Material Matters: Base Metals, Gold, Oil, Fertilisers And Iron Ore

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-Unexpected draw on lead stocks
-US oil production slows considerably
-M&A picking up in gold sector
-China's urea exports surge
-Iron ore demand still weak
 

By Eva Brocklehurst

Commodities

A recent rally in commodity prices now begs the question: how long will it last? With global oil in surplus Macquarie suspects the headwinds will resume to some extent. The lack of constraint on raw materials means some prices should continue to trade into the cost curve. Bulks are expected to trend lower mid year.

Sentiment was very subdued at the end of March and as demand improved in April, certain commodities such as copper, zinc and oil led a widespread price rally. Macquarie notes this was off a very low base in most cases and the vast majority remain below the average prices from April last year, being 50% lower in the case of oil, iron ore and bulk freight. The exceptions are aluminium and zinc prices, which are up on April 2014. Macquarie expects some improvement in underlying demand in China will offer support to refined metal prices over coming months.

Base Metals

National Australia Bank analysts find no evidence of an acceleration in growth, either in developed or emerging economies. The Chinese economy expanded by 7.0% in the March quarter, its weakest rate of growth since the GFC. The analysts note conditions softened for all base metals and new capacity has meant the copper market has moved back to surplus.

Deficits exist in aluminium markets outside China but the analysts expect premiums may fall as China increases exports. Weaker demand in nickel has offset supply constraints but a deficit is expected as high grade ore stocks are depleted. The zinc market appears the more balanced but the analysts expect a deficit will return with scheduled mine closures.

Lead prices surged in the quarter on the unexpected draw-down of stocks and the analysts find the medium term outlook for the metal is favourable. The lead price surged following a large cancellation of London Metal Exchange warrants on March 23 with more than 40% of stocks taken out of warehouses. The analysts expect the price to stay elevated for some time as the fundamentals show a lack of new mined supply outside of China, with tighter environmental controls on the refined lead industry also evident in China.

Oil

Oil prices rose in April on the back of escalating conflict in Yemen but NAB analysts do not expect serious disruptions to supply at this stage. There are some signs US field production rates are slowing and stronger domestic gasoline demand has reduced fears of an indefinite build up in US crude stockpiles. This provides some support to the market, the analysts contend. US production is expected to slow significantly more in the second half of 2015, as the impact of the reduction in rig count overwhelms efficiency gains from existing wells.

A temporary respite for oil prices is unfolding on softer momentum in the US dollar, with weaker economic information driving expectations that the US Federal Reserve will hike rates more gradually. The Organisation of Petroleum Exporting Countries (OPEC) is forecasting a strong pick up in global oil demand, emanating from China and India, while most developed countries, with the exception of the US, are expected to show declines.

Gold

Apathy is the word for the gold market at present, in the view of ANZ analysts. They suspect the next move in the price is dependent on the impact of US economic data on the US dollar. Physical gold demand is soft, with China's imports in March falling to a seven-month low of 66 tonnes. Indian imports were much stronger but this is the peak demand season in India and comes after the lifting of import restrictions in December. The analysts note the traditional safe-haven demand does not seem to be forthcoming for gold at this stage.

The Australian gold sector is signaling to UBS that merger & acquisition deals are picking up. OceanaGold ((OGC)) has bid for Newmont's Waihi gold mine while Evolution Mining ((EVN) is acquiring La Mancha's Australian assets. Meanwhile, Newcrest Mining ((NCM)) has its Telfer mine up for sale and Barrick has put Cowal on the market. UBS considers the environment for M&A is favourable as major overseas gold producers are looking to realise cash to restore balance sheets. Mid-tier domestic producers, which have restored cash flow, are seen taking advantage of this situation and finding value upside through extracting costs from assets that the major miners have overlooked.

For many investors, Newcrest is the gold play in Australia because of its size and liquidity but UBS has a negative stance on the stock, because of a lack of disclosure about Lihir. Instead, UBS is drawn to low -cost producers such as Alacer Gold ((AQG)), Independence Group ((IGO)) and OceanaGold.

Fertiliser

Prices for urea have fallen further in 2015 on the back of the drop in energy prices, and depreciating exchange rates in the case of a number of major producers. Macquarie suspects the market will be subdued this year as Chinese suppliers raise production levels to benefit from lower coal prices and favourable tax reforms. Exports are showing no signs of slowing and as long as this is the case global prices will be under pressure, the broker maintains. There is abundant supply of Chinese urea exports and it is now the main player to watch in this market.

Macquarie observes, as with many other commodities, China is exporting processed product at record levels. Increases in capacity have been driven by cheap feedstock which has pushed production costs lower. With coal prices declining further in 2015 Macquarie expects Chinese costs of production will fall by another 20%. The broker also observes that the adoption of a fixed export tax in China has supported producers and Chinese urea producers are expected to flood the seaborne market. Although the urea market could return to balance in 2018, Macquarie finds no reason for it to trade out of the cost curve, which is likely to move higher on any recovery in energy prices.

Iron Ore

UBS observes supply rationing is occurring in iron ore. Atlas Iron ((AGO)) will cut to 8-9mtpa from 14mtpa and BHP Billiton ((BHP)) has deferred the inner harbour de-bottlenecking project. Vale has signalled it will export up to 30mtpa less iron ore as new cheaper capacity replaces expensive mines. Cost cutting has accelerated and all-in break-even targets are into the US$35-45/t range for most major suppliers. Still more is needed, in the broker's opinion, as supply growth continues. Rio Tinto's ((RIO)) next 60mtpa comes on line in the near term and Roy Hill is expected to commence first shipments late this year.

There remain risks on the demand side, nonetheless. Steel output in China was weaker in the March quarter and while output picked up in April, the property sector remains under pressure. Land sales, which typically lead property construction starts by 5-12 months, fell 32% in the year to the March quarter. The broker is mindful that the iron ore price softens into the northern summer once the lift in spring construction runs its course.

Morgan Stanley observes seaborne iron ore prices lifted in late April, the first sustained lift in 2015. The broker suggests the rally was also a source of confusion following China's unexpectedly subdued steel production rates. Morgan Stanley suggests it might be a late buying spree for iron ore as China's mills would be reluctant to be short of ore ahead of the peak in steel production, regardless of the weakness in downstream demand growth in property and infrastructure.

The broker envisages further upside for the iron ore rally to US$70-80/t , but expects it will eventually be capped by more new low cost supply from Rio Tinto and BHP Billiton, and the seasonal pull back in steel production rates. This makes Morgan Stanley bearish on September quarter prices with ore prices to peak mid 2015.
 

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