Metal Matters: Australian Dollar, Iron Ore, Tin And Gold

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-A$ weakness to help miners?
-Iron ore prices seen underpinned
-Tin in short supply
-Deflation impact on gold
 

By Eva Brocklehurst

The Australian dollar has dropped below parity to the US dollar for the first time in 12 months. So what does this mean for Australian miners? UBS notes the Australian currency's fall has come as a result of talk in the market that the US is exploring a way to exit the QE program, combined with a cut in the Australian cash rate. UBS has run several scenarios at varying Australian dollar forecasts of US$1.03, US$1.00 and US$0.97 to gauge the  impact on miners' FY13/14/15 earnings.

The biggest impact is felt on the earnings of Western Areas ((WSA)), Alumina ((AWC)) and Perilya ((PEM)). Here there is a 100% change in earnings for a US5c change in the Australian dollar. The broker cautions that these companies have only small incomes as yet, which amplifies the sensitivity. At the other end of the scale, BHP Billiton ((BHP)) is slightly more sensitive than Rio Tinto ((RIO)). A weaker Australian dollar over a length of time could drive earnings upgrades across the board, as UBS notes consensus forecasts are at US$1.04 in 2013 and US$1.00 in 2014. Complicating the general expectation for earnings upgrades from a weaker Australian currency is the reasons behind a currency move. This is the possible winding back of the US quantitative easing and weaker commodity prices. Both these could weigh on equity performance, regardless of the Australian dollar's value. UBS retains a preference for the high quality diversified names.

Goldman Sachs notes iron ore prices have softened in spite of strong steel production rates. The current price correction is expected to be similar in scale to previous downturns in 2010-11, when iron ore slipped below US$140/t for 15-30 trading days. This is the more likely scenario, rather than the longer, deeper correction witnessed in the second half of 2012. Goldman believes downside risks for iron ore are limited this time by low inventory and price arbitrage. The domestic price of concentrate in China has also fallen in recent weeks but the decline has been less pronounced than that of seaborne ore. Goldman notes seaborne imports are now selling at a relatively wide discount of US$12/t and bearish sentiment is driving many steel mills and traders away from bulk shipments. They are opting for smaller parcels with prompt delivery. The analysts maintain the view that another de-stocking cycle is unlikely because inventory across the value chain is too low.

Meanwhile, tin prices have tumbled 15% since January, which Macquarie thinks is partly from a combination of strong Indonesian production and Chinese consumer de-stocking. The analysts think the negative factors will abate in the medium term. April trade data from Indonesia showed a 13% month-on-month contraction in exports and Macquarie expects the fall in LME prices will instigate a resurgence of refined import demand from China. Inventories are still stretched and with a market deficit likely in the medium term Macquarie thinks the current weakness in  the price is a good opportunity to go long on the metal.

Tin production has fallen over recent years and this has driven the outperformance in the price up until early this year. The top three producers, Indonesia, Peru and China, all have had flat output. Macquarie notes Indonesia's industry has proven the most volatile in terms of supply to the global market. While exports have averaged an annualised rate almost 20% higher over the past year compared with the previous five years, this has been in part achieved by de-stocking. As prices subside to levels that previously triggered production cuts, Macquarie expects supply to fall in coming months.

Indonesian mine legislation also threatens to impact supply. Indonesia is expected to introduce new standards for tin exports from July 1, including raising the minimum metal grade to 99.9% and reducing the permissible lead content to 100 parts per million. Macquarie notes the latter is harder to achieve and may result in a sharp fall in exports. China has also struggled to maintain production volumes while Peru's production is in structural decline. Combine this with no known tin mine start-ups, or expansions of significance this year, and it all adds up to demand for tin being more positive.

Deutsche Bank's global commodities team is forecasting headwinds for gold as an asset class over the near term, leading to an expected trough in average pricing at US$1,450/oz in 2015. The analysts believe the structural drivers of the price will shift further out and price support will be found in outer years at the marginal real cost of production of US$1,300/oz. Deutsche Bank suggests the overall weakness demonstrated in the market over the past several quarters is reflective of fundamentals such as a stronger US currency as superior US growth prospects coincide with the gradual withdrawal of accommodative monetary policy by the US Fed. This strength is expected to create a foil to gold's attractiveness as an investment, as real interest rates may move into positive territory.

The other factor is the reduced inflation threat. Despite the unprecedented use of expansionary monetary policy by the US central bank, inflation remains subdued. Furthermore, with expectations that the US Fed begins to quit QE by the end of 2013 combined with softer global economic growth, the prospects for inflationary fears to diminish further is high. Deutsche Bank analysts believe deflation is now a real possibility. This change in inflation perception is helping to drive capital out of assets which have been used to hedge such as gold and into yielding assets such as US equities.

The importance of near-term catalysts for gold stocks from the revamped forecasts brings Independence Group ((IGO)) more squarely into Deutsche Bank's vision, on the back of the imminent delivery of the Tropicana project. Deutsche Bank expects first production could be late in the September quarter. The broker's valuation of Alacer Gold ((AQG)) suggests 30% upside to the current share price, underpinned by the flagship Copler development. Papillon Resources ((PIR)) is progressing the Fekola project, and is seen as a Buy while the broker is positive on Regis Resources ((RRL)), given the compelling free cash flow yield and maiden dividend due in FY13 but retains a Hold.
 

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