Material Matters: Gold, Zinc, Lead, Oil And Fertiliser

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-Brokers wary on gold stocks
-Indian gold tariffs expected to stay
-lead outlook more positive than zinc
-OPEC expected to react to oil price pressure
-Deutsche Bank focus on oil production stocks
-DAP prices rise, China flexes on export policy
 

By Eva Brocklehurst

Gold. The word doesn't elicit much excitement at the moment. Goldman Sachs takes a cautious view on gold stocks, forecasting gold prices to continue declining. With current macro views generally bullish, Goldman acknowledges an overall aversion to investment in the gold sector.

Ratings on stocks are now relative to the broker's gold price expectations, although a discounted cash flow basis is still the primary assessment of value. The updated framework means the broker has initiated coverage of Beadell Resources ((BDR)) with a Buy rating, because the sole operation has high margins and strong free cash flow. Other Buy rated stocks are Medusa Mining ((MML)) and Alacer Gold ((AQG)). On the Sell side Goldman places Evolution Mining ((EVN)), Teranga Gold ((TGZ))) and Kingsgate Consolidated ((KCN)). Australian gold market leader, Newcrest ((NCM)), was upgraded to Neutral last week.

The underpinnings of the broker's selections are exposures to operations with the lowest cash costs because, in the event of a further decline in the gold price, these have the greatest potential to return cash, grow through development of individual assets or acquire distressed peers. Goldman is also moving coverage to a stand alone Australian gold group, outside of the broader resources sector. Hence the stock ratings are now relative to the Australian gold coverage only.

Macquarie is also cautious about Australian gold equities, expecting the precious metal will remain range bound between US$1,200-1,400/oz through to 2015. Again, stocks are picked with the best cost profile and balance sheet, in order to survive the next year. Volatility is expected to stay higher and impact investor sentiment. The broker considers Silver Lake Resources ((SLR)), Kingsgate and Newcrest could all be candidates for near-term hedging in relation to their higher-cost operations. Mergers are an ongoing theme and Macquarie suspects Gryphon Minerals ((GRY)) could be a target. Macquarie's advice: avoid high-cost, near-term producers with stressed balance sheets.

A catalyst for gold could be the easing of Indian import tariffs but Macquarie is not that hopeful. There has been a successful attempt this year to reduce the country's gold imports, usually the world's largest. While Macquarie does not envisage any break down of the tariffs in the near future, and imports are likely to be lower in 2014 than 2013, the run rate should pick up from the basement levels currently in place. The Indian government's actions over 2013 took place across several measures, raising import duty on bullion, then increasing excise on gold bars. Mid year they restricted the imports of gold by banks and then linked the volume of allowable imports to actual exports. Macquarie expects India will have officially imported about 160t less gold in 2013 than 2012 and 260t less than in 2011. The price has had to fall further than it should have done in order to balance the market, in Macquarie's opinion.

JP Morgan has updated gold price forecasts as well as iron ore, base metals and silver. The analysts expect gold to be at US$1,263-1,275/oz in 2014/15. Silver is seen at US$21.38-22.00/oz. The analysts expect precious metal prices in 2014 will be characterised by the US Fed tapering and lower US inflation, with the downside exacerbated by the re-emergence of producer hedging. JP Morgan expects Chinese crude steel output will continue to surprise on the upside and forecasts iron ore prices at US$125/t in 2014 and US$110/t in 2015. Copper demand is expected to stay robust but emerging mine supply and smelter expansion in China will affect the tightness of the market, leading to copper prices in the second half of 2014 at around US$3.11/lb.The broker sums up the preferred picks in Australian resources as Rio Tinto ((RIO)), Fortescue Metals ((FMG)) and Iluka Resources ((ILU)).

Zinc and lead are expected to sustain tighter markets in the coming year, according to Macquarie. The International Lead & Zinc Study Group has highlighted tighter conditions, with the lead market running a deficit of 54,000 tonnes in October. Zinc is reported to have swung into deficit from a surplus the preceding month. Global zinc supply is estimated to have risen by just 1.7% through the year to October. The lack of growth is attributed to two Canadian mines being closed earlier this year, while weaker grades at Australia's Century zinc mine, the world's third largest, offset the record level of ore that was extracted. China has accounted for the net increase in zinc output.

On the demand side, global output of galvanised steel, the single large first use of zinc and accounting for 55% of consumption, rose 2.5% in the year to October. Macquarie is cautious about being too positive on the zinc market, believing the inventory overhang suggest the market is in a phase where concentrate surplus is simply flowing through to increased refined output.

Lead is looking more positive, in the analysts' opinion. Primary lead supply is the key to market balance, as Macquarie estimates that secondary lead output from recycling is running at capacity. This means Chinese mine output is the key. On the other side, demand has been sluggish for lead. October is usually the key month for shipments, ahead of the peak in battery failures in the northern hemisphere's winter. Yet total battery replacement shipments were down 1% in the year to October. Lead usage in Japanese battery production is also down 3% over the same period. Hence, while the current lead market appears tighter than for zinc and long-term prospects are probably more positive given the lack of new mine supply from China, Macquarie thinks zinc is more positive on a relative basis.

Oil supply growth is expected to strengthen and Deutsche Bank expects OPEC spare capacity will reach its highest levels in over a decade from next year. Hence, the broker has reduced Brent oil price forecasts to US$98/bbl and this has resulted in earnings downgrades of 8-14% for the large cap stocks in the sector. The analysts expect that 2014 will mark the third consecutive year in which the US has posted oil supply growth of over 1mmbbl/day, accounting for 60% of non-OPEC supply growth. This is also compounded by expectations of a recovery in Iranian oil exports. The analysts' long-term Brent forecast is US$95/bbl, from 2016. Deutsche Bank expects OPEC will cut production in order to defend oil prices.

Expectations for declining prices means the broker's preferred exposures offer a combination of material positive news catalysts and earnings growth through production growth. The top pick is Oil Search ((OSH)), with the upcoming start of PNG LNG in 2014. Santos ((STO)) is number two. The GLNG project may not be without challenges but recent news suggests lower drilling costs. This gives the broker confidence that capex pressures are easing. Deutsche Bank's preferred emerging stock in energy is Drillsearch ((DLS)), which offers substantial exploration upside and production growth.

Fertiliser prices continue to improve. DAP prices rose US$11/mt last week. The third consecutive weekly rise. This has increased spot DAP prices to Goldman Sachs' price estimate for FY14 of US$375/mt. The broker notes a 5% change in this assumption results in a 3.5% change in Incitec Pivot ((IPL)) earnings forecasts. A key announcement during the week was the changes to China's fertiliser export tax policy. The export tax during the low tariff period will be a fixed amount of RMB50/mt and during the high period DAP and MAP will be taxed at a rate of RMB50/mt plus 15% of the export value. Goldman believes the outcome is negative for global DAP pricing, with China a net exporter of finished DAP products attempting to develop a more favourable export policy.

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