Commodities | Jan 23 2014
-Oz grain to outperform
-Gold rally needs inflation kick
-Copper drawdown key to balance
-Zinc surplus to stay a while
-Thermal coal rally unlikely
By Eva Brocklehurst
There's some relief on the way for local agricultural commodities from the weaker Australian dollar but supply will continue to rule the roost. Commonwealth Bank analysts observe the market traded defensively in 2013, pressured by an increase in supply. This should remain the case in 2014, particularly for grain and oilseeds. Longer-term, the analysts suspect waning demand in the biofuel market – from probable legislative changes – will constrain prices. Also, changes to China's agricultural policies, including a shift from domestic price support to direct production subsidies, could add pressure.
CBA analysts expect grain prices to stay high relative to long-run averages. Australian grain prices should outperform international benchmarks this year because of tight supply, although local prices are expected to be under some pressure as, and when, new supply comes on board. Beef is expected to be a better performer in the year ahead, contingent on a return to favourable conditions. Australian cattle prices have dropped, reflecting drought-induced de-stocking, despite US cattle prices rising to record highs. Re-stocking will emerge if widespread rains are received this year. If that occurs the analysts expect that, combined with strong international markets, the Eastern Young Cattle Indicator could bounce back to $4.20/kg by the end of 2014 from the current drought-induced level of $2.92/kg.
Gold endured a tumultuous year in 2013 but Macquarie doesn't think the price has yet found a low. The analysts tip the gold price to fall to new post-2010 lows in the first half of 2014, as investors continue to liquidate holdings and supply/demand fundamentals remain weak. Now that bad news is out of the way, an Indian-led recovery is expected in the second half. There's been a modest rebound this month, which the analysts attribute to short covering, index re-balancing and seasonal demand from China. Still, the base case trends – tapering of QE, improving global economy and low inflation – are intact and factored in. Hence, the analysts believe the risk now lies with any disruption to this benign scenario. Macquarie expects mine supply will be only slightly below 2013, with new projects sufficient to offset reduced supply from older mines. Also, producer hedging, while likely to rise in this period of low gold prices, is not expected to have a significant impact.
So it's up to India to provoke any rally in gold, it seems. Macquarie notes the country's call on the global market was dramatically reduced by government intervention last year. The analysts believe the government policies will, in the end, be unworkable and controls will be relaxed at some point this year. Gold imports should pick up when this happens. The analysts believe a more substantial recovery requires fresh investor demand, or a sign that the global inflation genie is stirring. One notable aspect, according to Macquarie, is that China surprised the market last year by the extent of gold demand. The analysts assume this will continue in a theatre of low prices and growing incomes.
Two questions JP Morgan is asking in respect of the copper balance is how quickly concentrate stocks will be drawn down and whether mine supply disruptions will be lower than in recent years. Mine supply growth was driven by a rise in output in the second half of 2013 and global realised mine disruption of 2.3% was well down on expectations for 5.0% at the start of the year. This is a big change from recent years, when mine production tended to be over-estimated. JP Morgan expects strong production growth, primarily driven by high grading at major mines, will not persist.
Hence, the question regarding how quickly stocks are consumed. There's been a notable increase in concentrate stocks, particularly in China. JP Morgan expects a gradual drawdown as smelting outpaces production growth in concentrate. Outside of China, the analysts note stock accumulation occurred in Chile as a result of technical issues at key smelters and many of these issues are still to be dealt with. The analysts also expect exports of copper concentrate should continue from Indonesia. All up, for the present, the analysts expect cathode markets and LME copper spreads to stay tight in the first half of this year.
In zinc, the analysts conclude that aggregate mine production growth will be higher in the next two years than the prior three years combined. Zinc concentrate markets are expected to tighten from the second half of 2015 but JP Morgan does not expect any major refined market deficits until 2016.
On the subject of thermal coal, Goldman Sachs suspects productivity gains could be a mixed blessing for producers. The industry is now expected to focus on efficiencies instead of rushing supply to market, as demand growth slows and margins come under pressure. Higher volumes and lower costs at a company level imply an industry-wide downward shift in the cost curve. India and other emerging markets, while supporting seaborne demand, are not expected to match the scale seen in China in the period 2008-12. Environmental legislation will also increasingly take a toll. Global carbon prices are too low to affect consumption in the near term but the analysts expect they will drive future investment to other types of power generation.
Goldman analysts believe an end to improving productivity in China and a rise in input cost inflation is needed for seaborne coal prices to rally once more. Either that, or a faster appreciation of the Chinese currency. These scenarios while possible are considered unlikely. On the downside, falling commodity currencies and rising productivity is likely to drag the cost curve down and demand from emerging markets will suffer as a period of cheap capital comes to an end. This could put high cost producers under considerable pressure and Goldman analysts believe those in that camp in the US, Russia and Indonesia would respond with production costs.
Current prices should be sufficient to keep the market well supplied and meet modest growth and Goldman expects prices around US$83-86/t for 2014-16. India is considered the biggest wild card. There is significant latent requirement for electricity and domestic coal producers are unable to maintain enough supply, so coal must come from more expensive imports. Still, economic growth is slowing in India and the weaker rupee will affect demand for imports priced in US dollars.
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