Material Matters: Iron Ore, Bulks, Gold, Oil And Steel

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Iron ore exports down in August; Deutsche Bank raises forecasts for bulks & base metals; gold outlook & US Fed; oil outlook & OPEC; BlueScope Steel.

-Risks to the upside for iron ore producers if iron ore prices continue at current levels
-Demand concerns may weigh on bulks, base metals by the second quarter of 2017
-Gold prices likely to range trade but heavily dependent on US dollar
-Uncertainty over oil market balance in 2017
 

By Eva Brocklehurst

Iron Ore

Demand indicators for iron ore are robust although Ord Minnett observes the seasonal slow down into the year end is apparent. Meanwhile, Port Hedland and Brazilian iron ore exports rose in August, up 11% and 14% respectively month on month, while Chinese domestic output fell.

The broker believes the data points to a 1.5% increase in Chinese steel production growth in 2017. Ord Minnett observes spot iron ore averaged US$57/t in September and, while down on August's US$61/t, is still providing healthy margins for the major producers.

Macquarie suspects BHP Billiton ((BHP)), Rio Tinto ((RIO)) and Fortescue Metals ((FMG)) will report weaker iron ore shipments in the September quarter and reduces forecasts by 2%, 3% and 6% for the big three producers respectively.

Rio Tinto is expected to miss its 2016 shipment target of 330mt by 3mt. Fortescue Metals is still expected to achieve its FY17 guidance of 165-170mt. Roy Hill has indicated it shipped 14.1mt in the first half of 2016, in line with Macquarie's estimates.

The latest port data suggests the average shipping rate for the September quarter is is running around 3% below expectations. The broker makes only modest adjustments to forecasts as the rates are broadly within annual seasonal differences.

Iron ore prices continue to trade above Macquarie's forecasts for 2016 and 2017 and, therefore, the risk is to the upside for base case forecasts. BHP has the superior upgrade potential of the big three, the broker maintains, given a stronger exposure to coking coal.

Bulk And Base Metal Commodities

Deutsche Bank has raised its forecasts for a number of bulk and base metal commodities for 2016 and 2017 to reflect supply-side changes. These include China's policy on coal, the potential for the Organisation of Petroleum Exporting Countries (OPEC) to curb production, uncertainty regarding Philippine nickel exports and the slower ramp up of iron ore producer Vale's S11D project.

By the second quarter of 2017 the broker expects demand-side concerns will weigh, as a result of a significant slowing in Chinese construction activity. The broker suspects positive Chinese data could continue to support bulks and base metals over the near term. Deutsche Bank upgrades price forecasts by an average 3% for 2016 and 6% for 2017.

2017 iron ore forecasts are upgraded 7% to US$45/t, coking (metallurgical) coal by 25% to US$111/t, Newcastle thermal coal by 27% to US$63/t, copper by 1% to US205c/lb, manganese by 37% to US$3.8/dmtu, aluminium by 2% to US71c/lb, nickel 7% to US488c/lb and zinc by 22% to US113c/lb. Gold is unchanged at US$1,328/oz.

Gold

Citi remains sceptical of a gold price rally into the end of the year as prices in the year to date have largely traded sideways. Several structural drivers appear challenged, with stable mine supply coupled with subdued Asian retail demand.

The broker expects gold prices to average US$1,320/oz in the fourth quarter and gold to trade within a US$1,300-1,350/oz range until the US Federal Reserve meets and potentially raises rates in December, after which prices are expected to modestly decline throughout 2017. [Note: Citi is writing prior to this week's sudden US$40/oz drop in the gold price — Ed]

The broker interprets the September statement from the Fed as indicating the case for a second rate hike has strengthened, pending confirmation from the data. Citi believes the US dollar could make or break sentiment on gold and this may have ramifications for the rest of the precious metal complex. Moreover, the US election is significant in that, absent an asset sell-off with a Trump victory, a stable US dollar could keep gold from rebounding aggressively in the fourth quarter of 2016.

In terms of central banks, Citi believes, outside of Venezuela, net movement of gold reserves should be minimal in the short term.

Energy

As oil prices rallied after OPEC announced a vague agreement to reduce total crude output, Citi observes uncertainty has increased, with Iraq's new oil minister claiming that third party estimates of the country's oil production were too low and this needed to be addressed for Iraq to accept any November agreement.

The broker does not believe the OPEC move is a game changer but probably raises the floor of the oil price to the mid US$40's a barrel from the low US$40's. Moreover, countries may try to push production as high as possible in the next two months before they are forced to freeze or cut.

Sticking with OPEC's forecasts, a cut in output to a production ceiling around 32.5-33mmb/d, presumably starting in January 2017, would imply inventory builds up through the first half of 2017 at 0.9mmb/d but this would be reversed in equal magnitude in the second half. At 33mmb/d Citi envisages the oil market would be over supplied into 2018.

Deutsche Bank believes the proposed production ceiling will tighten oil markets by 0.4mmb/d in 2017. This move offsets the broker's expectations for higher US oil supply from 2017 and has kept its oil market re-balancing thesis on track for a return to deficits in 2017.

Deutsche Bank retains its US$55/bbl Brent oil forecast for 2017 and Oil Search ((OSH)) its top pick in the sector as it has superior asset quality coupled with the lowest-cost proposed LNG projects globally.

BlueScope Steel

Australian steel spreads – the difference between the price of a commodity and the price of the raw material in that commodity – have fallen significantly, Morgan Stanley observes, largely because of higher coal prices and somewhat weaker regional steel prices. Spot spreads in east Asia have fallen to $183/t.

The broker envisages limited downside to first half guidance for BlueScope Steel ((BSL)) but significant downside potential in the second half should spreads remain at current levels, albeit this is not a base case.

The broker expects China's measures to relax its coal production cap should help moderate coal prices from October and, all else being equal, a move to US$140/t for coking coal is required for spreads to equal second half forecasts.

US steel spreads have also fallen in line with the company's guidance, currently at around US$325/t. The broker's US steel analysts continue to flag downside risks to US hot rolled coil prices although this may be offset to some extent by lower scrap prices.

A rebound in spreads is required to justify upside in the stock price, Morgan Stanley believes. Management is expected to reiterate first half guidance at the AGM in November.
 

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