Material Matters: China’s Seasonality, Uranium, Nickel, Iron Ore Production

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-China's seasonality to the fore
-Uranium under further pressure
-Better outlook for nickel producers
-What's in Sep quarter production reports?
 

By Eva Brocklehurst

What is changing in patterns of demand in commodity markets? As China has evolved to be the dominant buyer of many commodities, the seasonal effects in this region of the globe have started to exert a greater influence on many markets. These effects are both weather-related and also framed by buying patterns. The impact on production and demand has greater predictability than the impact on pricing, in Deutsche Bank's view. The broker has examined the case for thermal coal and iron ore as well as the individual base metal markets in an attempt to discern pricing patterns.

Based on China's percentage of global consumption, which is around 70% of the seaborne iron ore market and 40-45% of the base metals market, these two are the most likely to be affected by seasonal effects within China. Coking and thermal coal are influenced as well, but to a lesser degree. In terms of production, China contributes nearly 50% of global thermal coal and aluminium production, around 30-35% of copper, zinc and nickel and only 16% of global iron ore.

The results of Deutsche Bank's analysis show that, in thermal coal, small variations in China's domestic demand and supply can have an impact. Demand for electric power in China peaks in July and August and dips in February. Hence, thermal coal demand follows the same pattern and this is despite the July/August peak in hydro power output. Iron ore imports, as with base metals, are influenced by the New Year holidays, with a slow start in January and February before ramping up in March. Imports of iron ore have tended to fall to the lowest levels in October because of the mid-autumn festival and week-long National Day holiday before recovering to end the year on a high.

In terms of iron ore production China's peak production month is in June or July and the average price trough for iron ore has, historically, coincided with the same months. Copper imports start low in January and February and ramp up in March, before slowing in the summer months to coincide with weaker construction and infrastructure activities. The lowest level for refined copper imports is seen in October, before a recovery occurs towards year-end. This year, Deutsche Bank notes, refined copper imports have bucked the trend and the broker suspects this was because of abnormal seasonal growth in industrial activity and a shortage of  scrap.

Uranium's spot price has fallen a further 13% to US$35/lb. The 8-year low has been driven by ongoing issues at Fukushima and further delays to re-starting reactors in Japan, which in a normal year would represent 12% of global uranium demand. JP Morgan has reduced earnings estimates for Australian uranium stocks as a result. The broker thinks these problems in Japan have resulted in an inventory overhang which, despite the expiry of the Russian HEU contract at the end of this year, and the fact that current uranium prices are less than half of estimated inducement prices, has made utilities reluctant to secure long-term supply and drive prices higher. JP Morgan has lowered forecasts by 8% in 2013 to US$39/lb, by 22% in 2014 to US$45/lb and 14% in 2015 to US$60/lb.

The broker retains an Underweight rating on Energy Resources Australia ((ERA)) as the stock is trading above the risk weighted price target of $1.30 a share. The other Australian uranium stock, Paladin Energy ((PDN)), is being hampered by weak uranium prices and struggles to deliver positive cash flow at a time when costs are being managed better.  In this instance, the stock is trading well below the broker's unrisked valuation so a Neutral rating is retained.

Nickel miners have garnered scrutiny from Macquarie, resulting in changes to the modelling of Western Areas ((WSA)), Independence Group ((IGO)) and Panoramic Resources ((PAN)). Sirius Resources ((SIR)) and Mincor Resources ((MCR)) have now been added to the broker's coverage. Western Areas is the top preferred stock but Sirius is also preferred. The broker may have recently downgraded short and medium-term nickel price forecasts to reflect the oversupply of the metal, but still forecasts a strong recovery over the next five years. The compound annual growth rate over those five years is forecast at 7% for US dollar denominated nickel prices and 12% for Australian nickel prices. Assumptions include a negative 4% compound annual growth rate in the AUD/USD exchange rate over the same period.

This price improvement should mean profitability for Australian nickel producers is significantly better in years to come. Based on Wood Mackenzie's global nickel cost curve and Macquarie's estimates, most Australian nickel producers are not generating meaningful cash flow at current spot prices. A recovery to the extent implied by Macquarie's modelling should enable most producers to be back in the black by 2015. Aside from Sirius, where Nova production comes on stream in FY17, other producers that won't generate meaningful earnings in FY14 are Panoramic and Mincor. Independence is considered much less sensitive to movements in nickel prices because it is more diversified.

Iron ore exports from Australia increased in the September quarter and UBS expects production to have followed this trend. Fortescue Metals ((FMG)) is expected to reach nameplate production and UBS estimates iron ore shipments of 28m tonnes in the quarter, up 17%. Atlas Iron ((AGO)) has stated it shipped a record 960,000t during August and is on track to ship 2.3-2.4mt in the quarter. Rio Tinto ((RIO)) also had a strong month in August, shipping 22.8mt. BHP Billiton ((BHP)) is expected to drop slightly from the June quarter. UBS forecasts September quarter production of 45.2mt, down 5%. BHP's metallurgical coal production is forecast to fall 15% quarter on quarter because of scheduled maintenance, while energy (thermal) coal is expected to be down 1%. BHP's copper production is forecast to be down 2% in the quarter. In the gold sector, UBS expects most producers will report improved cost metrics over the September 2013 quarter with Newcrest Mining ((NCM)) the exception because of lower expected output at Lihir.

Of interest, during the September quarter three of of the resources companies covered by UBS received proposals that could result in a change of ownership. Inova ((IVA)) received a bid from Shanxi Donghui, Perilya ((PEM)) received a proposal from its largest shareholder, Zhongjin Lingnan to acquire the outstanding shares and Discovery Metals ((DML)) received a recapitalisation proposal that would see the Singaporean domiciled Blumont Group take a 60% stake.
 

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