Material Matters: Bulks Forecasts, Coal, Copper, And Gold Stocks

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Morgan Stanley upgrades forecasts for bulk prices; surging coking coal; copper outlook brightens; and time to engage with gold stocks.

-Morgan Stanley's top 5 picks in resource stocks carry coal and gold exposure
-Coking coal price expected to be more resilient than thermal coal
-End user demand for copper picking up, smelters hanging out for high charges
-Rapid de-gearing of gold stocks likely to provoke investor attention
 

By Eva Brocklehurst

Bulk Commodity Forecasts

Morgan Stanley's quarterly updated commodity price forecasts are most pronounced for bulks. These are the materials that have benefitted most from the stimulus and policies applied in China and the broker's forecasts are raised 10-30% for 2016-17 yet remain 10-90% below spot prices, so upside risk still exists.

The broker's top five picks in resources carry coal and gold exposure. These are Perseus Mining ((PRU)), Whitehaven Coal ((WHC)), BHP Billiton ((BHP)), Evolution Mining ((EVN)) and Rio Tinto ((RIO)). While BHP and Rio Tinto are a nod to quality and longevity the broker has Perseus and Whitehaven in the mix to combine growth and value.

There remains the potential for a pullback in the fourth quarter in commodity prices, particularly iron ore, and Morgan Stanley believes this has the potential to weigh on the sector in the short term. In the context of an industry that has refinanced and is still pursuing productivity gains, while facing favourable mark-to-market price revisions, the broker envisages equity weakness as a buying opportunity.

Coal

Macquarie observes the rise in metallurgical (coking) coal appears unstoppable, with spot prices trading at US$210/tonne and up 123% from US$93/t on July 1. The meteoric rise has largely been caused by the Chinese decisions regarding the 276 operating days policy, with some support from demand. Surveyed traders are forecasting US$150/t in 2017 while Macquarie expects US$121/t.

Thermal coal's base is shakier, the broker contends, with prices having rallied 24% to US$73/t over the same period. The Chinese government has stated that it allow some extra thermal production to shift prices back to US$60/t.

The impact of these price moves has been disproportionate for coal producers, in Macquarie's view. Whitehaven Coal produces 80% thermal coal and 20% semi-soft PCI material, which typically trades at a 10% discount to the already-discounted semi-soft price, but has experienced a share price rally of 126%.

In contrast, the broker notes South32 ((S32)) has rallied just 56%, with 24% and 11% of EBITDA from coking and thermal coal respectively and with material that receives the benchmark price for hard coking coal. Macquarie believes there is material upside risk to its base case forecasts and the outlook for coking coal is extremely positive while the risks for thermal coal are becoming more apparent.

Shaw & Partners observes the first signs the panic buying in coking coal may have eased. Spot premium prices flattened over the last day or so and spot prices appear to be heading for the first week on week decline since the beginning of August.

While demand for seaborne supply remains relatively strong in China because of ongoing logistic constraints for local coal, demand from end users outside of China has slowed. The analysts observe, with China's domestic coal prices still well below seaborne material, Chinese end users are trying to source as much domestic supply as possible.

Shaw & Partners has a Sell rating for Whitehaven Coal as, despite liking the stock, the share price versus investment fundamentals looks stretched.

Copper

Macquarie observes end user demand for copper has picked up, driven by growth in orders from the construction and transport sectors. Sentiment among Chinese fabricators and traders has improved although smelters are comparatively negative.

Demand is expected to pick up in September and October ahead of a seasonal flurry and fabricators have signalled they are intending to raise production. In terms of concentrate, smelters remain more conservative and seem to be de-stocking raw material amid concerns about oversupply. Macquarie suspects smelters are intent on maintaining high spot treatment and refining charges for the upcoming annual contract negotiations.

Gold Stocks

Is it time to engage with gold stocks? UBS believes so. Gold equities appear to be moving with the macro outlook for US interest rates and the pendulum is currently swinging to the more dovish side. The broker suspects this could now be a good time to seek gold equity exposure.

The Australian sector has de-leveraged considerably and most stocks now hold net cash balances. The broker notes Newcrest Mining ((NCM)) and Evolution Mining are geared around 20% and both have strong cash flows and therefore little balance sheet risk.

UBS expects the de-gearing story will advance quickly and provoke investor attention. Australian gold producers are targeting an average all-in sustainable cost (AISC) of US$828/oz with the notable outlier being Perseus Mining with a FY17 AISC of US$1,218/oz.

The broker's preferences are with Evolution Mining, Alacer Gold ((AQG)) and Silver Lake Resources ((SLR)). While acknowledging Regis Resources ((RRL)) has quality domestic production growth and strong net cash UBS finds it hard to envisage value at current prices.
 

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