Material Matters: Weak Prices, Base Metals, Oil And Oil Stocks

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-Majority of prices lower in April
-Renewed demand for gold
-Base metal surpluses
-Oil price resilient
-Potential in mid cap oil stocks
 

By Eva Brocklehurst

April has come and gone and the majority of commodity prices are sequentially lower. Macquarie cites re-emergence of concerns over the recovery in the US economy, supply availability and few signs of policy changes in China as putting pressure on prices. The analysts believe some of the selling has been overdone, based on physical market conditions. Nevertheless, markets are not as supportive of prices in general as they were a year ago. Weak growth has increased expectations for policy stimulus. Has anything changed? National Australia Bank analysts suggest attention has shifted slightly from Europe's financial problems to a general disappointment at the malaise in the global economy.

Macquarie find that gold buying has renewed in recent weeks as consumers take advantage of relatively lower prices. Physical demand is also likely to remain firm until the price recovers sufficiently to limit further purchases. NAB analysts suggest the need to offset risks was prevalent, as low inflation and a shift towards better-performing equities weighed on prices. Gold prices are expected to end 2013 around US$1,470/oz and moderate to US$1,300/oz by the end of 2014, in their view. Gold and silver may have suffered a sell-off but current prices still compare well historically, according to Macquarie. Comparing the April price with the average over 2007 to 2012, gold was still 27% higher and silver up 17%, only surpassed by palladium, up 46%. Iron ore and copper prices are now trading close to the 2007-12 average, while nickel and metallurgical coal are over 30% lower.

NAB analysts believe soft demand and increasing supply does suggest that there will be surpluses in base metals this year. They note copper is losing the benefit of tight fundamentals and is expected to record its first surplus since 2009, when prices slipped below US$4,000/tonne. Economic activity is expected to improve later this year, sustained by accommodative policies, but the talk is is about increasing stockpiles of metals, particularly in China. These stockpiles suggest there will be no abrupt recovery in prices when demand improves. Friction, in the analysts' view, could come from warehouse incentives and financing deals and markets could tighten later this year.

Bulk commodity prices face difficult conditions in steel markets and increases in supply. End user demand is low but a modest recovery could be in train by the end of the year, in the NAB analysts' view. Macquarie found iron ore had a mixed April with a sell-off at the end of the month and into May perhaps a sign of things to come. They describe it as iron ore's usual yearly "flash crash" coming a bit earlier than normal, the catalyst being the precarious position of steel traders pushing back on the ferrous value chain.

NAB is reasonably positive about the near-term outlook for oil. Demand is expected to pick up in the second half of 2013, with further traction from loose monetary policy. A number of refineries in Asia that are currently undergoing maintenance will also be running and benefiting crude oil demand and prices. The effect on prices of stronger demand is likely to be counteracted, in part, by improving production from non-OPEC countries. The analysts have revised down forecasts for Brent, expecting the gap between Brent and West Texas Intermediate prices will narrow over the year ahead. The price of Brent is expected to lift to around US$109 a barrel by the end of the year and the price of WTI rise to around US$98 a barrel.

The analysts note natural gas prices in Asia are dictated by long-term contracts tied to oil prices, keeping them higher than in other parts of the world. The high import bills for LNG faced by the Japanese, the largest LNG importer globally, have prompted a search for cheaper supply. Japanese authorities have announced about US$11 billion in loan guarantees to fund direct investments by Japanese companies in US shale gas. In the near term, moderating oil prices and seasonally low demand may alleviate some of the pressure on Asian gas prices.

Despite the weakness among other commodities, oil prices have remained resilient with Brent above US$100 a barrel. While this has helped the energy sector, stocks have been affected by the disillusionment with resources and the move towards industrials. Macquarie finds value in the small to mid cap energy sector, with stocks trading at an average 10% and 52% discount to core and risked net asset value, respectively. The broker notes, with average decline rates across the mid caps under coverage of around 2.5% over the last five years there will be an increasing reliance on the next wave of new growth projects, exploration success or further acquisitions. Also, exploration is on the increase in the sector. Expenditure increased by 44% in the March quarter to the highest quarterly level in more than five years.

Macquarie prefers AWE ((AWE)), Horizon Oil ((HZN)) and Karoon Gas ((KAR)). For AWE the decisions to be made this year are on phasing of remaining work at BassGas MLE, completion of Senecio feasibility study, testing at Arrowsmith-2 and partial sell down on the Ande Ande Lumut. Horizon's production base is expected to growth following commissioning of the Beibu Gulf in March and the Stanley liquids project early in 2014. Karoon has just reported two oil discoveries in Brazil ,with further appraisal planned for late this year/ early next to confirm commerciality.

During a pricing downturn the market tends not to value exploration, CIMB' suggests, and those with significant cash flow do best. The broker finds share prices are trading below exploration value for a number of mid cap producer/explorers. Mid to long-term, CIMB thinks energy prices will stay high and short-term weakness could create value and opportunity for investors. There are plenty of catalysts among the mid cap players and the broker highlights Sundance Energy's ((SEA)) good initial results from drilling at Eagle Ford and Anadarko, as well as first production at Horizon's Beibu Gulf.

Senex Energy ((SXY)) had a good year in oil, with production estimated to be 1.2m barrels in FY13. CIMB expects more exploration drilling, to begin in FY14, could result in further upside for production. The broker notes that Senex is the last company of size in the Cooper Basin that is not partnered with a major player in the sector and there is potential for this to happen amid expected gas supply shortages in the Australian east coast market. Another the broker flags is Maverick Drilling and Exploration ((MAD)), which is undertaking a substantial amount of high impact drilling and ramping up production at Blue Ridge. The broker thinks confidence in the stock will improve as production increases and is shown to be sustained over several quarters.

WestSide Corp ((WCL)) and Tlou Energy ((TOU)) are also of interest. CIMB suspects the takeover bid for WestSide may not conclude positively, given the current share price. A negative reaction is considered largely priced in and the broker is focused on the value in the longer-term development of its acreage, provide gas flows can be managed. Tlou is embarking on a pilot drilling campaign in coal seam gas. The broker expects a re-rating towards valuation if gas flows and subsequent initial 2P reserves are achieved.
 

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