Material Matters: Lithium, Oil, Base Metals, Gold

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A glance through the latest expert views and predictions about commodities: Lithium, oil, base metals, and gold

By Mark Story

-Material shortages predicted for lithium from 2025
-Galaxy Resources earnings estimated to more than double over next 5 years
-Fears of steel output cuts from Tangshan over-blow
-Major iron ore producers well positioned to re-rate

Lithium: Bullish price outlook

Based on its revised bullish electric vehicle (EV) demand outlook, Macquarie sees the lithium market moving to deficit in 2022 with material shortages emerging from 2025. Macquarie expects lithium prices to trade at incentive levels and the broker has upgraded its lithium price forecasts by 30-100% for 2021-2025.

Chinese spot lithium prices started to recover in late 2020, with the recovery accelerating over the first three months of 2021. Lithium carbonate prices have been stronger, up around 70% year to date, while Chinese lithium hydroxide prices are up 55-60%. Macquarie notes lithium carbonate prices in China are currently trading at 10-20% premiums to lithium hydroxide prices.

The rise in China spot prices has started to translate through to a recovery in regional lithium prices. Given that Chinese carbonate prices are up 110% and 80% from the beginning of 2020 – while Chinese hydroxide prices are up around 40% – Macquarie believe there could be further upside to regional prices in coming months.

Upgrades and re-ratings

Macquarie’s lithium price upgrade has led to earnings upgrades and re-ratings for Australian lithium miners. Both Orocobre ((ORE)) and Galaxy Resources ((GXY)) have been upgraded to Outperform. Macquarie has also resumed coverage of Pilbara Minerals ((PLS)) with Outperform, and after remodeling the miner's growth outlook with a staged approach, expects to see a nine-fold increase in spodumene production by 2028.

While Orocobre's near-term earnings are largely unaffected as lithium carbonate prices have been locked in at US$5,500/t in the seocnd half FY21, Macquarie believes the improved earnings outlook eases funding concerns for the miner’s Olaroz and Naraha expansions.

Galaxy Resources' earnings outlook has been transformed by the material upgrades to Macquarie’s lithium and spodumene rising near-term pricing outlook, with the broker’s earnings estimates having more than doubled over the next five years.

Lithium price upgrades have also enhanced Macquarie’s view on Mineral Resources ((MIN)), which remains one of the broker’s key picks across the broader resources sector. Macquarie expects Mineral Resources share of lithium hydroxide production to grow to 60ktpa by FY28, with first production expected in FY22.

The broker expects Mineral Resources earnings upgrade momentum to remain strong with a spot price scenario generating 160% higher earnings in FY22. Macquarie believes the stock trades on much lower multiples than its peers due to its diversified earnings, which are currently dominated by iron ore.

Macquarie has also upgraded its earnings forecasts for IGO Ltd ((IGO)) with its share of production from Greenbushes expected to rise to 300ktpa from FY25 and Kwinana Hydroxide online in FY22. The broker expects production from Greenbushes and the ramp up of the Kwinana Hydroxide plant should generate $300mpa in earnings for IGO from FY25. Macquarie notes that IGO is also trading at lower multiples due to its earnings currently being more weighted to gold and nickel.

For pure lithium exposure the broker has set its order of preference as Galaxy Resources, Pilbara Minerals and Orocobre, with price targets of $4.20, $1.30 and $7.10 respectively.

Oil: Higher production levels

With Iranian exports and US drilling activity taking some steam out of the bullish view oil prices in recent months, Morgan Stanley has moderated its third quarter price forecast.

While the broker had only expected a modest increase in Iranian exports by fourth quarter 2021, tanker tracking data suggests exports have already picked up more than Morgan Stanley assumed. With renewed negotiations between the partners to the JCPOA (Iran nuclear agreement) current going on in Vienna, the broker believes there’s the possibility that this gains momentum.

While much remains uncertain, Morgan Stanley is raising its estimates for Iranian production, which moderates inventory draws over the balance of the year. Morgan Stanley now assume Iran's oil production will average 2.7 mb/d in the third quarter, growing further to 3mb/d by year-end (up from 2.2and 2.5 mb/d before respectively).

