Metal Matters: Lead, Coal And Iron Ore

Array
(
    [0] => Array
        (
            [0] => ((CPL))
            [1] => ((NCR))
            [2] => ((CZA))
            [3] => ((COK))
            [4] => ((EER))
            [5] => ((GUF))
            [6] => ((BTU))
            [7] => ((CKA))
            [8] => ((RIO))
            [9] => ((BHP))
            [10] => ((AGO))
            [11] => ((FMG))
            [12] => ((MGX))
        )

    [1] => Array
        (
            [0] => CPL
            [1] => NCR
            [2] => CZA
            [3] => COK
            [4] => EER
            [5] => GUF
            [6] => BTU
            [7] => CKA
            [8] => RIO
            [9] => BHP
            [10] => AGO
            [11] => FMG
            [12] => MGX
        )

)

This story features COKAL LIMITED, and other companies.
For more info SHARE ANALYSIS: CKA

-Commodity demand to pick up
-Lead to remain sluggish
-Coal stocks weak
-Iron ore cooperation required
 

By Eva Brocklehurst

There's been another sell-off in commodities in the June quarter. CIMB notes a combination of strong supply growth and weak demand has prevailed. This may be changing now. Supply growth is seen leveling out and, on the demand side, momentum is expected to pick up in the second half of the year. Usually, it's the third quarter that produces the strongest performance for the year and the recovery this year is expected to be even stronger, because of the heavy selling that occurred in many markets in recent months.

CIMB sees opportunities in several commodity markets and favours the base metals with copper the highlight. The analysts believe the recent selling of copper has been unwarranted. Recent supply disruptions have already resulted in premiums moving higher around the world, and there are signs that demand is about to pick up strongly. According to LME data, cancelled warrants have reached 240kt, up 50% in May. This, combined with further supply disruptions and a steady economic recovery in China, should push copper prices higher.

The price of lead underperformed other base metals, bar nickel, since the peak in February. Now the lead price has bounced and LME cash-to-three month spreads have moved into backwardation for the first time in several months. Macquarie finds the outlook mixed and the fundamentals have not justified this bounce back in prices. While lead-acid battery shipments to the US fell 6% in the first quarter and Japanese lead use in battery production fell 10% this is typical for the time of year. At a time when offtake tends to be soft for seasonal reasons Macquarie finds the supply of lead appears to be enough to meet demand. Meanwhile, unit prices for lead scrap have been falling. There are both forecasts for surplus and deficit in the global lead market but these are quite modest. 

Macquarie thinks there will be a global market surplus of around 100,000 tonnes this year. Either way the market conditions are not sufficient to be outright bullish on lead. The analysts do query whether the rise in LME lead stock cancellations is being driven by genuine demand but don't see much evidence for this. Warehousing developments may be playing a part and the analysts would not be surprised to see stocks rebuild to some extent. In sum, lead's latest price developments are probably less fundamentally related and more to do with the distribution of warrants.

May was another tough month for coal, in particular the juniors. CIMB's Australian Junior Coal Index was down 17%. Excluding Coalspur Mines ((CPL)), which was the worst performer and largest contributor to the index, the index would have been down around 5%. Best performers were Nucoal Resources ((NCR)) and Coal of Africa ((CZA)). The worst, excluding Coalspur, were Cockatoo Coal ((COK)), East Energy Resources ((EER)) and Guildford Coal ((GUF)). Subdued prices have persisted and the sector's share prices have declined by around 50% year to date, based on this index. Outside of the prospects of project funding, cash is tight at Cockatoo Coal, Bathurst Resources ((BTU)), Guildford Coal and East Energy. Cokal ((CKA)) is the broker's preferred pick in the sector.

Thermal production is continuing to be strong and few miners appear to be cutting production. This is worsening an already weak market. The one bright spot is India's NTPC, which has estimated it will have to double purchases of imported coal over the rest of this year to address fuel shortages at plants. South Korea has also taken more nuclear plants offline over safety concerns, which should benefit fossil fuel demand. Coking coal continues to struggle with weak steel markets and spot prices well below US$150/tonne. CIMB notes producers are aggressively increasing production to reduce costs and demand is not expected to improve sufficiently in the short term to underpin a sustained recovery in prices.

Iron ore has been volatile, sliding to US$120/t recently. Citi notes, as an immature spot market, this volatility can be expected to a degree. The analysts believe there are two key changes the major iron ore producers need to implement – to flex production to meet demand and increase liquidity in the spot market. Low cost Australian and Brazilian producers have little capacity to flex production. When demand falls they switch from supplying customers under contract to dumping excess volume into the spot market. If this occurs when demand is falling, as happened in the third quarter of 2012, this compounds the pressure on the spot market. Citi asserts the major producers need to act like an oligopoly and adjust supply in periods of demand weakness. Systems need to be configured so that rail/port capacity can be used to release material that's been stockpiled during demand weakness.

The other aspect is that less than 5% of the iron ore seaborne volumes goes through the spot market. In order to be truly representative as a pricing mechanism this needs to be 15-20%. Until the market is liquid there will be questions over the validity of the index price and this will drive defaults through contract non-performance and increased volatility in the market as cargoes are re-sold. So, according to Citi, there is a risk of the worst of both worlds as volatility continues to be high short term and new supply drives prices lower over the medium to longer-term.

Nomura finds an improvement in some short-term indicators for the iron ore price, with the exception of Chinese steel prices. Chinese steel prices are still weakening, compounded by the de-stocking of iron ore inventories at small mills. Nomura notes the supply chain is carrying fewer raw materials and a de-stocking of the extent seen in 2012 is therefore less likely. Mill de-stocking is still following the trend seen over the preceding few years but Nomura suspects that, as the cost curve support kicks in, the iron ore price will recover by around US$20/t in the month following the bottoming in the iron ore price. So, support is seen at around US$10/t below spot or at US$100/t.

At spot prices, iron ore margins for the Australian sector are estimated by Nomura to be comfortable at US$55/t for Rio Tinto ((RIO)) and BHP Billiton ((BHP)). On average, for Atlas Iron ((AGO)), Fortescue Metals ((FMG)) and Mount Gibson ((MGX)) this comfort zone falls to US$25/t.

In Fortescue's case, with an estimated net debt position of close to US$11 billion, margins are further compressed. Spot iron ore highlights the need for the company to execute on the strategy to sell a non-controlling interest in its rail infrastructure in the short term, in Nomura's view. The analysts suggest such a transaction could raise around US$3bn in funds, which could be applied to debt reduction. Significantly, the estimate this would lower the mid-term average iron ore prices required for the company's obligations to a "through-the-cycle" figure of US$80/t.
 

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

Click to view our Glossary of Financial Terms