Material Matters: Iron Ore, Gold, Copper and Nickel

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– iron ore prices are out of whack with fundamentals, short term
– analysts remain divided about how low prices will fall later in the year
– UBS assesses gold stocks in Australia
– JP Morgan anticipates continued rally for copper
– Deutsche Bank predicts a flat outlook for crude oil prices in 2013

By Andrew Nelson

2013 has been good for iron ore prices, at least so far, but the move from US$116/t at the end of November to around US$155/t as of today certainly raises a few questions. Can it last and if it does, what will be the impact?

Economists Adam Boyton and Phil Odonaghoe from Deutsche Bank’s Sydney office reckon that spot iron ore prices could rally as high as US$170/t in the weeks ahead. However, the pair also believes such an eventuality would only be an overshoot of the seaborne iron ore market, which would normalise once re-stocking in China slows and supply from Australia and Brazil begins to pick back up.

Deutsche thinks that the majority of the growth in 2013 won’t actually take place until the second half of the year. This fact, combined with your normal soft seasonality into mid-2013, has the broker thinking iron ore could be back under the US$120/t level sometime this half. Supporting this view is the fact that the run in iron ore has not been matched by an equivalent increase in either coking coal, or Chinese steel prices. In fact, looking at the chart for the past five years shows that iron ore price typically jumps around 15% in the first quarter of the year, before underperforming in the second, third and fourth quarters.

Q: What does that mean? A: Don’t expect to see US$154/t for that much longer.

The economists also point out Australia’s economic sensitivity to swings in bulk commodity prices, noting that were iron ore to remain in its current vicinity, the interest rate outlook from H2 onwards would be about lifting rates, not cutting them. This isn’t what Deutsche expects. What the broker does see happening is rates being held steady over the next few months before easing around mid-year on the back of falling iron ore prices and an otherwise sluggish domestic economy.

Analysts at Macquarie are also of the belief that iron ore is now running well ahead of fundamentals and is starting to look pretty rich when compared to scrap prices, or when considering the Chinese restock is about to lose steam.

But unlike the pair at Deutsche, analysts at Macquarie don’t believe prices will collapse. This is especially so given Chinese plans to significantly lift output over Q1, which means more Chinese domestic ore will be required than at any point last year. The broker predicts US$140/t will be the fair price for iron ore and further expects steel prices to outperform iron ore over the coming months.

So what about gold? Now there’s a question everyone would like an answer to. Once synonymous with risk hedge, analysts from UBS note recent global economic uncertainly has left gold with few discernible drivers.  And with the US debt ceiling and spending cuts still a long way from being decided, the broker expects the gold price to remain fairly subdued until these issues are resolved.

In the longer term, UBS believes that given there has been no real change to US monetary policy, the likelihood of balance sheet expansion will probably push the gold price higher. The broker notes there is a strong correlation between a rising US debt ceiling, the St Louis Fed adjusted monetary base and gold prices. While UBS admits the link between gold and real interest rates is also important, it points out there is an almost equally strong correlation between Chinese GDP per capita and gold.

In the sector, the broker likes solid growth projects as insulation against possible price drops. Perseus Mining ((PRU)), Beadell Resources ((BDR)), Endeavour ((EVR)), Regis Resources ((RRL)) and Newcrest ((NCM)) are preferred in that order. The broker also warns that while Alacer Gold ((AQG)) is also Buy rated, more clarity on growth plans is needed.

JP Morgan still likes copper and notes the high correlation to improving global industrial production trends, which remains supportive. The broker also notes there are still some significant supply/demand deficits, while rising incentive prices are also currently supportive of copper prices.

At the same time, the recent run of M&A activity has really shrunk the gene pool. Thus, while many believe  the currently strong copper outlook is already incorporated in most share prices, JPM believes higher quality names can still  perform well. PanAust ((PNA)) is the broker’s top domestic pick.

It’s worth noting that Credit Suisse has downgraded its nickel price forecasts now that supply is starting to normalise.  The price estimate went down 4% to US$8.19/lb for this year, down 14% in 2014 to US$7.82/lb and down 10% in 2015 to US$8.62/lb.

On the back of these lower nickel prices, the broker has trimmed EPS forecasts across the board for both FY14 and FY15. Pure plays Western Areas ((WSA)) and Mirabella Nickel ((MBN)) and high costs producer PanAust ((PAN)) were hardest hit. Of these three, the broker thinks that only PanAust now looks cheap, although this comes with plenty of risk given the company’s short reserve life and high production.

Switching to energy, analysts at Deutsche Bank have formulated a benign, but still positive view for the year ahead. Global economic growth is expected by most to pick up in 2013, which should be a positive for oil demand. The broker has pencilled in US$112.50/bbl Brent for its 2013 average; pretty much unchanged from current price levels.

With oil markets looking relatively flat for the year ahead, equity investors will be forced to look for company specific, rather than sector specific drivers for the twelve months ahead. With the bulk of the current domestic backdrop still centred on LNG development, the broker sees 2013 as being another year of cost and timeline pressures.

In such an environment, the broker is wary of too much exposure to high Australian LNG development costs. JP Morgan’s order of preference is Oil Search ((OSH)), Woodside ((WPL)) and Aurora Oil & Gas ((AUT)).

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