Material Matters: Nickel, Coal, Iron Ore And Gold

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-Multi-year nickel deficit likely
-Some cut backs in coal supply
-Iron ore supply growth continues
-Gold break out likely on the downside
 

By Eva Brocklehurst

With the exception of iron ore, Macquarie observes supply growth rates in bulk materials and metals markets are finally slowing, as the miners' productivity push abates. Demand outside of China is outperforming expectations as sentiment turns more positive. China is still expected to deliver the majority of global commodities demand this year, but the government's efforts to drive change in the business models of state-owned enterprises and maintain tight credit means sentiment is being kept in check.

Macquarie thinks nickel's story is just starting. For the first time in over two years there is a pronounced constraint to the raw material because of the Indonesian ore ban. Ore prices have doubled this year and fed through to higher quotes on the London Metal Exchange. There are some concerns that Indonesian nickel pig iron capacity could ramp up more quickly than expected via the blast furnace route. Macquarie thinks this view is flawed as the saprolitic ore faces severe technical challenges when used in a blast furnace. Even with aggressive re-balancing assumptions, Macquarie believe a multi-year deficit in the metal is likely.

In contrast, bulk commodities are suffering from the supply growth from the past two years and need higher Chinese imports to clear the market. Macquarie has once more lowered both metallurgical (coking) and thermal coal price forecasts, as a reticence to cut immediate supply and a lower cost structure in China prolong the impact of the supply overhang. The analysts observe there's some supply reaction from the coal market which should limited downside risks form current spot levels. This is not the case in iron ore, with supply continuing to exceed expectations.

UBS has revised iron ore price forecasts lower for 2014, by 9% to US$111/t. Chinese steel production is running at record rates and iron ore supply is also at record rates. Much of the steel production is ending up in the export market, signalling to UBS that domestic consumption is not as strong as the production data would suggest. UBS has reduced earnings forecasts for Australia's major iron ore producers, by 12% for Rio Tinto ((RIO)), by 11% for Fortescue Metals ((FMG)), and by as much as 29% for Atlas Iron ((AGO)) in FY14. Australia's strong supply response to the lift in Asian steel making activity is largely to blame for the drop in prices and UBS has retained longer-term iron ore price forecasts.

UBS counters perceptions there is reduced demand for iron ore. China's imported and domestic ore supply is at record highs. Steel output is at record highs and steel inventories are being drawn down. Regional steel prices are either stable or lifting. So, if consumption is robust then the weaker price must be a function of even larger supply. Brazil and India have delivered little growth in volumes so the surge has come from Australia. UBS already forecasts a 19% lift in Australia's 2014 exports, but notes the actual expansion rates are even larger. Pilbara ports are shipping at record rates and a competitive push by Australia's three biggest names in iron ore is creating a surplus and undermining prices.

The supply surge has encouraged discounting among the miners, short selling by traders and a push back from the steel mills. The policy shifts by the Chinese government to address excessive sintering and steel production capacity are also bearish. The broker thinks pure play iron ore stocks are the most exposed to the deteriorating fundamentals and the long life, low cost assets of the diversified majors offer the best margin protection.

The gold market is waiting for an event to break prices out of the US$1,270-1,320/oz range of the past six weeks. ANZ analysts think China will be the market to watch, given a mild retracement in that country's currency over the last two weeks has helped improve the Shanghai-London gold premium. The analysts think this is unlikely to trigger a supportive price response. The market is also watching India, hoping that the incoming government will relax import restrictions on gold. Furthermore, electronic traded fund selling of gold has pressured the precious metal, more than unwinding gains sustained during the year.

ANZ analysts believe, if a break out of the range occurs, it will be to the downside. Moreover, on COMEX, speculative gross short positions have been unchanged for three weeks, while those holding long positions have been quick to take profits on rallies. The analysts observe the tensions in Ukraine deserve continued monitoring but the market reaction to the news flow is waning.
 

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