Material Matters: Global Gold Survey, Copper, And Bulk Updates

This story features RIO TINTO LIMITED, and other companies. For more info SHARE ANALYSIS: RIO

 – Commodity price forecasts revised
 – Earnings, price targets and ratings adjusted accordingly
 – Fall in Chinese copper imports in June not bearish
 – JP Morgan reveals results of latest gold survey
 – Chinese demand concerns for bulks overdone

By Chris Shaw

As Credit Suisse points out, changes in broad measures of commodity prices are essentially a function of global economic growth. As a base measure, average global growth of 3.5% has historically been matched by broadly flat real commodity prices.

The correlation with economic growth has played havoc with commodity prices in recent months, as the European sovereign debt crisis has impacted on the global growth outlook and caused commodity prices to overshoot to the downside. 

A subsequent relief rally in recent weeks now appears mostly complete, leading Credit Suisse to suggest the next move in prices is again likely to be driven by global growth developments. With the pace of economic growth likely to remain subdued in coming months, the broker suggests the balance of near-term risks for industrial metals remains to the downside.

By the northern autumn conditions should have improved enough to allow prices to gradually move higher, a trend Credit Suisse expects will continue into 2013. Such an outlook remains contingent on a period of relative stability in Europe, as another episode or episodes of market panic centred on the issues of Europe could interrupt a recovery.

Longer-term the view of Credit Suisse is the prospect of a return to 4.5-5.0% global growth has diminished significantly. This implies while commodity prices should remain at elevated levels in historical terms, it is likely many prices have peaked for this cycle.

Under such a basis Credit Suisse has adjusted commodity price forecasts. Among the largest revision has been oil price expectations, the broker cutting its numbers for Brent crude to an average of US$95 per barrel in the final quarter of this year, rising to US$105 per barrel in the final quarter of 2013.

A more modest cut has been made to Credit Suisse's iron ore price forecasts, with the expectation for prices to broadly continue in the recent range of US$130-$150 per tonne through the second quarter of next year. Beyond that, additional supply is expected to weigh on prices.

Coal price forecasts have also been reduced, with met coal expectations trimmed to an average of US$210 per tonne through 2013 and thermal coal forecasts cut more significantly to reflect a lack of supply discipline in the market. 

While gold and silver forecasts have been reduced modestly, Credit Suisse has made more substantial cuts to base metal forecasts. Here estimates have been reduced by 8-16% this year and by 8-20% in 2013, compared to cuts of 5-10% for gold and silver price forecasts over the same period.

The changes to Credit Suisse's forecasts for commodity prices have impacted on ratings for diversified resource stocks, as the broker has downgraded BHP Billiton ((BHP)) to Neutral from Outperform as a result. Rio Tinto ((RIO)) remains preferred and continues to be rated as Outperform given a more attractive market positioning at present. In both cases earnings estimates and price targets have been reduced, while adjustments have also been put through to earnings forecasts, price targets and in some cases ratings among resource stocks under coverage.

Credit Suisse has made similar changes to its oil sector expectations, with both Santos ((STO)) and Caltex ((CTX)) being downgraded to Neutral ratings from Outperform previously. For Santos the change reflects additional concerns with respect to the GLNG project and the need to accelerate significant capex. 

To reflect this, the full life cycle value of the project has been removed from its model, which sees Credit Suisse cut its target on the stock to $11.80 from $12.00. For Caltex the refinery review remains the key potential catalyst but a positive outcome may take some time to be fully reflected in group earnings and closure costs assuming such a decision is made. 

Key picks in the energy sector for Credit Suisse remain Oil Search ((OSH)) and Aurora Oil and Gas ((AUT)), while the broker also rates as Outperform Woodside ((WPL)) and Origin Energy ((ORG)). Among the smaller caps Credit Suisse also rates Karoon ((KAR)), Australian Worldwide Exploration ((AWE)), Molopo ((MPO)) and Tap Oil ((TAP)) as Outperform. 

UBS is also cautious on the commodity price outlook, this given capital continues to flow out of emerging markets and liquidity continues to tighten, which is impacting on commodity demand. To reflect this UBS has trimmed forecasts across the base and precious metals and the bulks, largely by way of marking-to-market its models. 

In terms of market positioning, UBS's key call now is to buy gold/sell copper on a 3-6 month view, while looking to buy oil/sell copper on a 3-year view. The former reflects the expectation investors will buy gold earlier than copper, while the latter is based on the view copper prices will return to the metal's cost curve, which is around 20% lower, as the market moves to a surplus in 2014.

Unlike Credit Suisse, UBS continues to list BHP Billiton as one of its most preferred commodity exposures, attracted to both the group's diversified asset base and exposure to the oil market. 

As with UBS, BA Merrill Lynch has marked-to-market commodity prices for the end of the June quarter. The largest impacts are in aluminium, where forecasts for this year are cut 12% to US$2,076 per tonne and in thermal coal, where forecasts have declined 8% to US$98 per tonne for this year. 

In contrast, copper price forecasts have declined by just under 3% given the market remains in deficit.

Factoring in the changes has resulted in adjustments to earnings estimates and price targets for resource stocks under coverage by BA-ML. Target price cuts of 15-20% for the diversifieds and iron ore plays have been the among the largest, while targets for base metal stocks have also come down by between 10-25%.

Chinese copper imports fell in June but as this was expected Macquarie suggests the numbers are not bearish for the price of the metal. The decline for the month was likely due to the negative LME/SHFE arbitrage in place through 2Q12, while Macquarie notes the fall comes on the back of higher than expected copper imports in May.

In the precious metals, a survey of investors by JP Morgan revealed US$2,000 per ounce was the favoured long-term price expectation for the metal. Expectations ranged from a long-term average of US$500 per ounce to as high as US$10,000 per ounce.

Within the survey, JP Morgan notes 71% of respondents expect gold will rise over the next 12 months, though this falls to 65% if the timeline is extended to three years. A slight majority expect gold equities will outperform the metal price in the coming year, up from 42% with such a view last December.

Among those responding, the preference remains for dividends over growth when it comes to gold mining companies allocating free cash flow. On average, JP Morgan notes investors want 42% of free cash flow to go in dividends, 40% towards growth and 15% on share buybacks. 

A majority of investors involved in the survey continue to see changes in interest rates as the biggest risk to long gold bullion investors, while just under 25% are most concerned about changes in central bank reserve policies.

Turning to the bulks, Goldman Sachs notes spot prices for iron ore, metallurgical coal and thermal coal are down year-to-date by 2%, 2% and 21% respectively. This reflects a softening in spot demand for steel raw materials and a growing preference for gas-fired power.

In the view of Goldman Sachs, negative commentary with respect to Chinese demand for the bulks is overdone, as year-to-date commodity imports remain strong relative to 2011. While a short-term pick-up in Chinese demand is unlikely, downside risk is also limited according to Goldman Sachs. This leads to the suggestion the glass is likely half-full rather than half-empty.

 
Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

Click to view our Glossary of Financial Terms