Material Matters: Bears Persist, Nickel, Coking Coal, Zinc-Lead, Energy Stocks

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-Commodity prices should edge up
-Nickel prices still depressed
-Coking coal stabilises
-Balance swinging from zinc to lead
-Cost pressures easing for Big Energy

By Eva Brocklehurst

Investor sentiment for exchange-traded commodity markets is still bearish, perhaps with the exception of energy, according to the ANZ commodity analysts' latest view. Speculative positioning in WTI crude oil was at a record high 15% of open interest at the end of July, supported by declining US crude oil stockpiles, better-than-expected US data and supply bottlenecks in Iraq and Libya. In contrast, copper's net speculative positioning reached a 4-year low, reflecting bearish Chinese sentiment, with net short positions accounting for 22% of open interest.

Short positions in gold, silver and platinum remain stretched according to the analysts, although they're off the record lows, while palladium is being supported by ongoing industrial action in South Africa. Agriculture turned bearish, with speculators net short soybeans for the first time since December 2011, and corn at a record net short, 11% of open interest.

Commodities could start to push higher in the coming months as market participants begin to price in better demand at the end of the year. The analysts think China could be improving, with equity markets bottoming in July, but the general mood in China is still cautious. Participants appear to be getting used to more difficult conditions, but most expect the current quarter to be slow. As China's growth has slowed, traders expect other markets to continue to exert greater influence on sentiment.

There's no grounds for optimism in nickel, despite a recent rally in prices, in Macquarie's view. Taking on board the latest International Nickel Study Group data the analysts think the market will stay in significant surplus for a while. Macquarie thinks the market needs a substantial supply shock – such as a sharp fall in Indonesian ore exports leading to cuts in Chinese and Japanese smelted nickel production. Chinese production has grown strongly this year and not just from nickel pig iron. Jinchuan Nickel and other smaller refineries have obtained more imported intermediate feed – mainly from Australian producers. Looking ahead, Chinese nickel pig iron production will be a key indicator. Macquarie assumes second half 2013 production will be 42,500 tonnes lower than the first half and 2014 will see a year-on-year fall of 32,500t. This assumes that closures of high-cost operations will exceed the ramp-up of others and that Indonesian nickel ore exports, while not ceasing, will fall in 2014.

Metallurgical (coking) coal prices appear to have stabilised, rising by around US$15/t recently. They're still at extremely low levels relative to history. Macquarie notes demand from Asia ex-China appears to be improving and the first signs of Chinese production cuts are also emerging, underpinning a nascent price recovery. The World Steel Association released global steel and iron production data for July and the numbers revealed a continuation of the trend of improving pig iron output across the Asian coking coal buyers – Japan, India, Korea. This points to steadily rising real demand for coking coal.

While the Chinese may be planning to re-stock, they have already been active in the seaborne market for the last few months. Seaborne prices ticked up while domestic prices continued to slide, so the arbitrage opportunity may now be closing, in Macquarie's view. If the Chinese do plan a re-stock, this should provide some volume and price support for the coking coal miners. Demand may be improving but Macquarie also sees the first evidence of supply rationalisation. Implied coking coal production in China dropped 11% in July from June to the lowest level seen in 2013, with the exception of January which is always seasonally low. Other than the apparent cutbacks in Chinese output there is so far little evidence of other regions cutting supply significantly and, with seaborne prices starting to stabilise, it may be less likely that significant cut-backs will now occur.

The International Lead & Zinc Study Group's latest data appeared positive for the lead and zinc markets. The lead market is shown running a small deficit from January to July and the zinc market is seen in a moderate surplus. Macquarie warns that first impressions may be misleading. On closer scrutiny it appears consumption might be overstated. Macquarie thinks zinc, both for refined metal and concentrates, remains firmly in surplus while lead looks to be broadly balanced. With the northern hemisphere winter ahead, which is seasonally positive for lead and negative for zinc demand, the relative balance between the two metals looks set to swing further in favour of lead.

Goldman Sachs has scrutinised the three large Australian energy stocks – Woodside Petroleum ((WPL)), Santos ((STO)) and Oil Search ((OSH)). The companies have recently reported interim results which show cost pressures are easing. This bodes well for margins and brownfield LNG expansions. Santos' strength resulted from increased confidence in the GLNG budget and a favourable result from Gashnitz-1 in the Cooper Basin. Both Santos and Oil Search are flagging dividend increases, in 2014 and 2015 respectively. Woodside disappointed the market on its interim dividend but management was keen to affirm it will remain growth focused. The other two have made similar comments in the past according to Goldman, and the broker suspects, given the declining nature of oil & gas projects, this may always be the case. The capex cycle has passed its peak and, while a period of stronger free cash flow is likely, investments in further growth and reserve replacement should continue.
 

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