Commodities | May 07 2012
This story features RIO TINTO LIMITED. For more info SHARE ANALYSIS: RIO
– Scope for squeeze in resource shares
– Miners and capex
– Precious metal updates
– Aluminium likely to underperform
– NAB updates forecasts
By Chris Shaw
Standard Chartered notes while investors remain negative on the resources space at present, too much focus is being applied to the sluggish Chinese economy. The bearish China trade is now a crowded one and with the June quarter likely to be the low before some strengthening into the second half of this year, there appears scope for a squeeze in resource shares in coming months.
This also reflects the fact equities typically move well ahead of the fundamentals, which supports Standard Chartered's view investors should now be looking to get involved in the big-cap mining space ahead of a bounce in the next couple of months.
In Standard Chartered's view China A shares are a good leading indicator of resource stocks, as investors in this market appear to have a better read of the Chinese economy than do other markets. With the China A market enjoying a strong run over the last week it adds weight to the view now may be time for investors to again look at resource stocks.
From an Australian perspective, Rio Tinto ((RIO)) remains among Standard Chartered's top picks for playing a more positive outlook for commodities. On the broker's numbers Rio Tinto is trading on an earnings multiple of around seven times for this year, this despite the imminent delivery of two high quality projects in Oyu Tolgoi in Mongolia and Pilbara iron ore expansions.
There are other reasons to be positive, as Standard Chartered suggests Rio Tinto's iron ore expansion plans are easier than the plans of BHP Billiton ((BHP)), while a strong balance sheet should allow Rio Tinto to be active in M&A markets and to boost shareholder returns. Standard Chartered has Outperform ratings on both Rio Tinto and BHP.
One issue identified by Standard Chartered was the level of capex plans in the iron ore sector, where cost pressures are becoming more significant. As an example, BHP's outer harbor expansion is now set to cost US$22 billion, up from a initial estimate of US$5 billion.
BA Merrill Lynch also noted this, pointing out both BHP and Rio Tinto last week guided the market to a future of greater scrutiny with respect to future capex intentions. BHP has indicated it will slow down and stagger mega-projects, meaning capital will be rationed and centred on key investment basins.
If Australian capex plans were to be cut across the sector, there would potentially be funds freed up for capital management purposes in the view of BA-ML. Funds could also become available through non-core asset divestments, with both BHP and Rio Tinto already starting the process of disposing of such assets.
In terms of current capex plans, BA-ML notes BHP has 22 major projects in execution with committed spend of US$27 billion, while Rio Tinto plans to spend US$20.6 billion through the end of 2015. BA-ML rates BHP as Neutral and Rio Tinto as a Buy.
Morgan Stanley has extended the capex cut analysis across the sector, noting earnings growth for resource companies is becoming more expensive thanks to ongoing cost inflation. This increase in costs suggests mining capex will plateau, Morgan Stanley arguing capex for the sector will be below current market forecasts in both 2012 and 2013.
In the precious metals, the Shanghai Futures Exchange this week begins trading silver contracts and Chinese commentators expect the contract will do well given a cheaper minimum purchase value than gold.
While the introduction of the contract could mean additional investment demand for silver, there is also scope for increased interest from Chinese corporates looking to invest in silver projects and companies abroad.
As Standard Bank noted earlier this year, China has very large silver stockpiles and so little need for physical silver today. This means such investment would be about meeting demand requirements in coming years. While the new contract may make the market more liquid, silver remains a volatile commodity and this is not likely to change as a result of the new contract and increased trading in China.
In gold, Standard Bank remains positive on the metal despite current price weakness. Supportive conditions remain, including low long-term interest rates and global liquidity growth.
As well, Standard Bank notes the US Taylor Rule, which gives an indication of where the Fed funds rate should be relative to US unemployment and inflation, is signalling rates may be too low at present. If the Fed were to keep rates lower than what is suggested by the Taylor Rule, the bullish case for gold would remain intact in the bank's view.
While seeing gold as on course to record another record annual average price this year, RBS expects prices will decline thereafter. This opens the way for platinum and palladium to become the outperformers of the precious metals sector.
