Material Matters: Metal Prices, Palladium, Zinc And Wheat

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-UBS likes platinum, uranium, alumina
-Vehicle increase supports palladium
-Zinc market surplus prevails
-A record year for wheat exports to Indonesia?
 

By Eva Brocklehurst

As we embark on the September quarter, UBS reminds us it is a particularly weak trading period for commodity markets. It features de-stocking of supply chains and widespread production cuts. This is being exaggerated this time by a staged withdrawal of fiscal and monetary support in China and [possibly] the US. Demand has held up in key markets such as iron ore, coal and copper but these are overwhelmed by even stronger supply growth. Almost all commodity markets have therefore witnessed price falls this year with the greatest being in those exposed to speculators – the metals markets.

So where are the preferred commodities? UBS favours the platinum metals (PGM), uranium and alumina. Platinum and palladium are preferred on a short and medium term basis. Supply issues in South Africa, coupled with stable demand in China and the US make it a tight trade and at odds with the macro weakness. Uranium's spot price is close to the marginal cost of production and now carries upside risk, given the gradual re-start of Japan's nuclear power generating capacity. Alumina is a potential beneficiary of an imminent ban on Indonesia's unprocessed mineral exports which will force China to lift alumina imports.

Metallurgical coal should get some price support heading into the fourth quarter after being hit hard in the second quarter, while buoyant iron ore prices are increasingly exposed to a correction on seasonal weaknesss in the steel sector and an Australian-led supply surge. Meanwhile, longer-dated and deep downgrades have been incurred in nickel and metallurgical coal prices and recent cuts have been made to gold and silver price forecasts. What matters at present for UBS are the low cost assets of the diversifieds. Line up BHP Billiton ((BHP)) and Rio Tinto ((RIO)) as well as Glencore. Among niche metals the broker likes Paladin Energy ((PDN)) and Alumina ((AWC)).

The platinum group also features in Macquarie's current thinking. More cars than ever before were sold in the first half of 2013, the latest data shows. This is supportive of PGM demand, especially palladium, as well as many other commodities, such as aluminium and steel. But the year-on-year growth rate has been relatively modest, as strong US and Chinese sales were offset by weakness in many other key markets, especially Europe. China continues to be both the largest and fastest growing market, with 8.7m units sold. China remains almost entirely a gasoline engine market so it's an important source of palladium demand.

Further support for PGMs should come from tightening emissions legislation. Beijing imposed stricter standards, equivalent to Euro 5 standards, on cars earlier this year. Meanwhile the US has performed more strongly, with light vehicle sales up 7% in the first half of the year. Monthly sales are at their highest since before the 2007-2009 recession, which Macquarie notes defies some predictions that these levels would never be seen again. This is positive for palladium, which has now almost entirely displaced platinum from US gasoline vehicles. The two technologies that would radically change this picture such as diesel vehicles, which use much more platinum, and electric vehicles, which use no PGM, pose no immediate threat.

ANZ Bank analysts look ahead to some emerging signs of a bottoming to prices. That doesn't mean they're set to rally. The analysts believe upside will be short-lived. Blurring the picture is the passing of a peak in seasonal demand and lack of clarity over China's near-term growth outlook. In addition, the perception and eventual withdrawal of US dollar liquidity from global financial markets will likely generate some uncertainty for commodity markets. The analysts have downgraded commodity price forecasts by an average 4.5% in 2013 and 5.5% in 2014, adjusting for weaker Chinese demand and, in some areas, inelastic supply response.

Selling by investment funds has also prompted a lower short-term price outlook, particularly for the precious metals. The biggest downgrades in the analysts' forecasts have been for precious metals, down an average 8% over 2013/14. In most cases, prices are expected to decline further in the coming quarter, before recovering later in the year. Other big downgrades to forecasts are in coal and nickel, down an average 7% over the next two years.

While the debate about China's reported zinc mine output continues, another year of increases in the official statistics must add to worries over the outlook from a fundamental perspective, in Macquarie's opinion. More mine output means more metal production. If mine output is rising more rapidly than demand for zinc, it's a surplus market, since there is no shortage of smelting capacity. Macquarie expects that zinc concentrate prices as well as the miners' price share could fall further as a result of surpluses.

Zinc smelter inventories are reported to be rising as production has increased but deliveries have dropped, in part due to customer worries over falling prices. It appears that China can fulfill its demand for zinc concentrates entirely from domestic sources.There will probably still be a certain volume of imports into China under long term contracts, encouraged in some cases by more flexible payment terms. Secondly, some traders will probably continue to import concentrates on a speculative basis at the right price. Nevertheless, Macquarie warns investors should not lose sight of the likelihood that increased mine output in China will contribute to a resilient market surplus.

The CIMB Australian Junior Coal Index continued its downward trend in June, shedding 7%. It's not getting easier. India's move to allow utilities to pass on higher costs associated with using more imported thermal coal has the ability to open up imports but the monsoon season should keep this subdued for the moment. Supply could then tighten up in the next six months and push the prices higher.

The coking (met) coal market continues to struggle in the face of weak steel markets, with spot prices now below US$150/t FOB for premium hard coking coal. This has flowed into the quarterly contracts, with third quarter contracts settled at US$145/t. This price is a reduction of US$27/t from the second quarter price of US$172/t and is the lowest settlement since the quarterly price system was introduced in April 2010. With prices now cutting into the industry cost curve, there will be increasing pressure on producers to cut production. To that end, CIMB observes some signs this is starting to happen.

ANZ analysts are talking about wheat imports to Indonesia, the world's second ranked importer by volume. These are set to accelerate sharply. The analysts forecast Indonesian wheat imports to jump 15% year on year, implying volume growth of around one million tonnes over the next 12 months. For Australia, this should mean another record year for wheat exports to Indonesia, hitting 5mt per annum for the first time. Factors driving this growth include: a widening disparity between the price of rice and wheat, curbing of flour imports, high food (non-cereal) CPI and fuel inflation and new Indonesian flour milling capacity.

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