Material Matters: Gold, Iron Ore & Base Metals

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A glance through the latest expert views and predictions about commodities. Gold; iron ore; coking coal; and base metals.

-Gold price likely to be stronger for longer
-Is further upside in the iron ore price likely?
-Risk to the downside in chasing copper price
-Implied demand growth for aluminium a mystery
 

By Eva Brocklehurst

Gold

A strengthening Australian dollar has chewed the margins for Australian gold producers, JPMorgan notes, and estimates are downgraded by -5-10% for the short term as a result. Still, stocks are beginning to price in more modest FY21 guidance and valuations are not considered stretched.

Morgans, meanwhile, suspects the gold price will be stronger for longer, i.e. at least the next 1-2 years, as central banks increase money printing to support their respective economies throughout the pandemic

The US Federal Reserve has also put upside pressure on the US dollar gold price in shifting its policy on inflation targets, although the response may be more subdued in Australian dollar terms.

The Australian dollar gold price rose to a high of $2800/oz and is currently around $2650/oz. This compares with $1800/oz at the beginning of 2019. No two gold miners are the same, as scale of production, jurisdiction and number of operations feature in market valuations.

In this way, Morgans suggests the larger miners have safer options regarding the gold price as production is spread across several operations. In contrast, small producers may offer more leverage but are relatively high risk.

Within the broker's coverage, Ramelius Resources ((RMS)) and Regis Resources ((RRL)) are preferred producers for a combination of scale, management, cost discipline and delivery. For those comfortable with development, West African Resources ((WAF)) and Westgold Resources ((WGX)) also rank well.

JPMorgan upgrades Newcrest Mining ((NCM)) to Overweight and Regis Resources and Saracen Mineral Holdings ((SAR)) to Neutral. JPMorgan retains a long-term gold price forecast of US$1600/oz with an AUD rate of US$0.74.

Iron Ore

Credit Suisse asserts the iron ore price should hold up, despite Chinese authorities attempting to pressure the price down. Margins in steel have disappeared and the broker suspects mills are complaining that all the benefits of stimulus have gone to overseas iron ore producers.

Credit Suisse envisages little risk in subduing the demand for steel at this point in time as inventory is relatively elevated. The autumn construction season in China is likely to mean inventory is consumed as well as new production, although a further climb in the iron ore price appears more difficult.

Macquarie notes demand outside of China is also recovering. Benchmark iron ore prices have averaged US$116/t for the September quarter. Meanwhile, major Australian miners continue to ship at strong rates with July volumes matching April and August producing a run rate of around 818mtpa.

The current strength underpins upside risk to the broker's earnings forecasts with 11% upside cited for BHP Group ((BHP)), 23% for Rio Tinto ((RIO)), 38% for Fortescue Metals ((FMG)), 9% for Mineral Resources ((MIN)), 25% for Mount Gibson Iron ((MGX)) and 14% for Champion Iron ((CIA)).

JPMorgan upgrades Fortescue Metals to Overweight, becoming more confident iron ore prices will remain buoyant. The broker concedes that its previous -20% forecast discount in the company's iron ore price realisation was too bearish.

The estimate now reflects an improving product mix and the valuation for the stock rises to $20/share, with the next three years' average projected dividend yield set at 9%. Meanwhile, valuations for BHP and Rio Tinto are compelling, in the broker's view, on current metrics. One-year forward free cash flow yields are calculated at 8.2% in FY21 for BHP and 11% for Rio.

Coking Coal

Credit Suisse's top pick in commodities is metallurgical (coking) coal, expecting the price to lift in the fourth quarter. Indian steel mills are increasing production and depleting inventory and should return to the coal market by the fourth quarter. In Japan some blast furnaces are expected to re-start by October and spot trade from these markets should allow the metallurgical coal price to rise.

Base Metals

Credit Suisse asserts risk is to the downside in chasing the current copper price, as the fundamental reason for the increase has passed. A price of around US$3.10/lb now reflects depleted London Metal Exchange (LME) stocks after record copper imports by China.

China's imports are expected to fall sharply and surplus copper from elsewhere, where demand remains soft, should now be available to refill warehouses. While there is the potential for the arbitrage to re-open later in the year and copper demand in China is likely to be positive, this is not yet a fait accompli and there is great uncertainty, the broker assesses.

That said, copper fabricators are experiencing strong activity and if that follows through then a new wave of demand has probably begun and demand growth in China may be significantly greater than the 2.5% Credit Suisse forecasts for 2020. As a result, imports may be needed later in the year, but for now the trade appears to be over.

Copper and nickel are well above Macquarie's forecasts which underpin a preference for OZ Minerals ((OZL)) (copper) and Western Areas ((WSA)), Nickel Mines ((NIC)) & Mincor Resources ((MCR)) (nickel).

Western Areas offers the greatest leverage to nickel prices on average, the broker notes, as a 20% rise in nickel prices has enhanced momentum in the spot price scenario which suggests more than 100% higher earnings in FY21/22.

Sandfire Resources ((SFR)) has the greatest leverage to copper. Both OZ Minerals and Sandfire continue to offer upside risk to earnings in a spot price scenario and the broker notes both have robust balance sheets.

Macquarie prefers Western Areas and Nickel Mines as producers and Mincor as a development play. Panoramic Resources ((PAN)) will need to return to the market for additional capital as the broker highlights it is loss-making on current forecasts and spot prices until FY25.

Meanwhile, the earnings risk for IGO ((IGO)) has moved into positive territory on spot prices, driven by the re-basing of nickel forecasts and the gold exposure from the company's Tropicana mine.

Credit Suisse assesses, in the case of aluminium, where the quantities in both LME and other warehousing are greater than for copper, heavy imports by China have modestly reduced levels but not to a level where a price spike is likely to occur. China's import arbitrage was so great that total aluminium imports overtook exports in July, which Credit Suisse notes is an extremely rare occurrence.

Hence, the LME price climbed to US$1750/t and the arbitrage narrowed. The broker finds it hard to explain where all the metal is going in China, as it is not appearing in visible inventory. The explanation may be consumption but on Credit Suisse's estimates the implied demand growth rates appear extraordinary.

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