Material Matters: Mineral Sands, Copper, And Coal

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-Gradual mineral sands price rises
-Entry point for copper looming
-Impaired value for Rio's Grasberg?
-Coal price weakness continues
 

By Eva Brocklehurst

Credit Suisse thinks conditions are ripe for a recovery in mineral sands prices. The remaining zircon and titanium dioxide inventories are concentrated with Rio Tinto ((RIO)) and Iluka Resources ((ILU)) and the broker observes the pair have the strength to liquidate stocks slowly this year, without discounting, in contrast to 2013. Credit Suisse expects a global deficit of 181,000 tonnes of zircon in 2014 which should be enough to shrink inventories to 140,000t. The high grade titanium feedstock is dominated by Rio Tinto, which has indicated there's half a year's supply on hand. Credit Suisse has reduced price expectations for the second half of 2014 and into 2015, expecting any recovery will be gradual.

Credit Suisse strategists assume that, until economists cast doubt on China's 7-7.5% growth forecast for 2014, there's enough momentum in construction to sustain zircon and titanium dioxide demand. Moreover, the analysts believe mineral sands are more defensive against Chinese growth risks that the likes of iron ore, for example. The reason is that high grade chloride titanium dioxide feedstock is not used in China and zircon supply/demand forecasts do not assume strong Chinese growth. The analysts note there's insufficient visibility in ilmenite to provide a definitive outlook but there are abundant supplies in China, apparently. Hence, the price forecast is subdued for 2014 but Credit Suisse expects a modest recovery in 2015.

The copper market is in transition, in Macquarie's view. Raw material is being pulled into refined copper stockpiles and concerns about Chinese growth are pushing prices down. Macquarie expects sentiment to remain subdued but for the longer term outlook, an entry point is approaching for the metal, although a V-shaped recovery in the price is not considered likely. The spotlight will increasingly fall on deceleration in mine supply as the year progresses. Macquarie's analysts believe tight credit conditions in China will continue and, as a result, near-term sentiment towards copper will stay skewed to the short side. A price around US$6,000/t is considered possible over the next few weeks should concerns over China's growth escalate and the analysts believe it's too early to say the worst has passed for copper.

Morgan Stanley suspects a real risk of impaired equity value at Rio Tinto' s Grasberg copper mine. The broker formed this view following a visit to Indonesia to examine the mineral export restrictions. Grasberg is one of Rio Tinto's four key copper assets. Since January, there's been an obligation to process all ore in the country but Grasberg only has capacity for 40% to be smelted. Hence, 60% of the mine output has been shut in. Rio Tinto projected no metal share this year so this makes little difference to earnings. Going forward, there is the potential obligation to reduce the company's 40% stake while the new export duties make concentrate export uneconomic.

As a base case Morgan Stanley models full production and no divestment of any stake. The indefinite reduction in output and a divestment of control, as a bear case, could significantly erode the value of the company's stake, albeit the impact would be limited at a group level.Grasberg is one of the world's largest copper and gold mines in terms of reserves and production and the majority stake is owned by Freeport. Rio Tinto is in joint venture for a 40% share of production above specified levels until 2021 and for 40% of all production after 2021. Morgan Stanley focuses on the Grasberg contribution at the net asset value level rather than earnings level, as it is only after 2021 that the mine contributes a significant share of copper output and revenue.

Coal prices continue to trend lower. Goldman Sachs observes a significant share of seaborne production will operate at a loss in the second quarter, a result of the metallurgical (coking) coal benchmark settlement at US$120/t and the declines in spot prices, down 19% year to date. Goldman estimates a further 7mtpa of metallurgical capacity may have to close in 2014 to move the market back towards balance. In the thermal market, recent trade data from those at the higher end of the cost curve show that a slowdown in export volumes is yet to happen. Thermal coal prices are range bound, with the annual contract price with Japanese utilities reportedly settled around US$81.80/t. Many producers are operating at a loss under current prices but supply remains plentiful.

It adds up to the inevitable expectation for more downside to come, in the broker's view, as a delayed supply response from marginal seaborne producers and ongoing weakness in the Chinese market results in a longer period of oversupply. Goldman thinks the current prices are unsustainable but the resilience of producers in the face of operating losses and the deflationary pressure from rising productivity suggests an eventual recovery will be gradual. The broker notes the take-or-pay contracts on port and rail are widely blamed for preventing loss-making mines from cutting production, particularly in Australia. US exports have started to decline but this is being more than offset by strong growth in exports from Australia.
 

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