Meanwhile, US drilling activity has continued to increase. While the pick-up in activity in the Bakken and Eagle Ford shale deposits remains modest, the broker notes the rig count recovery in the Permian Basin is following a trajectory nearly identical to 2016. New well start-ups in the Permian were already back to 2018/19 levels in February/March.

Given the time lags involved, Morgan Stanley still does not expect much US shale growth 2021, and without the contribution from basins outside the Permian, production growth will remain only a fraction of the 2017-19 levels. However, Morgan Stanley notes US shale can start to grow several hundred thousand barrels per day again in 2022, which the broker believes is enough to start gaining market share.

The broker believes these factors set up an outlook in which OPEC may need to accommodate higher Iranian production in coming quarters, and rising US shale output in 2022. Morgan Stanley still sees inventory draws during the rest of 2021 supporting prices, but less than before. This moderates Morgan Stanley’s expectations for how backward-dated the forward curve can become and lowers the broker’s spot price forecast.

Whilst Morgan Stanley previously thought Brent could average $70/bbl in the third quarter and overshoot temporarily, it now expects a range of $65-70/bbl. If the 12-month forward WTI price at $55-60/bbl is already elevated, and the 1-12 month time spread can go to $6-7/bbl but not much higher, Morgan Stanley thinks it’s unlikely that front-month WTI moves much beyond $61-67/bbl.

Base metals: Returns underappreciated

Having concluded that fears of steel output cuts from Tangshan appear overblown, JPMorgan believes there is plenty of production capacity elsewhere to make up the difference. The broker believes losses to electric arc furnaces (EAFs) are likely have a minimal impact on iron ore demand.  

Based on JPMorgan’s review of the latest consensus data, the broker concludes the recent earnings upgrade cycle (ex. gold) is set to continue.

The broker notes that while iron ore has now recovered to above $172/t (within 3% of cycle high), BHP Group ((BHP)) Rio Tinto ((RIO)) and Fortescue Metals Group ((FMG)) are still well down from their March peaks.

Based on compelling valuation metrics, exposure to high-quality expandable assets (that are well positioned on the cost curve), and a strong balance sheet, JPMorgan rates BHP Overweight (price target $56). Based on its strong prevent net asset value (P/NPV) support, attractive free cash flow and dividend yield, and a low enterprise value (EV/EBITDA) multiple, the broker also has an Overweight on Rio Tinto (price target $163).

Based on its exposure to long life operations, with attractive margins and expansion optionality over the long term, JPMorgan is also Overweight Fortescue Metals (price target $29).

Stronger steel margins have led the broker to increase 58% Fe discount forecasts, although spreads remain near 15%. Based on free cash flow yields of 10-16%, strong dividend forecasts, and significant price to net asset value discounts, JPMorgan believes the major iron ore producers are well positioned to re-rate.

The broker revised its nickel forecasts last week on lower demand and potential for higher supply. OZ Minerals ((OZL)) is the broker’s key pick for base metal exposure. JPMorgan likes South32 Ltd ((S32)) from a value perspective (0.82x P/NPV) with the South Africa Energy Coal (SAEC) divestment progressing, and is Overweight on the stock (target price $3.50).

While lithium chemical prices are unchanged, the broker has increased spodumene prices a further 5-10% with reports of recent trades above US$600/t. IGO remains JPMorgan’s key pick in the space with the imminent sale of Tropicana potentially leaving it net cash post the Tianqi Greenbushes/Kwinana deal. The broker has downgraded Orocobre to Neutral following a strong run up to its $5.50 price target.

Gold

JPMorgan’s US$1,700 near-term and US$1,600/oz long-term price forecasts are not overly optimistic versus spot US$1,740/oz. However, the broker notes a recent WA trip reinforced concerns of potential risks on cost inflation (both operational and capital expenditure); and volume growth in a lower-margin environment.

JPMorgan’s (Overweight) sector picks remain Northern Star Resources ((NST)) – price target $13.50 – Gold Road Resources ((GOR)) – price target $2.05 – and Newcrest Mining ((NCM)) – price target $36.50.

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