Material Matters: Iron Ore, Sector Downside, Copper & Oil

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Upside for the iron ore price; near-term downside for global Metals & Mining sector; bullish view on medium-term copper price & scenarios for oil.

-Buoyant iron ore price, despite growing supply
-Near-term Metals & Mining downside, then a longer-term super cycle
-Morgan Stanley’s bullish medium-term call on copper
-The impact of Saudi Arabia and electric vehicles on oil demand

By Mark Woodruff 

Buoyant Iron ore price, despite growing supply

The iron ore market will remain tight over the next six months with low inventories supporting prices in the fourth quarter when China starts to curtail production, suggests UBS, and also because of seasonally weak supply in the first quarter of 2024.

Supply of iron ore has grown more than the analysts expected in 2023, yet the impact on price has been countered by a lift in Chinese steel production, driven by a material lift in steel exports. A reduction in domestic iron ore production and less scrap requirements by Chinese steel mills have also supported the iron ore price.

Based on Chinese customs data, iron ore imports are up 7% year-on-year to August. Traditional exports from of Australia, Brazil and South Africa are up around 3%, while non-traditional supply out of countries including India and West Africa is up 38%.

Over the medium-term, UBS expects iron ore supply will keep rising and scrap steel consumption should lift when the relative economics of scrap compared to pig iron are equalised by a carbon price. Chinese iron ore supply is also expected to hold steady until prices fall below US$100/t.

Regarding individual iron ore producers, the broker believes Rio Tinto ((RIO)) is on track to achieve the top end of its 2023 guidance for 320-335mt, and BHP Group ((BHP)) looks like achieving its FY24 production guidance of 282-294mtpa. 

By contrast, UBS forecasts first quarter sales by Fortescue Metals ((FMG)) will fall by -4% year-on-year to 45mt, a surprising outcome given the ramp-up of Iron Bridge magnetite mine in WA. Sales would need to lift over the next three quarters of FY24 to meet guidance of 192-197mt, point out the analysts.

UBS has upgraded its ratings for the majority of iron ore stocks under coverage after raising its long-term iron ore price forecast to US$85/t from US$65/t, while noting consensus sits at US$75/t. The broker has raised its global iron ore sector call to Neutral from Sell, and upgraded BHP, Rio and Deterra Royalties ((DRR)) to Neutral from Sell. Sell ratings remain for Fortescue and Mineral Resources ((MIN)).

Near-term Metals & Mining downside, then a longer-term super cycle

In the absence of significant Chinese stimulus, Longview Economics feels there is a growing risk the global Metals & Mining sector de-rates lower in coming months.

A US/global recession risk is rising, according to Longview, while Chinese real estate activity may also continue to weaken. It’s thought stress/panic could spread to the banking system and currencies along with the Metals & Mining sector.

After this scenario plays out, Longview’s valuation models would likely move to cheap levels from mid-range currently.

More positively, Longview sees longer-term indications for a new commodity super cycle partly based on the green energy/electric vehicle revolution and weak supply growth from an upcoming ten-year period of persistently low commodity-related capex.

From a price earnings valuation perspective, the sector is not currently cheap relative to either US treasury bonds or US cash rates, notes Longview.

Compared to other commodities, industrial metal prices are about mid-range and at relatively “normal” levels compared to the last few decades. The same relativities apply when comparing industrial metals to energy and agricultural commodities.

It’s only when comparisons are made to precious metals that industrial metals look cheap relative to recent decades, notes Longview, though, even on this comparison, industrial metals are broadly within their normal range, for the decade just past. 

Morgan Stanley’s bullish medium-term call on copper

While some indicators for global manufacturing improved further in September, led by China and the US, Citi cautions such growth is likely to be short-lived amid “higher for longer” interest rate expectations and a likely stronger US dollar.

The broker suggests weak growth in Developing Market economies through to the first half of 2024 will offset a modest ongoing economic recovery in China and base metal prices will grind lower by up to -10% over the next six to nine months.

Recent data releases out of the US indicate to the analysts the labour market is too tight to return inflation to target and the Federal Reserve may be forced to maintain or intensify its aggressive policy stance.

Once these macroeconomic headwinds occur, Citi anticipates opportunities to snap up copper and aluminium exposures for investors adopting a longer-term horizon. In particular, it’s thought the copper price will soar by around 50% to average $12k/t in 2025, while aluminium and tin are expected to climb beyond current spot levels in the second half of 2024.

The broker remains a conviction bull on copper over the medium term due to the red metal’s unique characteristics, which makes it the most high-probability Energy transition trade within the commodities complex.

Decarbonisation-related demand has almost single-handedly kept global copper consumption growth around the historical trend since 2022, note the analysts. Hence, when cyclical demand eventually rebounds, total consumption growth is expected to be well above trend, due to the compounded effect of growth across most copper-demand segments.

A synchronised structural and cyclical copper demand surge will likely peak in 2025 as global economies recovery from a period of slower growth in the first half of 2024, explains Citi.

The impact of Saudi Arabia and electric vehicles on oil demand

Saudi Arabia has made a voluntary supply cut. Given the country’s oil production policy is the single most important factor for pricing, because of a limited possible supply response from other producers, UBS now expects Brent oil will trade in a higher range.

This view was expressed prior to the attack by Hamas on Israel over the weekend, which has kicked-off an oil price rally.

The cut of -1 million barrels per day (b/d) has shifted the oil market into a deficit of around -0.8m b/d, explains the broker, which now forecasts prices in a range of between US$80-90/bbl over the next 18 months. 

While a similar deficit is expected to continue into the fourth quarter, there is modest upside potential on the supply side from Iran, Venezuela and others in Latin America, suggest the analysts.

Weak economic growth is considered the key risk to demand growth over 2024.

Demand has risen by 2.5m b/d year-on-year over the first seven months of the year, with China a key contributor, though UBS forecasts global oil demand growth will slow in 2024 to 1.1m b/d from the 2.1m b/d expected this year.

This 2024 decline will be due to weak GDP growth, explains the broker, as the post-pandemic recovery will have been largely completed.

For the fourth quarter of FY23, UBS increases its Brent forecast to US$92/bbl from US$85, bringing the 2023 average price to US$84/bbl from US$81/bbl previously. 

The broker’s 2024 forecast rises by US$7 on average to $87/bbl. While the 2025 forecast is unchanged at US$80/bbl, the 2026 estimate increases to US$80/bbl from US$75/bbl. From 2027 onwards the forecast is for US$75/bbl. 

A rising electric vehicle (EV) uptake will reduce global oil demand growth over time, and UBS anticipates demand measured in b/d will continually ease over 2025-2027 to 900,000, 600,000 and 400,000, respectively.

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