Material Matters: Copper, El Nino & Iluka

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A waning Chinese property/construction sector may further impact copper prices; forecasts for El Nino have repercussions for commodity markets; and UBS reviews commodity exposures for Iluka Resources.

-Chinese property to weigh on near-term copper prices
-Looming El Nino to impact commodity markets 
-More reasons for UBS to be bearish on Iluka Resources 

By Mark Woodruff

Chinese property to weigh on near-term copper prices

Significant uncertainty hovers over the Chinese property/construction sector and how conditions play out over the next few months will likely determine the direction for copper prices.

Construction typically accounts for around 20% of total Chinese copper demand. 

Copper and Chinese real estate equity prices have become closely correlated over the last 15 months, and Longview Economics suggests both prices are at risk of material falls in the coming months and quarters, in the absence of meaningful government support.

In an attempt to ward off a major collapse in housing completions, the Chinese government has been providing support by various means, yet Longview points out policymakers are reluctant to overstimulate the real estate market.

This balancing act has resulted in flat average house prices in China since 2021.

Worryingly, in the past few weeks, defaults and delinquencies for major property developers have picked up again, notes Longview, and pushed US dollar high-yield bond prices to the lowest levels since late 2022 (yields rise when bonds are sold off).

Longview highlights the Chinese government is faced with challenges across four key parts of the real estate market: land sales; transactions; construction activity; and completions.

In China, property developers purchase land from the local government for the purposes of construction.

Unfortunately, Chinese land sales have been broadly flat over the past five years, resulting in considerable pressure for local government revenues, particularly in the past two years, explains Longview.

Moreover, because local governments have turned to local government financing vehicles (LGFVs) for financing, Longview suggests organic local government revenue via land sales is likely to be much lower than suggested by the official data. As a result, local government’s ability to fund construction of infrastructure projects has been impacted.

On average, it’s taking 26 months to sell a house/apartment in China’s Tier 1 cities, which is contributing to a fall in confidence and declining transactions since a peak in 2021, explains Longview. 

Now, forward looking liquidity indicators, a key driver of transactions, suggest further weakness in purchases is likely over coming months.

Adding to the general woe, residential and non-residential construction investment is down almost -50% from 2021 highs.

One bright spot is a high level of (government-assisted) completions which, according to Longview Economics, is helping prevent a collapse in the real estate sector, yet there remains significant risk to buyers/developers and the Chinese housing market in general. 

Looming El Nino to impact commodity markets 

Over the past 40 years there have been four strong El Nino events, each with significant impacts, highlighting the importance of the recent onset of El Nino conditions, as recently declared by the World Meteorological Organisation.

Last week, the Bureau of Meteorology in Australia also declared a 70% chance of an El Nino developing this year.

As a result of these forecasts, ANZ Bank expects warmer and drier weather in Europe and Asia, placing additional short-term pressure on energy markets and requiring increased consumption of coal and gas.

The bank expects the largest impacts will be felt in the energy markets of Asia, given recent high temperatures in China led Yunnan’s provincial government to ask heavy industry to reduce power consumption. It’s felt China’s only real option is to revert to coal-fired power, which leads to a surge in coal imports.

El Nino could also cause a cold dry winter in Europe, which may see demand for gas rise, according to ANZ. It’s thought Europe needs to reduce gas consumption by -15% to avoid further shortages.

Regarding oil, the forecast weather pattern is unlikely to have a material impact on demand. The bank explains demand is more driven by transportation dynamics, but El Nino could hit oil production, given a subdued Atlantic hurricane season could lead to less disruption to offshore oil production than usual.

The biggest impact of El Nino tends to be on agriculture, explains ANZ, as droughts in Asia and monsoons in India impact crop yields.

El Nino typically brings drought to the western Pacific (including Australia), rains to the equatorial coast of South America and storms and hurricanes to the central Pacific. 

Australia and Indonesia will likely be hotter, with a greater possibility of wildfires. ANZ notes major droughts for both countries originated from El Nino in 1982/83, causing extensive economic damage via crop failure and loss of livestock.

Demand for gold could be impacted as lower revenue from reduced crops in India could restrict discretionary buying from local farmers, ANZ Bank suggests.

There may also be an increased level of disruptions to supply in other metals markets. The bank suggests copper from South America is the most exposed, with rainfall, flooding and earthquakes predicted, delivering potential impacts on production for the copper industry in Chile and Peru.

ANZ Bank also highlights an increased risk of disruption to aluminium supply in China.

While the analysts see a range of potential impacts on commodity markets, secondary effects on shipping and transportation can also impact prices of commodities transported by sea.

Higher prices for energy-related commodities in past El Ninos have increased headline inflation and can hit economic growth, observes ANZ, especially in Brazil, Australia, India and other affected countries.

More reasons for UBS to be bearish on Iluka Resources 

Mineral sands consultant, TZMI, expects weaker demand for titanium dioxide (TiO2) feedstocks on a shaky global macroeconomic outlook, along with growing supply, and forecasts prices will remain range-bound around US$1500/t (global average) for at least the remainder of the year.

The consultant's industry outlook has made UBS marginally more negative, while also lending conviction to its mid-June move to downgrade Iluka Resources ((ILU)) to Sell from Neutral. The broker’s $10.90 target price is retained.

TZMI expects global pigment demand growth for 2023 and 2024 will be below long-term growth rates, resulting in weaker demand for TiO2 feedstocks. The consultant also sees overall TiO2 feedstock supply growing due to increased concentrate imports from Africa and Australia, though skewed to lower-grade products.

Iluka is a producer of zircon and high-grade titanium feedstocks, rutile and synthetic rutile, with the latter having a lower TiO2 content.

Illuka acts as a market leader, observes Ord Minnett, and is willing to increase inventory or even curtail production in a downturn to moderate cyclical mineral sands demand.

TZMI is similarly cautious on the zircon outlook given the onset of new supply from Strandline Resources ((STA)), along with increased heavy mineral concentrate (HMC) imports into China.

Consequently, the consultant expects a surplus for zircon markets for 2023 and potentially into 2024.

In early-May, Morgans highlighted the economics of Strandline’s Coburn mineral sands project were improved by a positive third quarter operating cash performance.

The project commenced sales of HMC in the March quarter and Shaw and Partners noted management was assessing alternatives to expand beyond the expected production of 230,000t of HMC per annum for the 22.5 years of mine life.

Adding to the current negatives for Iluka Resources, UBS observes a US$53/kg NdPr price is not helping the company’s rare-earths aspirations.

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