Material Matters: Coal, Iron Ore, Copper And Gold

This story features WHITEHAVEN COAL LIMITED, and other companies. For more info SHARE ANALYSIS: WHC

-Coal price outlook poor
-Coal, iron ore stocks pressured
-Roy Hill a game changer?
-Copper stocks struggle
-Gold still a reserve asset
 

By Eva Brocklehurst

Metallurgical (coking) coal is going from bad to worse, in Macquarie's opinion. A quarterly contract settlement between Anglo Coal and Japanese mills has been agreed at US$120/t FOB Australia, down 16% from the prior quarter and below levels sustained during the global financial crisis. The broker notes increased supply has to be pushed into China, which has been the market of last resort for coking coals, but steel makers are exhibiting increased elasticity on the demand side. This is telling producers to take firmer action on reducing supply or, in Australia's case, shifting semi-soft tonnage into the thermal market, as current levels are unsustainable in Macquarie's opinion.

Given the excess supply, Macquarie sees no reason for the contract price to go above US$150/t in the next couple of years. Macquarie observes mills in China continue to hold excess inventories of finished goods, tying up capital and hindering raw material purchases, hence a de-stocking of metallurgical coal. Macquarie thinks the pull back in production will commence in China but the US capacity that's been in the Pacific Basin for some time now needs to exit the market. This is likely to now create pressure on the Atlantic price, which is currently at a premium.

Persistent weakness in coal prices has caused Bell Potter to downgrade short to medium term prices by up to 17% and long-term coking coal prices by around 10%. This has led to downgrades to earnings forecasts and valuations of key stocks. Whitehaven Coal ((WHC)) represents value at current prices, notwithstanding the subdued coal price, and the broker retains a Buy rating. The broker observes the company has overcome a number of challenges and is continuing to drive costs down. Bell Potter observes weak coal and equity prices have created opportunities for junior miners to consolidate and larger players to acquire undervalued assets. Coalspur Mines ((CPL)) is also a Buy rated stock and its valuations are not so affected by changes to the forecast. It is not expected to be in production until 2016. The broker believes the Vista project is attractive to strategic investors, when compared with competing thermal coal developments.

Major iron ore stocks are also under pressure as Chinese credit concerns drove spot prices to US$110/t. CLSA is concerned that new supply may drive prices lower in the second half, but the recent correction does provide a short-term opportunity ahead of the peak season in Chinese steel production. The broker's preference for BHP Billiton ((BHP)) is unchanged but upside to prices near term may offer an opportunity in Rio Tinto ((RIO)) and Fortescue Metals ((FMG)). CLSA sees a marked divergence in short-term free cash generation from iron ore producers. Only BHP and Fortescue appear to have significant surplus cash above capital commitments and dividends.

UBS has reviewed the implications of the Roy Hill iron ore development in the Pilbara, Western Australia. The plan is to ship through Port Hedland alongside BHP and Fortescue. The planned production of 55mtpa is to match the Port Hedland capacity allocation and first ore is schedule for September 2015. Based on the UBS price deck for iron ore the broker estimates a break-even price of US$54/dmt for the mine. Roy Hill is preparing to consider third party access/haulage once funding is complete. This should provide additional income and lower capital intensity, in UBS' view.

Atlas Iron ((AGO)) and Brockman Mining ((BCK)) are considered the most likely candidates, as both have 50mtpa of combined shipping entitlements. Provided unit costs are no more than $50/wmt Free On Board, their projects could be economic in UBS' view. Additional tonnage from any new entrants that benefit from Roy Hill is not included in the broker's supply/demand model but possible entry in 2017 is unlikely to materially affect the view, given the oversupply that's forecast and the long-term price forecast of a freight cleared US$89/dmt, in 2017.

Copper has been the worst performer of the metals so far this year and corresponding equities have struggled. JP Morgan has looked at the sector and the sensitivities to commodity and currency. From a valuation perspective PanAust ((PNA)) and Sandfire Resources ((SFR)) are the most sensitive, while the broker thinks OZ Minerals ((OZL)) is the most sensitive from an earnings perspective. The copper market is expected to be well supported in the near term. Drawing of inventories on the London Metals Exchange are expected to be sustained as demand growth in developed markets improves. In the medium term, with refined inventory rising in China, there's limited pressure upward pressure on the price.

The broker thinks a global refined copper surplus is likely in 2014. Sandfire and OZ Minerals are significantly affected by lower spot copper prices, while PanAust has some offset with a stronger gold price. JP Morgan retains a preference for PanAust, given its combination of strong free cash flow, upgrades on mark-to-market pricing in gold and medium term growth potential. Sandfire has the cash flow and de-risked balance sheet with an undemanding earnings profile, in the broker's opinion. The least preferred, OZ Minerals, has elevated operational risks, albeit a significant valuation discount.

In six months time the third agreement between central banks on gold will expire. This pact has limited sales of gold and, if it is not renewed, Macquarie observes it may be initially bearish for gold. Longer-term it's a positive as the broker does not think the agreement serves a useful purpose these days. The pact originated in the 1990s when the gold market was under siege and there was heavy European bank selling of gold as the reserves left over from the days of the Bretton Woods monetary system were reduced. The lumpy effect of such reductions on the gold price led to the agreement. Now, Macquarie believes there are few such sales and, prompted by the recent eurozone crisis, there is actually increasing interest in gold as a reserve asset. A better price performance has made it more conceivable to hold gold and, although the most recent price performance may not be so lustrous, there's little reason to expect a sizeable increase in central bank gold sales, agreement or no agreement.
 

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