Material Matters: Steel, Cement, Copper, Iron Ore, Oil And Gold

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-Steel, cement producers fight back
-Copper, aluminium surplus to stay
-Iron ore vulnerable to Chinese policy
-Oil price vulnerable to Iraq turmoil
-India key to further gold rally
 

By Eva Brocklehurst

Citi visited several steel and cement producers in China recently. They expect prices to remain weak in the current quarter while any rebound in the following quarter depends on Chinese macro policy. Environmental measures should herald consolidation in the industry, while the best opportunities for mergers and acquisitions are envisaged as yet to come. The broker finds few catalysts around to reinvigorate steel and cement prices and remains bearish on those sectors. Producers Wugang and Magang expect steel production to remain strong in the near term, which will weigh down the price.

Product upgrades are the way producers are fighting the downturn. Examples are Wugang expanding into autosheet and Magang improving train wheel production for high speed rail. In cement, Conch is leveraging its low-cost advantage. Huaxin notes strong infrastructure demand in Wuhan but considers this may not be enough to offset the property downturn. Citi also found that industry M&A has been slow and some producers expect further stimulus plans and want high prices, hence their unwillingness to sell. China's base metal consultants and traders expect a surplus should remain in place for both copper and aluminium in 2014/15, capping price upside.

Macquarie has looked at copper markets in China and has found rather stable fundamentals. Low stocks and consumer inventory levels are compounding a physical squeeze but expectations for a surplus remain intact. Refined copper supply is expected to outperform demand in the second half. The analysts note a visible surplus in the concentrate market, amid expectations for growing supply. Smelters are returning to production and supply is expected to improve sequentially, whereas demand lacks momentum. Macquarie believes this should undermine the recent rally in the copper price over the current half year.

BA-Merrill Lynch assumes new low-cost iron ore from the seaborne market displaces higher cost ore produced in China. Further risk to iron ore is based on demand for steel in China, primarily as a result of the weakening property market. China produces and consumes roughly half the world's steel, with residential construction accounting for around 20% of this demand. The key, too, is whether the government is preparing to step up stimulus measures. National Australia Bank analysts observe stockpiles of iron ore at Chinese ports are at record levels, although these remained fairly stable over June. There are also reports that some Chinese steel mills are selling future iron ore cargoes and purchasing material at the ports, for which the prices are lower. The NAB analysts suspect this may have supported the recent modest recovery in spot prices.

Macquarie thinks the investment case for the major miners has become uncomfortably exposed to the political will of Chinese policy makers. The miners have countered this vulnerability by cost cutting and capital management, but the momentum on these measures appears to be slowing in the broker's opinion. Further operating expenditure cuts look harder to make and buy-back potential is fading with a falling iron ore price, given the need to maintain balance sheets to shelter operations from price volatility.

The sector is not particularly cheap in the broker's view and both BHP Billiton ((BHP)) and Rio Tinto ((RIO)) are trading at premiums to historical averages. This suggests the market has faith in their initiatives. However, Macquarie suspects that with much of the anticipated free cash low generated by falling capex, and opex budgets being offset by falling commodity prices, there is a growing probability that investors get neither growth investment nor buy-backs. Fortescue Metals ((FMG)) is particularly exposed to growing discounts for lower grade material and Macquarie has downgraded its rating on the stock to Neutral from Outperform.

UBS has taken account of supply/demand balances and increased long-term oil price forecasts to US$100/bbl from US$92/bbl for Brent. The analysts also think long-term prices need to be near this level to enable non-OPEC production growth to match demand growth, and for North American producers to fund the capex required to support the majority of non-OPEC production growth. Meanwhile, strife in Iraq reduces the outlook for capacity growth in that country. The broker has raised 2014 and 2015 Brent forecasts to US$109/bbl and US$105/bbl respectively.

National Australia Bank analysts note relative price stability in Brent and Tapis in the first half of the year has been upset by the recent turmoil in Iraq. The deterioration in security for OPEC's second largest producer is yet to dent exports, given the fighting is located away from the production areas, but the spectre of further unrest should weigh on the minds of investors. Increased output from Saudi Arabia and Nigeria has been noted while US benchmark West Texas Intermediate has continued to climb relative to Brent. On balance, the NAB analysts think the fundamentals point to stable or moderately declining prices over the next six months. Still, a disruption to Iraqi supplies could turn all that on its head.

Political tensions, an easing of policy by the European Central Bank and softer US dollar contributed to a gold price rally in June. The NAB analysts note this is being countered by lower inflation expectations, which limits demand for gold as a hedge. Also, Exchange Traded Fund holdings have stabilised, relative to the sharp fall earlier this year, and a probe into commodity financing in China, which revealed some fraudulent gold transactions, could dent Chinese demand. Aside from geopolitical risks, a potential unwinding of India's gold import restrictions poses the most significant upside risk, in the analysts' view. They expect, in the medium term, that gold prices will ease to below US$1,100/oz as global interest rates normalise.
 

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