Material Matters: Downtrodden Miners, Iron Ore, NatGas, Gold And Nickel

Array
(
    [0] => Array
        (
            [0] => ((BHP))
            [1] => ((AGO))
            [2] => ((FMG))
            [3] => ((BCI))
            [4] => ((GRR))
            [5] => ((MCR))
        )

    [1] => Array
        (
            [0] => BHP
            [1] => AGO
            [2] => FMG
            [3] => BCI
            [4] => GRR
            [5] => MCR
        )

)

This story features BHP GROUP LIMITED, and other companies.
For more info SHARE ANALYSIS: BHP
The company is included in ASX20, ASX50, ASX100, ASX200, ASX300 and ALL-ORDS

-Why own a miner?
-Iron ore discounts widen
-Gas outlook mixed
-India a catalyst for gold
-Risk of nickel price spiral
 

By Eva Brocklehurst

Why would you own a miner? That is the question Citi thinks investors are asking. The broker observes the miners are doing all the right things, such as cutting capital expenditure and costs and attending to value-adding growth but the macro environment is not supportive. The market is mispricing the value available in mining stocks, in Citi's view. The broker aims to identify those that are mispriced, arguing that, while mining is not a growth sector overall, any value-accretive growth should be rewarded. Citi is adding BHP Billiton ((BHP)) to its European focus list, as the company is looking to divest non-core assets and is expected to restructure over the next six to 12 months. The broker also expects the company will return cash in the form of a buy-back close to mid year.

Iron ore: If the fall in the price so far this year is not enough, UBS notes the discount that lower quality product receives has now widened materially. The discount for 57-58% iron product, priced off the 62% index, is upwards of 15% today from 4-5% in January. An increase in impurity discounts implies break-even prices for iron ore miners have risen. The extent of this rise now means some companies are struggling for cash.

Atlas Iron's ((AGO)) break-even price has risen to US$89/dmt, from US$81/dmt, such that UBS calculates the all-in cash margin has been reduced to US$3/t, from US$35/t when the analysis was performed back in March. Fortescue Metal's ((FMG)) margin has shrunk to US$15/t from US$55/t while BC Iron's ((BCI)) is down to US$13/t from US$46/t. For Grange Resources ((GRR)), UBS assumes the pellet premium has dropped to US$20/t from US$30/t and estimates the company is cash negative at the current 62% index price.

National Australia Bank analysts note the bulk commodity market was weak again in May and iron ore prices continued to ease. Thermal coal prices remain weak while metallurgical (coking) coal pushed a little higher. All these markets remain well supplied. Oil prices are garnering support from tensions in Ukraine and a coup attempt in Libya also drove Brent higher in the month. US natural gas prices moderated slightly as production continued to proceed at a record pace. Prices are around 13% above the same time last year on extremely low inventories. In contrast, European gas prices are still sliding, with low heating demand on the back of a warmer-than-usual spring and one of the mildest winters in several years.

Meanwhile, Russia's Gazprom has signed a landmark supply deal with China which will allow the company to supply 38 billion cubic metres of gas to China annually for 30 years, lessening the pressure from any US and EU sanctions on Russia. The NAB analysts believe the attempt by Europe to wean itself off Russian gas is not likely to be successful, given a lack of feasible alternatives. So far, natural gas from Russia to Western Europe via Ukraine is flowing as normal.The analysts expect a further weakening in natural gas prices in the northern hemisphere over the summer.

Asian gas imports are expected to be robust, as the pressure to steer away from nuclear energy in Japan and Korea and polluting sources of energy in China lend support. China plans to develop diversified sources of natural gas with supplies from Asia, Australia and now Russia. Japanese imports of LNG and coal have reached unprecedented levels as a colder-than-usual winter and tight global supplies produced a flurry of stockpiling activity by utilities. South Korea, the world's second largest LNG importer, has maintained a resilient pace too. Overall, NAB analysts maintain price forecasts for gas, as the risks for the outlook remain broadly balanced.

Gold's risk premium has come down, as tensions between Ukraine and Russia are viewed as less disruptive. The analysts observe the average price of gold fell slightly in May following a period of relative stability. Given the unpredictable nature of emerging markets and geopolitical risk, the analysts think it possible that the US dollar – with which gold usually has an inverse relationship – and gold will experience periods of positive correlation. Longer term the US dollar is expected to strengthen on the back of an improving macroeconomic environment and a resultant rise in risk appetite will drive gold prices lower.

One potential upside risk is stronger demand from Asia, as consumers respond to lower prices. Specifically, India's ban on gold imports could have a significant impact if it is fully reversed by the new government. The ban has already been modified and expectations are for gold imports to almost double from the 25-30 tonnes per month currently being booked. Still, the analysts believe this will be largely offset by reductions in illegally imported metal and there is the potential to tighten the ban if the country's current account begins to deteriorate again.

ANZ analysts suspect traders may opt to wait and see until after the Indian budget in July, as the market is speculating that a reduction in the gold import duty could be announced. They believe the speed at which the new government moved to remove some of the distortion in gold trade policies could herald more changes in the future. ANZ analysts have revised near-term and medium-term gold price forecasts lower.  China's response to the drop in gold prices since March has been soft in comparison to last year and the analysts suspect there has been a substantial building of stocks onshore. September and December 2014 gold forecasts are revised down to US$1,220/oz and US$1,180/oz respectively. In the medium term, exchange-traded fund selling is expected to continue pressuring prices.

Morgans observes nickel prices have strengthened significantly in the wake of the Indonesian ban on nickel ore exports but does not expect the same dynamics are in play for other ores such as copper and bauxite. Nickel is among the smallest of all London Metal Exchange-traded base metals, and small changes in supply/demand dynamics have more of an impact than in larger markets like copper and aluminium. Morgans does not expect copper prices, subject to a similar ban on ore exports, will skyrocket any time soon, as the quota the Indonesian government has set is more than enough for both Freeport and Newmont to continue normal exports.

As the improving supply demand dynamics for nickel are policy driven by the government and not by economics, the analysts warn that trading the current upward momentum in nickel holds a risk that,if the country decides to water down the legislation because of pressure from customers or declining terms of trade, the price could correct rapidly. The broker believes opportunity lies with the higher cost producers such as Mincor Resources ((MCR)), which would benefit from improved margins.
 

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

Click to view our Glossary of Financial Terms