Material Matters: China, Iron Ore, G7 On Steel & Aluminium, BHP, Nickel And Oz Gold Miners

This story features FORTESCUE LIMITED, and other companies. For more info SHARE ANALYSIS: FMG

-Buying opportunity in iron ore?
-G7 strategies re steel, aluminium likely
-More value in shrinking BHP?
-Nickel deficit looms but price capped
-AUD drift down to support Oz gold miners
 

By Eva Brocklehurst

China Outlook

UBS observes real demand is improving in China, just as speculative and re-stocking demand reverses its first quarter momentum. Still, the broker's contacts expect sequential growth to slow through the second half.

Steel prices are expected to fall as supply is re-commissioned and outweighs demand. This, in turn, is expected to compress mill margins and suppress iron ore and metallurgical (coking) coal prices.

The broker observes neutral copper price risks relative to current forecasts, while aluminium and alumina are in deficit with production re-starts likely to cap prices in the near term. Meanwhile, zircon and titanium demand is lifting, but UBS does not observe any pricing tension returning as yet.

Iron Ore

Iron ore prices are back at levels not seen since February and Macquarie observes falling rebar prices in China have clearly put it under pressure. The likelihood is that both steel and iron ore could overshoot on the downside in the near term.

The broker observes steel production rose 0.5% in April and supply has responded to improved margins. Inventory build-up in steel appears to be pushed by supply, rather than any re-stocking demand. Prices should, fundamentally, be sustainable at US$50/t for iron ore, with US$60/t a cap to prices given the sensitivity of supply to re-starts, the broker maintains.

Macquarie suspects the current softness in iron ore pricing could present a buying opportunity for the iron ore miners. Port data suggests Fortescue Metals ((FMG)) is shipping ahead of forecasts while BHP Billiton ((BHP)) is lagging and could miss FY16 guidance.

Rio Tinto ((RIO)), meanwhile is running in line with forecasts. The broker's latest port data has separated shipments for Roy Hill berths for the first time. Roy Hill's shipments have been running at close to 30mtpa for the past four weeks. The broker's preference in the sector lies with Fortescue Metals and Rio Tinto.

Steel & Aluminium at G7

The G7 is in discussions around potential solutions to global industrial over-capacity. Macquarie believes steel and aluminium will be at the forefront of the talks, given the scale of excess supply, high Chinese exports and the interest generated among the G7 constituency.

While the US is likely to lead the lobbying call, the broker observes it is actually the smaller G7 manufacturing oriented countries such as France, Italy and the UK which have suffered the most.

While steel exports tend to hit the headlines, Maquarie notes China's output has dropped more rapidly than its peers in the past three years. In contrast, aluminium has been steadily ramping up, meaning 55% of global output now originates in China.

Macquarie suspects that, like it or not, what happens in China will govern these industries over coming years and, from a G7 perspective, they should accept these industries are lost. Hence, the G7 discussions are expected to be about strategies to protect areas where the next battle lines are likely to be drawn, namely capital goods.

BHP Billiton

Citi suspects BHP is suffering an identity crisis. Its diversity during the “super cycle” was expected to help its dividend policy weather any downturn but the deterioration in commodity prices has proved this incorrect.

Now the broker observes there is nothing in the company's proposed minerals development pipeline defined as greenfield discoveries while oil exploration has been more successful in that regard. While de-merging South32 ((S32)) was viewed as, partly, a recognition that more complex operations do not suit the company's profile, Citi believes there is more work to be done at core operations to be best in class in terms of operating performance.

The broker also observes a reluctance at BHP to trade low margin third party material more aggressively and suggests failed tilts at Rio Tinto and Potash Corp indicate M&A is not the company's forte either. To value the stock the broker notes the main issue is increased volatility around earnings and dividends, and further analysis suggests the company could deliver greater shareholder value by shrinking the business further.

Nickel

Macquarie finds increasing signs the nickel market is moving to deficit, amid a significant tightening of the global physical market. Production cuts have so far been larger in nickel than for any other base metal. Macquarie forecasts a deficit of over 70,000 tonnes this year.

Nickel use has surprised the market, with a sudden rise in Chinese stainless steel production. Macquarie observes March production rose 50% month on month. The surge is a consequence of the fiscal and monetary stimulus enacted by the Chinese government, with a real consumption impact in construction and infrastructure.

While this is expected to unwind gradually in the second half of the year it should still leave usage higher than previously envisaged. Macquarie also observes a tightening in supplies of secondary nickel. If the nickel scrap shortage turns out to be more serious than assumed, and nickel ore supplies from the Philippines do not accelerate sharply, the broker suspects the deficit into 2017 could even be larger.

While history suggests high inventories do not stop prices rising when the market moves to deficit, Macquarie believes high stocks will restrict, but not prevent, upside in nickel prices over the next 18 months.

Gold Miners

Gold prices are likely to rebound to over US$1,400/oz by mid 2019, driven by investment demand, inflation and global negative real rates, Macquarie contends. In this case the broker's revamped, lower-for-longer, Australian dollar forecasts translate to a 1-6% increase in forecasts for the Australian dollar gold price.

In the near term, however, Macquarie believes weakness in gold is not helped by the Australian currency and expects Australian dollar spot gold to trend down to $1,670/oz. Marking to market the gold price has driven modest upgrades to all producers, with the broker noting Alacer Gold ((AQG)) and Saracen Minerals ((SAR) feature larger percentage upgrades because of modest earnings forecasts in the current year.

Key near-term beneficiaries of the broker's lower currency estimates are Evolution Mining ((EVN)) and St Barbara ((SBM)). As a result of the strong appreciation in the share prices the broker has downgraded Evolution Mining to Neutral from Outperform and Regis Resources ((RRL)) to Underperform from Neutral.
 

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