Material Matters: Gold And Gold Miners, Quarterly Outlook, Oil And Nickel

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-Gold stocks face downgrades
-Quarterly focus is on costs, productivity
-UBS expects near-term rebound in Brent
-Bleak prospects for nickel price rise
 

By Eva Brocklehurst

There is a belief that gold is less risky or more desirable relative to other commodities. Hence, gold miners have been valued and traded at a premium to other miners for reasons that are only logical to gold bugs, in Citi's view. The analysts would like to relegate that belief to the dustbins. The gold sector's operational and market risks are little different to other metals. Analysis shows, while the precious metal has been less volatile than other metals, earnings certainty and share price volatility of the major gold stocks have been higher relative to diversified peers. Furthermore, returns have underperformed. Citi finds little justification for premium valuations.

Many ASX gold miners are trading at levels which, since the mid April plunge in prices, imply a period of gold price weakness and adverse outcomes for high cost operations. Against this, strategic plans are undergoing rapid change. Citi believes the sector will face reserve downgrades and impairment charges across the board. It's all a matter of relative safety and in this regard Regis Resources ((RRL)) lines up in the broker's view for outperformance. If gold recovers, high cost names are more highly leveraged to the upside and Citi's preferred stocks in this respect are OceanaGold ((OGC)) and Beadell Resources ((BDR)).

BA-Merrill Lynch also notes the rapid deterioration in gold prices which adds risk to earnings and valuation. With the price at around US$1,200/oz some 20% of worldwide production is considered uneconomic. The analysts expect a cumulative cash flow deficiency in the sector for those stocks under coverage of US$1.4 billion over 2013-2015. Unless the price rebounds above US$1,500/oz, many companies will have to cut dividends, reduce exploration, sell non-core assets, refinance debt and/or issue equity. In the associated engineering and construction stocks such volatility is expected to deliver revenue declines and magnify the earnings impact. For Merrills this is likely to have a negative impact on ALS ((ALQ)), Ausdrill ((ASL)), Boart Longyear ((BLY)), Emeco ((EHL)) and Imdex ((IMD)).

Global manufacturing purchasing managers indices (PMI) have been mixed in the latest month albeit net better than the prior month. This points to a tentative upturn in demand for metals and bulk commodities, in Macquarie's view. PMIs in the US and Japan which rank first and third respectively in world output, increased sharply. European PMIs, while weak, were also moving in the right direction with the exception of Germany. China's PMI did fall but the headline number still reflects a growth reading of 50-plus.

While sentiment and fund flows have overshadowed the fundamentals in commodity markets in recent weeks, CIMB sees some improvement over the northern summer. Investors are re-focused on US monetary policy and appear to be already pricing in the end to the quantitative easing program. Weak PMI numbers in China and tight liquidity will remain a headwind, nevertheless, and CIMB maintains a Neutral weighting in commodities. Opportunities in commodities exist but these are driven mainly by supply-side issues. CIMB favours positions on base metals, with copper the stand-out commodity. Crude is expected to be range bound with a gradual move higher in coming months and iron ore prices are expected to come under some pressure, although the downside may be limited.

UBS notes iron ore shipments from Port Hedland, Western Australia, reached 81.6m tonnes in the June quarter, up 22%. Expansion should stay strong with Fortescue Metals ((FMG)) and Rio Tinto ((RIO)) adding more tonnage in the December half. Meanwhile, the gold correction is likely to expose both the high cost gold miners and copper miners with large by-product contributions. The analysts expect cash costs for OZ Minerals ((OZL)), PanAust ((PNA)) and Ivanhoe Australia (((IVA)) to rise significantly as by-product offsets diminish.

While the fall in Australian dollar helps Australian-based miners, US dollar commodity prices remain under pressure. Upcoming quarterly reports are expected to focus on updated cost cutting and measures to improve productivity. UBS expects a lift in volumes for BHP Billiton ((BHP)) and Rio Tinto in key divisions, following low production the March quarter. Specifically, successful commissioning of Phu Kham increased recovery may allow PanAust to exceed UBS' estimates for copper volumes while wet weather in NSW could be a risk to Whitehaven Coal's ((WHC)) production. Cost cutting and optimisation may benefit Paladin Energy's (PDN)) bottom line.

Brent crude prices have averaged lower than expected in the June quarter, at US$103.35/bbl. It was Federal Reserve chairman Ben Bernanke's comments on tapering of quantitative easing that provoked the more recent sell-off and the IMF also reduced global GDP growth estimates to 2.7% from 3.0% for 2013. UBS analysts still envisage a near-term rebound in Brent, which is expected to average US$110/bbl in the third quarter. There are three main reasons for this. Global demand should strengthen in the third quarter. Secondly, despite non-OPEC supply rising, a shrinking of Brazilian output, flooding in Canada and the hurricane season in the US will pressure supply. Added to that Libya and Nigeria have curtailed output for security and political reasons. The third reason is that the geopolitical risk premium priced into Brent will rise if the situation in Syria deteriorates and spills over into neighbouring countries.

Market surpluses are growing for nickel. Stainless steel production, the main use for the metal,  is soft and there has been a strong advance in supply from newly-commissioned nickel projects. Nickel prices have had the sharpest falls of all LME metals. Prices may have been lower during the GFC in 2008 but this is little consolation for Australian producers, struggling with a strong currency even after the recent depreciation. Credit Suisse believes, in the absence of major setbacks to nickel projects, prospects for price rises look bleak in the second half of the year. Surpluses are likely to exceed 50,000 tonnes and there are risks of further price falls. Credit Suisse continues to forecast surpluses until 2015.

In the absence of a re-acceleration in Chinese industrial production and demand for stainless steel, Credit Suisse advises investors to stick to companies on the lower end of the cost curve. Western Areas ((WSA)) and Independence Group ((IGO)) will continue to report positive free cash flows, even at $6/lb nickel price, and these are the broker's preferred picks. Mirabela Nickel ((MBN)) and Panoramic Resources ((PAN)) are considered undervalued at a US$9/lb long-term nickel price but both have significant hurdles to overcome before any value can be realised.
 

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