Material Matters: Base Metals; Resources Shares; Iron Ore & China Zero Covid

This story features SOUTH32 LIMITED, and other companies. For more info SHARE ANALYSIS: S32

A glance through the latest expert views and predictions about commodities: Lower base metal price forecasts; recommended resource shares; a greater iron ore surplus in 2023 and signposts for an easing of China’s zero-covid strategy.

-The odds of a synchronised 2023 global recession sit at 50%
-Citi’s resource stocks for a hard and soft landing
-An even greater iron ore surplus in 2023
-Identifying first signs of an easing in China’s covid zero strategy

By Mark Woodruff

Dire base metal price forecasts 

Citi’s weekly take on commodities appears under the headline: a global recession could quickly spook the bulls.

The odds of a synchronised 2023 global recession sit at 50%, according to the broker. A series of “rolling recessions” is expected, with measurable downturns in the EU and UK this northern winter and in the US by mid-2023.

Investors are reminded that commodities post negative returns during recessions, while positive returns coming out of a recession occur largely in the first six months. The demand for commodity-intensive goods increases with a rebound in economic activity, explain the analysts.

Citi expects the worst is yet to come for base metal demand as economic activity deteriorates further, and forecasts price declines of up to -20% by the first quarter of 2023, varying by metal. 

This sell-off would be consistent with industrial metals price returns heading into and during a global recession, point out the analysts.

For gold, Citi sees a struggle for the bulls in the short term, but also notes signs of price stabilisation. Price support is evident at US$1,575-1,600/oz. 

The broker is more bullish on palladium, with current prices presenting a potential dip-buying opportunity. It’s felt US$2,250-2,300/oz may be reached in the next three to six months, as global auto production continues to recover on improved microcontroller chip supply.

Precious metals tend to outperform during recessions, says Citi, as investors turn to less risky assets, and prices may also be assisted by central bank policy easing.

In the case of uranium, a 9% price increase in October is supported by increasing appetite for nuclear energy globally, according to the analysts. Recent delays in closures for European nuclear reactors represents a stabilisation of Western uranium demand. 

As a result of this stability, Citi now believes nuclear power growth in Asia will provide positive incremental demand growth, as opposed to a mere shifting of demand from West to East.

Recommended resource stocks for hard and soft landings

Citi recommends different Resource sector (mining, oil & gas) stocks for each of its base level, hard-landing and soft-landing scenarios for 2023 global GDP.

In the case of a soft-landing, the broker sees clear upside to the miners (especially those in the second tier) with lower margins and higher operating leverage such as South32 ((S32)) and Fortescue Metals ((FMG)). Newcrest Mining ((NCM)), 29Metals ((29M)) and Mineral Resources ((MIN)).

The likes of Santos ((STO)) and Woodside Energy ((WDS)) should be eschewed if a soft landing arises but would be the most preferred under a hard landing, explain the analysts. 

While miners, especially mid-caps, will underperform the overall market due to materially lower earnings during a hard landing, Oil & Gas sector exposures would be relatively defensive, according to the broker, given the current Ukraine crisis and its expected impact on Asian gas markets. 

The analysts point out the Oil & Gas sector has outperformed the ASX300 Metals and Mining index by 25% over the last six months due to events in the Ukraine.

Least favoured by Citi in a hard landing include the soft-landing favourites of South32, Fortescue Metals and 29Metals, as well as Sandfire Resources ((SFR)).

Sticking for now with the broker’s base case, both Mining and Oil & Gas sectors offer value, with large cap mining cheaper than large cap oil & gas. Here, Rio Tinto ((RIO)), South32, Santos, Mineral Resources and Allkem ((AKE)) are preferred, while Whitehaven Coal ((WHC)), New Hope ((NHC)) and Pilbara Minerals ((PLS)) should be avoided.

Citi points out key oil & gas names are at a different point in the earnings cycle to other Resource sector stocks, with brokers raising gas price expectations given the European Union gas crisis.

Earnings momentum for Santos has largely remained positive since mid-2020, while Woodside’s earnings momentum has been positive since late October 2021.

Citi sees a greater iron ore surplus during 2023

Iron ore prices are now trading at their lowest levels since 2020, driven by a downturn in sentiment following disappointing policy emanating from China’s recent 20th Congress, explains Citi.

The broker cuts its (up to) three-month iron ore forecast to US$70/t from US$95/t and lowers its 2023 forecast to US$95/t from US$110/t, due to a gloomy outlook for demand globally.

Intensifying curbs at Chinese steel mills and a lack of a clear exit path from zero-covid policy are weighing upon iron ore demand, according to Citi. Also, as ‘houses are for living in, not for speculation’ according to the Chinese government, sentiment is considered poor for the property sector, which accounts for around 40% of steel demand.

Citi sees the iron ore market surplus building during 2023, driven by declining steel output globally. China’s steel production is expected to fall by -3.5% year-on-year in 2022 and be broadly flat in 2023. 

Outside of China, production during 2022 will decline by -4.5% year-on-year, forecast the analysts, as the consumer recession takes hold. It’s noted European iron ore demand has already taken a hit due to curtailed operations at blast furnaces.

While the nadir for apparent steel demand ex-China should be the fourth quarter of 2022, Citi doesn’t expect demand to return to 2018/2021 levels before 2024. Recovery is likely to be tepid with the broker forecasting 1.5% year-on-year growth in apparent steel demand in the ex-China world in 2023.

Some recovery in iron ore prices may occur upon a major vaccine roll-out or major easing in China, concludes Citi.

Potential signposts for an easing of China’s zero covid strategy

Morgan Stanley believes time needs to pass before any macroeconomic implications can be drawn from China’s 20th Party Congress.

As global growth slows into next year and inflation peaks, one key question, according to the broker, is whether China can provide support to the global economy. Also, will China rekindle inflationary pressures?

Both before and after the Party Congress, Morgan Stanley felt the answer to these two questions lay in how China negotiates covid zero polices and how it handles the property sector. 

There was no substantive news on the property sector at the Congress, so the analysts see a continuation for the current policy of meting out support when needed to keep delivery of homes going but hold very little prospect of a surge in residential investment.

An unchanged covid strategy leaves the broker still seeing little scope for a rapid exit from covid zero.  However, as spare fiscal reserves in China will be depleted by early next year, urgency levels are expected to rise, and some changes will likely occur over coming months.

The drain on reserves has been exacerbated by weaker exports to a slowing global economy and the continuing drag from the property sector, point out the analysts.

Signposts of a pivot in covid strategy will include rising vaccination rates for the elderly and greater availability of treatment facilities and medications, according to Morgan Stanley. Also, less government fear mongering about the virus may be another indicator.

The broker forecasts a modest recovery for China from the second quarter of 2023, which aligns with a three-to-six month lag for a pivot in the covid strategy after evidence of the above signposts emerges.

Once this private consumption-led rebound commences, the demand-pull for the rest of the world will likely be relatively muted, suggests Morgan Stanley, and unlikely to be an inflationary event, as some market pundits fear.

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

FNArena is proud about its track record and past achievements: Ten Years On

Click to view our Glossary of Financial Terms