Material Matters: Iron Ore, Energy, Base Metals And Gold

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-Iron ore production growth uncertain
-OSH, STO hard hit by soft LNG prices
-Losses still accruing for nickel producers
-NAB analysts: gold to resume downtrend 
 

By Eva Brocklehurst

Outlook

Heightened financial market volatility is dominating most commodity markets yet National Australia Bank analysts contend it is the fragile balance of supply/demand factors which is most material to the outlook.

The NAB US dollar denominated non-rural commodity price index is expected to fall by around 13% in 2016 and a further 8% in 2017, led by iron ore prices. US dollar appreciation is expected to partly offset the decline in Australian dollar terms. Overall, the analysts suggest Australia's terms of trade will continue its gradual descent.

Iron Ore

The analysts note iron ore and metallurgical coal prices have risen considerably in recent months as a credit-fueled rebound in Chinese construction activity underpins steel production. They argue that this is not sustainable, given excess property supply in many locations. Prices are expected fall on weaker demand, but the duration of the current uptrend is unclear. The analysts expect iron ore prices to average US$42.50/t in the second half of 2016 and US$40/t in 2017.

Port Hedland export data for June shows iron ore exports totalled 41.8mt, a record month both in terms of tonnage shipped and daily run rate. This should not be a surprise, UBS maintains, as Roy Hill is now contributing to exports along with the other big three.

The broker estimates BHP Billiton's ((BHP)) share for the month is 56.0%, up 9% sequentially. Fortescue Metals ((FMG)) share is 35%, up 6% sequentially. Roy Hill shipped around 2.0mt in the month of June, as it ramps up towards nameplate of 55mtpa.

Macquarie suggests BHP will miss its FY16 iron ore shipment target, with a 255mt result considered likely against a target of 260mt, while Fortescue could deliver a slight beat to guidance. The ramp-up at Roy Hill, which has gathered pace, represents some upside risk to iron ore supply estimates in the second half, the broker acknowledges.

Growth beyond 2016 is uncertain, Macquarie contends, with recent commentary, particularly from Rio Tinto ((RIO)), suggesting the commitment to its 350mtpa target could start to diminish.

Energy

Oil markets suggest significant upside risks exist to global supply in the short term, despite falling US production. Therefore, the NAB analysts maintain up-moves in prices will be relatively constrained in the near term and prices will fluctuate between US$45 and US$50 a barrel in the September quarter. LNG prices are also expected to be subdued unless there is a substantial jump in the price of oil.

UBS observes, with LNG prices lagging oil by around three months, these should bottom in the June quarter. Stocks such as Oil Search ((OSH)) and Santos ((STO)) are expected to be hardest hit, with the forecast LNG price to be 20-23% below the first quarter. The downside protection in Woodside Petrolem's ((WPL)) LNG contracts is expected to limit revenue declines to 3%.

Coal

NAB analysts expect hard coking (metallurgical) coal contract prices to average US$89/t in the second half and US$84/t in 2017. Thermal coal prices are expected to decline in the next Japanese fiscal year to US$58/t.

Citi upgrades its thermal coal price forecasts for 2016-19 by 12-37% and coking coal forecasts by 2-19% for 2016-18. The broker expects a recovery in coal, as well as in oil and copper prices, will drive BHP Billiton's earnings higher in FY17, partly offset by the bearish outlook for iron ore prices. For Rio Tinto, the broker suspects the upgraded coal prices will be largely offset by higher Australian dollar forecasts.

Base Metals

For base metals, the NAB analysts note demand from China has supported copper recently while aluminium faces favourable long-term demand from car making and power generation. Weak prices for nickel have delayed rather than cancelled new supply, they observe. Meanwhile, zinc deficits are expected in 2016 and 2017 and lead remains well supplied.

UBS observes the new government in the Philippines is placing its mining industry under greater scrutiny. This has potential to constrain or reduce the nickel ore export trade over time. At stake is around 400,000tpa of contained nickel supply which is mostly exported to China. This trade accounts for around 20% of global mined supply and almost all of China's nickel pig iron feed.

The nickel spot price has lifted around 10% to US$4.46/lb which is attributed, in part, to the supply risk emerging from the Philippines. UBS maintains spot prices have not reached levels which would put the industry back on a sustainable footing and cash losses are still accruing for many producers.

Nevertheless, there are some positives emerging on the demand side as China's stainless steel consumption has lifted 5.7% in the year to date, with the mix shifting to nickel-bearing stainless. UBS also suspects re-stocking in stainless could be a source of potential upside.

Gold

The NAB analysts suspect the US will take a more cautious approach to monetary tightening post the Brexit vote and this signals further upside potential for gold in the near term. They nonetheless expect gold prices will resume a modest downward trend in the December quarter. Gold is expected to trade above US$1300/oz for the remainder of the September quarter, ending 2016 at US$1280/oz before moderating to US$1100/oz by end 2017.

Citi upgrades its gold price forecasts by 4% for 2017 and 2% for 2018, but ascertains the impact is largely offset by higher forecasts for the Australian dollar.
 

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