Commodities | Apr 23 2012
– Slower Chinese growth outlook makes another super cycle unlikely
– Regulatory risks remain in oil market
– Aluminium market updates
– Steel market to remain under pressure
– Macquarie positive on precious metals
By Chris Shaw
The last three revisions of the International Monetary Fund's (IMF) World Economic Outlook has seen Chinese GDP growth forecasts revised lower. As Commonwealth Bank notes, GDP growth in 2016 was forecast at 8.6% in the April Outlook, which is down from 9.5% in April of last year.
This downward trend is consistent with the message from the Chinese government that the rate of growth in China will slow as the nation moves away from exports and towards consumption.
In the view of Commonwealth Bank this has implications for commodity demand, as it suggests the market is unlikely to enter another 'super cycle' of very strong demand and price growth. In line with the IMF's forecasts, CBA expects China's commodity demand growth will moderate in the medium-term.
Despite this, the base effect is now large enough that lower annual growth from the current base still equates to significant incremental requirements in terms of annual tonnage. The supply side will continue to be challenged to meet this demand in the medium-term in the bank's view, which means historically high commodity prices should persist for some time to come.
According to Barclays Capital, oil market volatility is now at its lowest level since 1995, which suggests the market is looking away from the centre of the political radar despite this being a US election year.
Recent comments from President Obama suggest politicians are now more direct about oil market interventions, but Barclays notes current low market volatility suggests the incentive or justification for political interjections such as occurred in 2008 and 2009 is not present to the same extent in the current market.
Regulatory risk does remain a factor in the oil market in the view of Barclays, which is of concern given investment in the oil market continues to fall short of what is needed to balance the market at reasonable prices.
This leads Barclays to suggest regulators are choosing a short-term and politically convenient approach to deal with what is a rather than more complicated set of longer-term physical issues. This runs the risk of resulting in increased volatility and higher prices.
Across in the base metals, Macquarie notes the recent strength in aluminium premiums is having an impact on where prices stand relative to the cost curve of the industry. The premium for base metals, such as aluminium, is the price a buyer will pay above the exchange price for physical delivery of metal to a specific location.
As Macquarie points out, aluminium premiums are currently close to all time highs as while the industry has high stock levels, physical financing in LME warehouses has restricted access to these stocks. This has kept premiums elevated.
In Macquarie's view these high premiums are a red herring because in the current surplus, market premiums have a greater impact on the profitability of producers than any sign of physical tightness in the market. On the broker's numbers, prices are trading at the 65 percentile of the global cost curve at present, while adding in an 8% premium puts prices at the 85 percentile. This is 45 million tonnes on a cumulative tonne basis.
Further on aluminium, Citi notes smelting losses in the market have stabilised since the start of this year given modest production cuts in eastern China. If prices were to drop further the broker sees scope for further cuts to output among Chinese producers.
What could assist in delivering further production cuts are a lack of experienced workers and tight funding positions for some private smelters. Given smelter re-starts can take two to three months Citi sees scope for the current supply surplus in China to reduce shorter-term, especially if demand in that market is solid.
Any supply disruption or slower production ramp-up in Western China may boost aluminium prices the shorter-term in the view of Citi, as this market accounts for more than half of total Chinese output at present.
Still in China, Macquarie notes construction activity in that economy is rising, this due to ongoing strength in end user demand from both the construction and infrastructure sectors. This implies relatively good economic activity in general and suggests a hard landing is unlikely in Macquarie's view.
Recent data has offered some mixed signs for the steel market in Australia in particular. UBS notes while interim earnings from OneSteel ((OST)) showed weak steel performance the result was not as bad as forecast, while iron ore and mining consumerables were better than expected. At the same time, BlueScope's ((BSL)) earnings highlighted a weak domestic steel manufacturing environment.
Chinese steel production appears to be ramping up and UBS expects this trend should continue leading into the mid-year manufacturing peak. Such an outcome may mean some pricing pressure if there is no pick-up in steel demand and iron ore pricing strength.
For UBS the domestic outlook remains challenging thanks to weak construction activity, a strong Australian dollar and weak leading economic indicators. Given this the broker has made modest changes to earnings forecasts among the Australian steel plays, though only BlueScope's price target has been adjusted as a result.
UBS's target for BlueScope falls to $0.48 from $0.54 and the broker retains a Neutral rating. Both OneSteel and Sims ((SGM)) score Buy ratings, the former with a target of $1.50 and the latter with a target of $15.93.
Turning to the precious metals, Macquarie notes speculative long positions in the sector have returned to levels seen at the start of the year. To the broker this represents a good buying opportunity, with the investment case for the platinum group metals looking more interesting than for gold at present.
In palladium, Macquarie points out while US auto sales have been strengthening so too has Japanese auto production, leaving China as the main soft spot. Production growth in this market should improve in the June quarter and through the rest of the year and along with falling mine supply suggests the global call on the metal will increase in coming months. This is expected to boost prices.
In the platinum market Macquarie suggests concerns over European exposure have been overdone as this market is not the be all and end all of demand. As well, Macquarie takes the view demand doesn't need to be particularly strong when supply is falling, so the fundamental deficit in the market should be supportive for price gains.
The gold market is suffering from some apathy at present in the broker's view, while foreign exchange markets have also offered little direction of late. While gold prices should be more competitive relative to US real interest rates, Macquarie sees no obvious short-term catalysts to deliver such a scenario.
Technical limitations
If you are reading this story through a third party distribution channel and you cannot see charts included, we apologise, but technical limitations are to blame.
