Metal Matters: Rio Tinto’s View, Gold and Nickel

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By Andrew Nelson

Analysts from JP Morgan recently attended an analyst forum; the draw card was a presentation by Vivek Tulpule, Rio Tinto’s ((RIO)) Head of Economics and Markets. What JPM found out is that Rio is fairly optimistic about the outlook, especially given the view that China will grow 8% this year.

The economic fragility in the OECD, especially Europe, and new supply additions could well weigh on near term commodity prices. Longer term is quite different, with Tulpule pointing out that capital preservation and cost escalation has effectively discouraged new supply. This has already started to limit production additions, which is supportive on a three to five year view.

As far as iron ore goes, Rio sees far less of a chance of a sharp drop in prices this coming September. First, most aren’t looking to build or hold stock, while construction is lifting from a low base and China. Given the current direction, the broker thinks China is far less likely to throw a spanner in the works like it did last year.

The company continues to expect the aluminium market to be soft near term because of a reluctance to shut down or idle production given the high re-start costs. Rio is positive on copper longer term given a lack of new supply. Declining production from established operations and delays on new projects given current capex tightness are pointing to future supply tightness.

In terms of coal, Rio is more upbeat than BHP Billiton ((BHP)), seeing long term structural coking coal deficits, while high production costs for thermal coal in China should also offer support for prices. Unconventional gas in China does provide somewhat of a threat, but Rio points out a huge amount of gas would be needed to displace enough coal to have an impact.

BA-Merrill Lynch has focused on some of the commentary out of the other big Aussie, BHP Billiton ((BHP)), also noting upbeat commentary on the general outlook, again with the usual warnings about a hard to predict China.

A little bit at odds with the positive commentary from Rio and BHP is the fact that share price performance from the metals and mining sector been mixed, at best, so far this year.  The broker notes most share prices is the sector are struggling to make any headway.

With gold back below US$1,600/oz, we’re staring to see weaker and weaker share prices across the sector. Morgan Stanley sees this as presenting a buying opportunity similar to the pullback in mid-2012, when shares ran hard after a collective sell-off.

The broker sees a chance for gold equities to outperform relative to gold as soon as the gold price improves. With a 30% discount to the gold price, there’s plenty of upside available when that gap does close. The usually less favoured high-cost, lower-margin, high-leverage gold miners may well out-perform peers once gold starts to rise. Although, the broker’s long term view is quite different, with the lower-cost, higher-margin, low-leverage gold miners likely to offer more stable cash flow.

Morgan Stanley also notes stocks that have encountered periods of underperformance, but are transitioning out of these periods, also offer an opportunity. Newcrest ((NCM)) is a good example.

Credit Suisse has taken a post reporting season look at the nickel segment and the news isn’t any better than it was going in. It’s not that the results were bad, it’s just that nickel prices are still weak and companies, for the most part, continue to tread water.

February itself was an interesting month in the nickel markets, with prices hitting $8.50/lb early in before pulling back to 2013 lows at $7.50/lb. Sentiment remains subdued and LME stocks continue to build, notes the broker. At the same time, production has reached new record levels and a number of major new projects are starting to recover from technical start-up issues.

While it sounds like there may be no near term relief, the broker expects any short term undershooting in the nickel price to be short lived, with a recovery soon expected as fundamental cost supports begin to re-gain some traction. Given this view, the broker likes Mirabella Nickel ((MBN)), noting the share price has overshot to the downside. PanAust ((PNA)) and Independence Group ((IGO)) are also at Buy on the broker’s book.
 

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