For gold, RBS expects world mine supply will increase 3% this year to 2,900 tonnes, with further increases to bring supply to 3,050 tonnes by 2015. Central bank buying should continue and help push average annual price for 2012 of US$1,725 per ounce, a cut of US$25 per ounce from RBS's previous forecast.
This would be a fresh annual record price for gold and mark the 11st straight year of annual price gains. RBS expects prices will fall from 2013-2015. At the same time platinum is forecast to regain its traditional price premium to gold, which compares to a current discount of around US$100 per ounce.
By next year RBS expects platinum will re-establish a premium to gold of around US$275 per ounce, so opening up the opportunity to trade this price spread. RBS's platinum forecasts stand at US$1,650 per ounce this year, before an increase to US$1,900 per ounce in 2013.
While a premium to gold should be re-established the platinum market is forecast to remain in a structural supply surplus, leading RBS to suggest platinum will be outpaced by palladium in coming years.
This reflects the fact the palladium market needs Russian stockpile disposals to fill in supply shortfalls, as without such sales the market is forecast to be in structural supply deficit of 175,000 ounces this year, more than 400,000 ounces in 2013 and more than 500,000 ounces in both 2014 and 2015.
This sets the stage for price gains in the view of RBS, the broker forecasting average prices of US$725 per ounce this year before a more than 20% increase to US$875 per ounce in 2013 and more than US$1,000 per ounce by 2015.
Among the base metals, Morgan Stanley argues the current oversupply in the global aluminium market won't fall until producers drastically cut output levels. This is unlikely to happen in China, where most aluminium smelters remain profitable on the broker's estimates when prices are compared to the domestic SHFE price. This price is more relevant in the broker's view as it is this price most Chinese producers will receive.
Rather, it is likely to come from the nearly three million tonnes of capacity elsewhere in the world Morgan Stanley has identified as being on the brink or currently unprofitable at current price levels. Significant cuts are necessary as Morgan Stanley notes at times over the past three years the persistent global market surplus in aluminium has totalled as much as 2-3 million tonnes.
This has made aluminium one of the worst performed of the base metals so far this year, a trend expected to continue given the current level of excess supply on the market.
On a final note, National Australia Bank has updated its commodity market views to reflect changes to market conditions in April. In the bulks NAB notes the market remained mixed, iron ore prices drifting higher but coal prices softening during the month.
There continues to be uncertainty stemming from the issues in Europe, while the slowing in the Chinese economy has also acted as a headwind for prices in NAB's view. Chinese re-stocking and bad weather helped support iron ore prices last month but NAB suggests there needs be stronger end-user demand to sustain presently bullish market conditions. Iron ore price forecasts have been revised slightly higher near-term, but NAB remains of the view prices will decline as supply constraints are resolved and sluggish demand persists.
Coal prices have been driven lower by moderate demand but NAB sees scope for demand to improve in coming months. Prior to this there remains some downside risk for prices, but not enough for the bank to adjust coal price estimates.
In quarterly average price terms NAB expects hard coking coal prices will range between US$210 and US$215 per tonne through the September quarter of next year, while thermal coal prices are expected to be steady at US$115 per tonne over the same period and semi-soft coking coal is forecast to range between US$160-$165 per tonne through September 2013. From prices of US$135 per tonne now, NAB expects iron ore prices will weaken to US$120 per tonne by the September quarter of next year.
NAB notes physical demand for gold has continued to soften over the past month, while price weakness has also reflected reduced expectations for further policy easing by central banks. As the outlook for the global economy strengthens the upside risks for gold are expected to dissipate in NAB's view, leading to a forecast for an average price in the June quarter of US $1,630 per ounce in the June quarter.
Prices should continue to weaken in subsequent quarters, with NAB forecasting quarterly average prices of US$1,550 per ounce in September and US$1,500 per ounce in December of this year, falling to US$1,420 per ounce by the June quarter of 2013.
In general, NAB expects movements in non-rural commodity prices will continue to be volatile as events play out in the macro environment. Longer-term prices should soften but NAB expects prices will remain elevated relative to historical levels.
In US dollar terms the NAB non-rural commodity price index is forecast to fall by around 6% this year and a further 5% in 2013. In Australian dollar terms this implies a similar fall of 6% this year but a gain of 1% in 2013.
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