Material Matters: Commodity Markets, Gold, Resources & Energy Stock Previews

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-Substantial downside risk priced in
-Gold re-rating crucial to bull market
-Miners to maximise cost efficiency
-Focus on value vs volume for diversifieds
-Large impairments in energy expected
 

By Eva Brocklehurst

Commodity Markets

Commodities remained weak in January, despite a short-lived firming in crude on hopes OPEC and Russia may co-ordinate supply cuts. Iron ore prices also strengthened late in the month.

ANZ commodity analysts continue to believe these two markets remain most susceptible to further weakness, given ongoing supply issues and iron ore also witnessing a structural decline in demand. Sentiment has also worsened on suspicions Chinese demand is likely to be constrained by ongoing structural reforms.

The analysts acknowledge concerns may be overdone, as China recorded strong import volumes in December as a result of opportunistic buying, and inventories did not materially rise. The analysts suspect quite a lot of downside risk is now priced in but remain unsure of whether January signalled a nadir.

Goldman Sachs has revised forecasts and, marking to market, highlights a broad downward movement across most commodities. The broker notes major monthly price falls of 3.0% in copper and nickel, while gold is up 2.0%.

The analysts revise metallurgical coal forecasts down for 2016-18 by 12-18%. Lower prices among most commodities have had a negative impact on most stocks, with the broker downgrading targets for Rio Tinto ((RIO)), BHP Billiton ((BHP)), South32 ((S32)), Western Areas ((WSA)), Independence Group ((IGO)), Alumina ((AWC)), Sandfire Resources ((SFR)), BlueScope ((BSL)) and Sims Metal Management ((SGM)).

Gold

Macquarie observes many things have gone right for gold this year but the rally is most easily explained by changes in US financial variables rather than any re-rating of gold against these variables. While further gains are possible, the broker believes the yellow metal is vulnerable to any shift in macro sentiment.

Gold traded to a peak of nearly US$1,160/oz on February 5 [1190 since] , up 9.2% for the year to date, which made it the best performer so far in 2016. Macquarie expected the rally but asks whether there is more to come?

The broker suspects that an actual re-rating of gold is crucial for a lasting bull market. On present evidence, a shift in macro sentiment which brings a US Fed tightening closer is likely to end the rally abruptly, Macquarie asserts.

Morgan Stanley also observes the indifference gold showed to the metal markets slump in 2015. The broker also believes the lift in the gold price in the year to date is mainly based on persistent US dollar weakness, which is the outcome of a belief that global growth will stay subdued.

Morgan Stanley forecasts a US$1,080/oz price in 2016 and longer-term expectations are generally flat with a peak at US$1,200/oz in 2018.

Resources Previews

UBS expects a number of Australian miners will use the lower inputs – FX and oil prices – to maximise cost efficiency. Bulk miners will benefit from lower sea freight rates while those with higher strip ratios and owner operator fleets will realise operational expenditure savings.

The broker also suspects estimates may surprise on the upside if the market has not correctly anticipated the FX impact on US dollar revenue and non-US dollar denominated costs. Miners with development projects and high sustaining costs may also witness deflation in capital intensity.

For diversified miners the broker expects the focus to be on value over volume. OZ Minerals ((OZL)) will be scrutinised for its 2016 guidance and the dividend. Guidance will also be key at Newcrest Mining ((NCM)), which switches to US dollar reporting in this financial result.

Energy Previews

Goldman Sachs is keen to hear from Santos ((STO)) and Origin Energy ((ORG)) regarding debt levels and cash conservation efforts. Both face financial stress due to the timing of their investment cycles as they reached peak debt as the oil market turned. The broker considers Origin Energy better placed of the two, but both are likely to continue cutting costs and seeking divestment.

In oil, Goldman prefers InterOil ((IOC)) on its attractive valuation and Caltex ((CTX)) for earnings momentum and capital management potential. The broker expects large impairments across the sector which, in most cases, should not have a material impact on valuation.

DUET ((DUE)) is the preferred utility for strong yield and growth. The broker looks for updated guidance on new acquisitions by both DUET with Energy Developments and Spark Infrastructure ((SKI)) with Transgrid.
 

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