Material Matters: Bulks, Precious Metals, Energy and Copper

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

Varied drivers for iron ore and coal; precious metals trajectory; focus on US oil production; copper drifts.

-Improved commodity prices factored into FMG and WHC?
-Evidence mounting for correction in silver prices
-Positive outlook for gold as real rates remain low
-US oil production still observed heading lower
-Subdued price action in copper heralds soft outlook
 

By Eva Brocklehurst

Bulks

Bulk commodity prices – iron ore and coal – have been stronger than UBS had expected in recent months. The drivers are varied but include Chinese steel prices and margins, which are conducive to higher raw material prices, while weather has affected Shanxi coal production. Some features of the rally will reverse and, on balance, the broker believes markets are a little tighter than previously expected.

UBS raises iron ore price forecasts by 6-7% for 2016 and 2017, to US$53/dmt CFR and US$50/dmt CFR, respectively. Hard coking coal estimates are lifted to US$96/t and US$101/t for 2016 and 2017 respectively, while thermal coal lifts to US$59/t for both years.

While Fortescue Metals ((FMG)) and Whitehaven Coal ((WHC)) have been the best performers over the year to date, as commodity prices have enabled debt to be reduced, the broker believes this is now factored into share prices. UBS retains South32 ((S32)) as its preferred exposure.

Goldman Sachs highlights the price movements for thermal coal, up 32%, metallurgical coal, up 28% and iron ore, up 12% month on month in August.

The broker's upward revisions to coal and Henry Hub gas forecasts have resulted in upward revisions to BHP Billiton ((BHP)), Rio Tinto ((RIO)) and South32 earnings per share estimates while the stronger Australian dollar has reduced 2017/18 estimates across the remainder of stocks under coverage.

Silver And Gold

The gains in the silver price in the year to date could be short-lived Citi contends, following a 7% decline in August. The broker observes both gold prices and the niche silver industrial sectors have stalled. A steepening curve and money market positioning add to the evidence for a correction.

Citi suspects the prospects for a rate hike from the US Federal Reserve at the upcoming FOMC meeting is slightly reduced following a soft employment figure in August. Despite the removal of US dollar pressure for now the broker does not believe there is enough impetus for markets to resume an overweight exposure in silver in the short term.

The broker notes US silver eagle coin sales have slumped and the cause is likely to be a function of price-sensitive retail investors preferring to buy on the dips. Citi expects silver prices to average US$19.20/oz in the December quarter.

Where did all the shine go? That's the question UBS asks regarding gold equity sentiment, which has turned almost 180 degrees, falling on an improving outlook for US interest rates. UBS maintains a positive view over the medium term for gold, considering real rates remain low or negative.

The broker believes gold has entered a new bull run and US real rates are likely to fall, with equilibrium real rates having limited upside. While recent Australian dollar strength has cast doubt over the direction of cost reductions for the sector, companies are still expected to keep a lid on costs.

The broker remains drawn to Evolution Mining ((EVN)) for asset diversification and notes Regis Resources ((RRL)) for production growth and a net-cash balance sheet. At the smaller end, UBS has raised its rating on Silver Lake Resources ((SRL)) to Buy. The broker also upgrades copper/gold stock Sandfire Resources ((SFR)) to Buy as value is emerging.

Energy

Global oil prices have declined following a build up in US inventory amid scepticism that OPEC members will commit to a production freeze at the meeting in Algeria scheduled for September 27-28.

UBS observes the market is focused on the US oil production and a sustained decline should help bring global supplies back into balance. Weekly estimates suggest US oil production is continuing its downward trend from a peak of 9.6mmbbl/d in June 2015, driven by lower rig activity.

UBS calculates that Woodside Petroleum ((WPL)) has the lowest break-even free cash flow for 2017 at US$29.54/bbl, trading at an implied oil price of US$62.16/bbl. Santos ((STO)) trades with the highest implied oil price of US$63.78/bbl.

Copper

A 3% increase in FY16 copper prices, revisions to FX forecasts and model updates to incorporate results means Goldman Sachs makes FY17/18 adjustments to earnings-per-share forecasts that range from down 9% to down 99%. The largest change is for OZ Minerals ((OZL)), which reflects the current break-even position of net profit.

Morgan Stanley observes copper has somehow missed out on China's credit surge this year and is now drifting into the typically tough trading period in the December quarter. The broker notes most of the 2016 price action has related to metal transfers in and out of China.

Grid investment in China is strong but the broker flags the fact it is being directed to less copper-intensive activities. Meanwhile, growth in construction has slowed to low single digits and while automotive output in July was robust the lift was from a low base.

The broker does not envisage a large copper surplus in 2016 and believes supply is sufficient to meet subdued demand growth.
 

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