Material Matters: China; Coal; Iron Ore; Lithium & Rare Earths

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China stimulus a boost for commodities; tough September quarter ahead for thermal coal; iron ore shipments increasing; lithium and rare earth prices rebounding.

-Chinese stimulus to boost recovery
-Lower gas prices to weigh further on thermal coal
-Australian iron ore shipments on the increase
-China EV sales boosting battery mineral demand

By Greg Peel

China

On Tuesday, the PBoC cut its short-term interest rate, which is the first sign of now long anticipated economic stimulus to boost China’s post-lockdown recovery.

When early this year China abandoned the zero-covid policy it was never going to abandon there were great expectations of a swift economic rebound. But it hasn’t happened. Chinese economic data in the interim have only disappointed.

Commodity prices shot up when China’s lockdowns ended but following little sign of any rebound, have drifted ever lower since, prompting Morgans to note the current sell-off in resources has removed the previous over-optimism seen towards China’s near-term growth potential. Writing the day before the PBoC announcement, Morgans had already decided sentiment was swinging too far the other way, presenting opportunities to accumulate quality sector exposures at a discount to recent levels.

Chinese property sales have remained soft, notes Macquarie, and trucking activities have only seen modest improvement, but the PBoC move could be seen as a sign that officials are stepping up stimulus to boost the recovery, with potentially more easing policies to follow.

Morgans suggested iron ore is in a “surprisingly strong” position in terms of having found a floor, with LNG and metallurgical coal not far behind it price-wise. Morgans also sees strong fundamentals for copper, oil and lithium chemicals.

The brokers preferences among resource sector large caps are BHP Group ((BHP)), Mineral Resources ((MIN)) and Santos ((STO)), and among smaller caps, Karoon Gas ((KAR)), Whitehaven Coal ((WHC)), Strandline Resources ((STA)) and Panoramic Resources ((PAN)).

Thermal Coal

Metallurgical is combined with iron ore to make steel. Thermal coal is burned to produce electricity.

Gas-burning power generation is a greener competitor to coal-burning power generation. The lower the price of LNG, the greater the impetus to lean to gas-burning generators, which, unlike coal-burning generators, can be swiftly switched on and off.

Looking ahead to the northern summer, Citi’s commodities analysts have cut their LNG price forecast by -50%. On that basis Citi’s stock analysts assume we could also see sizeable downside for thermal coal prices. After reaching US$400/t in December 2022 on extreme tightness in the Pacific high-CV (calorific value) thermal coal market, Newcastle coal is now down some -66% year to date to US$134/t, Citi notes.

Besides lower natural gas prices dragging down coal prices, Citi points out thermal coal market fundamentals are also looser due to inventory levels for high-CV importers remaining historically elevated after strong buying activities, and El Nino also pointing to dryer and/or warmer weather over the coming months for major high-CV exporters including Colombia and Australia with wet season impacts now in the past.

Citi has subsequently cut its target price for Whitehaven Coal but retains a Buy rating on valuation, albeit adding a High Risk qualification. New Hope Corp’s ((NHC)) target is also cut and given the stock has outperformed Whitehaven by some 27% in the last six months, Citi downgrades to Sell.

Morgans notes the recent sell-off across thermal and met coal prices has been sharp, and in the case of thermal coal also sees some further short-term downside to prices. This remains in stark contrast to long-term fundamentals for the coals, Morgans suggests, for which ESG pressures and other sector headwinds has seen supply increasingly constrained.

Iron Ore

Morgans has a positive view on iron ore, which the broker suggests is a “contrarian call”. While China’s property market is a critical demand-driver for steel, and is still depressed, Morgans sees enough demand from peaking infrastructure activity and other baseload consumption to see demand near balance against supply.

The broker foresees iron ore supported within a stable range of US$100-$120/t in 2023, which is above the highest cost production in the market at around US$100/t.

Macquarie notes the combined shipments from Rio Tinto ((RIO)), BHP and Fortescue Metals ((FMG)) increased by 9% week-on-week last week, with higher exports from Rio and Fortescue, while shipments at BHP were largely flat. Exports by Rio via the Dampier port reached their highest levels in ten weeks, according to the broker’s bespoke port data.

Shipping rates from smaller ports were also higher week-on-week but remained below Macquarie’s implied capacity target.

Vale’s (Brazil) iron ore shipping performance has been weak, with June quarter to date exports remaining below the company’s seasonally adjusted target levels. Vale’s exports dropped by -19% after a brief increase in early June.

BHP is Macquarie’s preferred large-cap exposure as the company boasts stronger organic growth options. The broker’s positive view on Mineral Resources is unchanged despite the weaker outlook for iron ore, as the impact is outweighed by a strong outlook for lithium, in the broker’s view.

Deterra Royalties ((DRR)) offers low volatility exposure to iron ore, while Champion Iron ((CIA)) offers high-grade exposure via its Bloom Lake operation and Direct Reduction Pellet Feed process, Macquarie suggests.

Lithium & Rare Earths

There are signs indicating continued improvement in EV sales in China, Macquarie reports. According to data from the China Passenger Car Association, Tesla sold 2.4% more EVs in May month-on-month and BYD's battery EVs and petrol-electric hybrid vehicles reported May sales 14% higher sequentially.

Note Eagers Automotive ((APE)) now has exclusive retail distribution rights for BYD in Australia – China’s fastest growing EV brand, catching up to Tesla.

China’s technical-grade lithium carbonate equivalent price rebounded 7% early this week, Macquarie reports, while battery grade prices also rose by 3%. Regional lithium prices remained unchanged during the week given these prices tend to lag the China prices. The spot spodumene price increased by 1%.

Mineral Resources and Pilbara Minerals ((PLS)) are Macquarie’s preferred lithium producers while Patriot Battery Metals ((PMT)) presents the greatest upside on exploration over the near term. The broker sees value in both Allkem ((AKE)) and Liontown Resources ((LTR)), with Allkem offering unique exposure to both lithium brine in South America and spodumene production in Australia.

Macqurie believes Kathleen Valley construction will de-risk the project and provide valuation support for Liontown. Global Lithium Resources ((GL1)) offers the greatest near-term exploration upside.

While the rare earths market continued its soft performance at the start of May, prices stabilised during the month, Macquarie reports, with NdPr prices rebounding. In China, the spot market tightened and trading activities increased.

Continued development in wind power drove light rare earths demand and resulted in higher downstream inquiry orders. The broker notes the coming rainy season could weigh on rare earths exports from Myanmar and other Southeast Asian countries, keeping the market tight in the short term.

Macquarie has an Outperform rating on Lynas Rare Earths ((LYC)).

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