back to a balance and as this process is likely to take some time, price growth expectations are modest. Forecasts call for a 2012 price of US$1.02 per pound, rising to US$1.11 per pound in 2013.
Copper remains the preferred base metal of Morgan Stanley, a reflection of the expectation prices will remain elevated until the global inventory pipeline can be replenished. Continued production losses suggest the market will not be in balance this year, which supports price expectations of US$3.70 per pound this year and US$4.10 per pound in 2013.
Nickel's price outlook is linked to the success of four major laterite nickel projects starting-up this year and the ramp-up of two conventional feedstock projects in the view of Morgan Stanley, so prices could fall if the market does return to a significant surplus. Forecasts stand at US$9.00 per pound this year and US$9.89 per pound in 2013.
Market fundamentals are worst in zinc as an oversupply situation remains, Morgan Stanley not expecting any relief prior to 2013 at the earliest. Zinc prices are forecast to rise only slightly, forecasts standing at US$0.91 per pound this year and US$1.00 per pound in 2013.
Also assessing the outlook for the remainder of this year, Deutsche Bank expects Chinese de-stocking and lower physical demand should result in weaker prices in the second quarter of the year. A rebound in Chinese growth should support price gains in the second half of 2012.
This supports Deutsche's view the sector remains compelling value, as prices at current levels are not pricing in an extended commodities cycle. At current levels the sector is trading on 10.4 times 2012 earnings and 8.6 times 2013 earnings, which implies a buying opportunity according to Deutsche.
Changes to price forecasts have seen Deutsche revise earnings estimates across the sector, the largest changes coming in the bulks sector where prices have been revised down by an average of 10% this year and 5% in 2013. Prices are expected to rise in the gold, nickel, iron ore titanium oxide markets.
Factoring in revised commodity price forecasts, Deutsche has adjusted its earnings estimates and price targets across the sector. The changes have resulted in a number of rating changes, though only Oz Minerals ((OZL)) has been upgraded to Buy from Neutral. Iluka ((ILU)), Sandfire ((SFR)), Fortescue ((FMG)) and Paladin ((PDN)) have all been downgraded to Neutral ratings from Buys previously.
Deutsche's top sector picks are Rio Tinto ((RIO)) and BHP Billiton ((BHP)) among the diversifieds given attractive valuations and growth options, and PanAust ((PNA)), Alacer Gold ((AQG)), Medusa Mining ((MML)) and Western Areas ((WSA)) among the more specific plays.
Alacer is oversold on Australian asset concerns in the view of Deutsche, Medusa has been oversold on the back of a recent production downgrade, PanAust offers strong production growth and upside from the commissioning of Ban Houayxai, while Western Areas should deliver on an expansion of its plant and positive exploration results.
Other Buys in the view of Deutsche Bank are Alumina ((AWC)), Aquarius Platinum ((AQP)), Independence Group ((IGO)), Lynas Corporation ((LYC)), Mount Gibson ((MGX)), Newcrest Mining ((NCM)), Regis Resources ((RRL)) and Whitehaven Coal ((WHC)).
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CHARTS
For more info SHARE ANALYSIS: AWC - ALUMINA LIMITED
For more info SHARE ANALYSIS: BHP - BHP GROUP LIMITED
For more info SHARE ANALYSIS: FMG - FORTESCUE LIMITED
For more info SHARE ANALYSIS: IGO - IGO LIMITED
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For more info SHARE ANALYSIS: LYC - LYNAS RARE EARTHS LIMITED
For more info SHARE ANALYSIS: MGX - MOUNT GIBSON IRON LIMITED
For more info SHARE ANALYSIS: NCM - NEWCREST MINING LIMITED
For more info SHARE ANALYSIS: OZL - OZ MINERALS LIMITED
For more info SHARE ANALYSIS: PDN - PALADIN ENERGY LIMITED
For more info SHARE ANALYSIS: RIO - RIO TINTO LIMITED
For more info SHARE ANALYSIS: RRL - REGIS RESOURCES LIMITED
For more info SHARE ANALYSIS: SFR - SANDFIRE RESOURCES LIMITED
For more info SHARE ANALYSIS: WHC - WHITEHAVEN COAL LIMITED