Material Matters: More Revisions To Commodity Price Forecasts

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– Citi sees mixed outlook for commodity prices in September quarter
– Brokers make further revisions to commodity price forecasts
– Implications for Australian resource company earnings, ratings

By Chris Shaw

With the September quarter of 2012 a couple of weeks old Citi has updated its expectations for commodity markets in the coming months, its analysis suggesting performance is likely to be mixed across sectors.

Energy prices are expected to rally in the quarter as the market has passed its weakest part of the year and as market fundamentals improve. Also supportive to prices in Citi's view would be any reawakening by the market to supply risks posed by the current stand-off with Iran. Demand growth for oil is expected to be weak and this trend is seen as continuing into 2013.

In the base metals, Citi sees a weaker demand outlook in the September quarter as physical markets reflect current uncertainty in financial markets. Supply expectations for the December half continue to increase and, when added to the EU crisis, should be enough for prices to move lower in the short-term. Medium-term a transition to later cycle commodities is expected, something that should benefit base and precious metals relative to the bulks.

Steel related markets are also expected to come under pressure in coming months given seasonally weak conditions in China just as the supply side recovers from recent disruptions. While cost pressures should contain market surpluses, Citi suggests any price upside will be reliant on a growth rebound in China.

In terms of price forecasts, Citi's oil price expectations are for Brent crude prices of US$105 per barrel in 0-3 months and US$100 per barrel in 6-12 months. Quarterly prices remains at US$120 per barrel for the September quarter, US$105 per barrel for December and US$99 per barrel in 2013.

Base metal price forecasts have been cut by 5-10% on average for 2013-2014, the smallest downgrades in nickel and copper and the largest in aluminium. Precious metals price forecasts with the exception of silver have also been downgraded, silver enjoying an average upgrade of around 7% and palladium and rhodium forecasts cut by just over 25% on average.

In terms of an order of preference, Citi's conviction calls are palladium, nickel and gold on the bullish side and copper and zinc on short-term bearish calls. The bearish view on copper stems from Citi's assertion upside for the metal rests on the assumption China will re-introduce targeted stimulus policies. As Citi notes, the Chinese government has repeatedly rejected such moves, which suggests Chinese copper consumption growth will slow to around 5.4% this year.

For zinc, the combination of continued evidence of oversupply and no major targeted stimulus measures in China leads Citi to suggest the market will find it difficult to generate any positive momentum in coming months. 

Following a review JP Morgan has cut iron ore price forecasts by 4-10% through 2014. The changes reflect weaker demand for steel and raw materials and leaves price forecasts at US$138 per tonne this year, US$135 per tonne in 2013 and US$120 per tonne in 2014. The long-term forecast of a price of US$80 per tonne is unchanged.

Near-term JP Morgan sees price risk as to the downside, though this is likely to be short lived as some stability in near-term growth and a pick up in Chinese investments are likely to see prices move higher in the final months of this year.

The changes in iron ore price forecasts, along with updated foreign exchange assumptions, have impacted on earnings forecasts for the Australian producers. For the mid-cap stocks under coverage – Aquila Resources ((AQA)), Atlas Iron ((AGO)), Gindalbie ((GBG)), Grange Resources ((GRR)) and Mount Gibson ((MGX)), earnings estimates have been reduced in general by 20-30%. 

The effect is net present value-based valuations have fallen 15-25%, while price targets have also been reduced in all cases.

In JP Morgan's view, consensus earnings forecasts for these stocks are now significantly too high. While this could mean the broker's revised iron ore forecasts are too conservative, more likely in the view of JP Morgan is others in the market will need to follow suit and cut earnings estimates for these companies.

The changes to its models have seen JP Morgan revise some ratings among the companies in question. Atlas has been upgraded to an Overweight rating and joins Grange as a preferred exposure. Mount Gibson has been downgraded to a Neutral rating following recent outperformance relative to peers, while Gindalbie has been downgraded to Underweight from Neutral. Aquila continues to be rated as Neutral by JP Morgan.

By way of comparison, Sentiment Indicator readings for the Australian mid-cap iron ore plays according to the FNArena database are 0.8 for Atlas and Grange, 0.6 for Gindalbie, 0.4 for Mount Gibson and 0.0 for Aquila.

While iron ore price forecasts are moving lower, Goldman Sachs continues to rate it as one of its top picks in the bulk commodities sector along with thermal coal. The attraction in both cases is cost support from high cost domestic producers in China for the former and marginal producers in Australia, Indonesia, Russia and the US for the latter.

I the medium term, this supports the Goldman Sachs view price risk for both commodities remains skewed to the upside. For thermal coal, which has been the worst performed of the bulk commodities this year in delivering a 23% fall in the Newcastle index, Goldman Sachs sees a challenging couple of months prior to a recovery in the December quarter of this year and into 2013. The recovery is based on the expectation of a supply response to lower prices and incremental demand from China.

Credit Suisse is less bullish on the coal price outlook and has revised near-term price forecasts lower, this while suggesting at current levels a floor is likely in sight for the thermal coal price. The latest changes to the broker's estimates have been significant, with thermal coal forecasts cut 11-20% in 2013-2015 and hard coking coal estimates reduced by 12-15% for the same period.

As with JP Morgan's changes to iron ore price assumptions, the coal price adjustments put through by Credit Suisse impact on earnings estimates across the sector. On average, earnings forecasts for the producers for FY13 have been cut by 45%, while FY14 estimates decline by an average of 36%.

This has resulted in cuts to price targets across the board, though Credit Suisse continues to see value in the sector and rates all the stocks under coverage as Outperform. This reflects attractive valuations, as on average the sector is trading at 0.48 times on a price/discounted cash flow valuation basis. As part of its review Credit Suisse has upgrade New Hope Corporation ((NHC)) from a previous rating of Neutral.

Factoring in ratings from other brokers in the FNArena database, Sentiment Indicator readings for the Australian coal plays stand at 1.0 for Whitehaven ((WHC)), Bathurst Resources ((BTU)), Bandanna Energy ((BND)), Cockatoo Coal (COK)), Stanmore Coal ((SMR)) and Tigers Realm Coal ((TIG)), 0.5 for New Hope and 0.3 for Yancoal ((YAL)). 

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