Commodities | May 28 2013
-Global easing threatening inflation
-Copper prices to reduce supply
-Retail buyers attracted to gold
-Weaker production supports iron ore
By Eva Brocklehurst
It's a volatile world in commodities at present. Macquarie finds a lack of fundamental conviction but there are some themes emerging which are important for the future direction of markets. The first of these is the loose monetary policy across the developed world and, hence, more inflation concerns for emerging economies. The global nature of financial markets and trade means the inflation genie will first appear in emerging markets, those with bottlenecks to growth. Here, China being the biggest emerging economy, is where the concerns lie, as there is not enough demand for metals outside of China to offset any slowdown in Chinese demand.
Having looked at China's real estate sector, Macquarie notes developers are optimistic. Chinese construction remains the biggest single driver of global commodities demand. Macquarie expects stronger construction activity in China over the rest of 2013 and, if this is sustained, it could mean upward revisions to steel demand forecasts for 2013 and copper for 2014. Another theme is costs. The US dollar's appreciation will likely produce lower commodity prices. So production costs in currencies other than US dollar should improve. That's conventional wisdom. What complicates the matter this time is that most of the production at a marginal level is from China and the renminbi is (loosely) pegged to the US dollar. Hence, Chinese production costs will rise relative to non-US dollar denominated peers. Those with assets at the lower end of the cost curve should sustain strong operating cash margins.
Another theme is that the high levels of cancelled warrants and warehouse queues at the LME won't disappear quickly. Over 40% of LME warrants are now cancelled in aluminium, lead and zinc and there are large load-out queues at certain locations. Macquarie suspects base metal premiums will push higher and this will benefit metal marketers and companies with existing smelting capacity. Copper stocks are set to build over the second half of 2013 and the premium over cost should be eroded. Macquarie's average price expectation for 2014 is US$6,550/t. The upshot is that delays to future copper projects will occur as cash flows become pressured and the higher cost producers will end up losing money at that price estimate.
One of Macquarie's themes is a battle that's shaping up for gold in terms of retail versus institutional investors. So far, institutions have won. The gold exchange-traded funds have been liquidated heavily and the gold price has fallen 17%. If these funds continue to drop gold then the price will depend on how strong the retail buyers are. What is yet unknowable is how much the recent surge in demand for jewellery and bar/coin investment, particularly in India and China, reflects additional demand or demand that has been brought forward in response to the price fall.
Iron ore is set up for a better second half. Perhaps better than expected, in Macquarie's view. Unlike other commodities, iron ore inventories have been falling thus far in 2013. While seaborne iron ore supply is expected to increase in the second half Macquarie believes Chinese mills can absorb this as they replenish inventory. This reduces the potential for a collapse in prices in the second half. A sustained fall below US$100/t is looking increasingly unlikely and Macquarie believes a US$120/t average price is fundamentally justified.
Poor margins for steel makers and a seasonal slowdown in demand could result in a rationalisation of capacity. Further draw-down of inventory would then help to re-balance the market and support prices. In the meantime, Deutsche Bank analysts expect iron ore demand will pause this quarter. On the supply side, Vale continues to disappoint and the analysts wonder if the company's supply growth targets over the next several years are realistic. First quarter production was 16% lower than Deutsche Bank had estimated. Australian production is expected to grow impressively and on this basis there should be enhanced ore availability for the seaborne market, putting additional pressure on iron ore prices. Deutsche Bank expects iron ore prices could fall an additional US$10-15/t over the next two months.
Goldman Sachs is also expecting a downturn in the iron ore price cycle but thinks it may be shorter and shallower than in the second half of 2012, when prices stayed below US$140/t for 132 consecutive trading days. A decline in steel inventories at a time of record steel production indicates demand is still robust. The analysts see the correction as indicative of the shifting balance of power from producers to consumers. Buyers are increasingly able to drive the spot price lower by deferring purchases. The seaborne market will move into oversupply in 2014, Goldman maintains. In addition, Chinese domestic iron ore production could surprise on the upside. In an oversupplied market the iron ore buyers could increase their bargaining power and the price linkage between the Chinese cost curve and the seaborne price could break. Goldman reiterates a price forecast for 2013, 2014 and 2015 of US$139/t, US$115/t and US$80/t respectively.
JP Morgan has lowered metal price forecasts on the back of reduced expectations for global economic growth as well as revisions to supply and demand balances. For Australian miner valuations the downgrade to prices has been partially offset by the lower Australian dollar estimates. Bulk commodity stocks have had earnings upgrades because of the lower Australian dollar while metals producer earnings forecasts, particularly copper and aluminum, have been hardest hit.
The Australian dollar forecasts have been revised, with the new 2013 fourth quarter target at parity with the US dollar. Copper price forecasts are reduced by 4% to US$3.50/pound in 2013, by 12% to US$3.48/lb in 2014 and by 13% to US$3.58/lb in 2015. Aluminium forecast are reduced by 5% to US89c/lb in 2013, by 12% to US90c/lb in 2014 and by 10% to US$1.00/lb in 2015. Prices for hard coking coal have been revised to US$168/tonne in 2013, from US$173/t, and to US$179/t in 2014, from US$183/t.
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