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Material Matters: The Outlook For Aluminium and Copper & Stock Picks

Commodities | Nov 09 2023

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Morgan Stanley’s bullish outlook for aluminium & varying views by brokers on the outlook for copper.

-Morgan Stanley’s bullish outlook for aluminium 
-Broker views on the outlook for copper

By Mark Woodruff 

Morgan Stanley’s bullish outlook for aluminium 

Aluminium is a key input needed to decarbonise the world, and is currently Morgan Stanley’s preferred base metal, yet the energy-intensive production process is not compatible with global decarbonisation efforts.

As a result of this conundrum, the broker identifies two ASX-listed companies that have significant exposure to aluminium and have made material progress toward lowering their carbon footprint.

Back in May 2018, Rio Tinto ((RIO)) announced the world’s first carbon-free aluminium smelting process, via a joint venture with Alcoa Corp. Aluminium is the company's second highest revenue exposure.

South32 ((S32)) has also been proactively accelerating decarbonisation plans for its largest aluminium production site at Hillside, which accounts for around 63% of the company’s overall aluminium production.

What sets aluminium apart, in the broker's view, is demand challenges facing many other commodities as they move into a decarbonised world.

The analysts highlight aluminium will be needed for use in electric vehicles (EVs) and renewable power (e.g. wind and solar), and in industries such as 5G, data centres, intelligent manufacturing and smart home appliances.

While a growing supply deficit will emerge from 2024, Morgan Stanley specifically identifies a further supply deficit re-emerging by 2026 at similar levels to 2022, when the aluminium price reached an all-time high.

By 2026, the broker predicts the London Metal Exchange (LME) aluminium price will reach US$2,650/t, around 20% higher than current levels. 

In the interim, Morgan Stanley forecasts an aluminium price for 2024 and 2025 of US$2,350/t and US$2,450/tonne, respectively.

Over the next three-to-six months, Citi sees more upside risks than downside risks for aluminium pricing given potential for Chinese supply downside and energy price upside.

Recently, aluminium spot prices have moved higher after a gradual decline in LME aluminium inventories and the risk of supply cuts from China during winter months, explains Citi.

Because of this potential for constrained power availability in China, a country viewed as the world’s premier producer of aluminium, Morgan Stanley also sees a risk of a much tighter market in the coming winter.

By way of example, the analysts cite the case of China’s Yunnan province, which has transitioned to more sustainable hydro power to generate around 80% of the total power supply. The broker explains insufficient rainfall sometimes causes power shortages and curtailment of aluminium production.

Moreover, China introduced a production capacity cap several years ago, which is currently being encroached upon. Morgan Stanley now sees this cap as a key factor in restricting the medium-term supply outlook.

This broker currently has Overweight ratings for both Rio Tinto and South32, with 12-month target prices of $134.50 and $4.15, respectively.

Broker views on the outlook for copper

Over 2024, Citi expects copper demand will be vulnerable to slowing cyclical growth and decarbonisation-related demand risks, though a widening surplus may already be priced into the copper price and downside appears limited.

Weakness in ex-China cyclical copper demand sectors and Chinese property remain headwinds for 2024, in the broker’s view.

In addition, it’s thought slower EV demand presents downside risk, with consensus likely to lower 2024 EV growth rates in China, while commentary from US auto original equipment manufacturers (OEMs) also implies slowing EV uptake.

Despite these negatives, elevated investor short positioning may leave the market vulnerable to short-covering on any downside surprise to US growth or an upside surprise to Chinese demand, suggest the analysts.

Indeed, ING Bank agrees such a revival in Chinese demand, along with lower supply, could support copper prices.

Supply may be endangered, notes the bank, as some of the major copper producers in the Americas have downgraded copper production targets for this year and next, due to operational issues.

Citi predicts copper will trade in a US$7,500-$8,500 range over the next three-to-six months, and will move into a refined surplus of 355kt in 2024 versus 112kt in 2023.

As this deeper surplus materialises, inventory gains could drive contangos wider, while an air pocket in green demand could add to oversupply, suggests this broker.

Morgan Stanley is also wary, given copper has gained circa 30% in the last five years, and the three copper stocks under Morgan Stanley's global coverage with the largest copper revenue exposure have gained a much greater 70-200% over the same period.

In explaining a current preference for aluminium stocks, the broker recently indicated most of the large copper stocks are trading at levels implying close to the current spot price.

While Wilsons concedes the global slowdown presents near-term cyclical challenges for copper, these will be offset by medium-term structural growth.

Growing global copper demand for EVs and renewables is overwhelming the impacts from a slowing construction sector in China, in the broker’s view, while the energy transition will underpin significant longer-term structural growth.

The broker points to the growing global adoption of renewables, grid expansion and EVs, which is helping to offset upcoming weaknesses for traditional copper-consuming industries such as construction.

For the naysayers suggesting construction weakness in China will offset the demand for copper from electrification, Wilsons points out the share of global demand share for the Chinese construction sector, and the grouping of EVs and renewables, currently stands at 7% and 13%, respectively.

By 2030, the energy transition share of copper demand is expected to be around 22%, and the broker still sees upside to this estimate.

On the supply side, the analysts note a 17-year lead time from discovery of copper to production, according to the International Energy Agency, and ongoing decline in copper ore grades requiring miners to process more ore to extract the same amount of copper. 

Given such favourable supply-demand dynamics, the broker is structurally bullish on the copper price. 

Having recently initiated research coverage on Sandfire Resources ((SFR)) with an Overweight rating and $8.45 target price, the broker has now decided to include the stock in the Wilsons Focus Portfolio, which aims for quality companies with strong track records, proven management teams and sustainable competitive advantages.

The broker points out Sandfire is one of the only (nearly) pure copper-leveraged producers on the ASX. The company operates two assets – Matsa in Spain and Motheo in Botswana – which are both considered high quality and are operating in robust mining jurisdictions.

Wilsons believes Sandfire is a potential takeover target, especially once Motheo is fully de-risked and functioning at its ultimate output level. It’s noted the major diversified miners have already signaled their intentions to diversify into future-facing metals like copper.

Moving away from discussing individual base metal exposures, Citi generally cautions against reading too much into China’s incremental policy easing and early signs of subsiding risks in China-US relations, which have slightly raised market sentiment for base metals over the last couple of weeks. 

The base metals complex is still subject to a major overhang from the higher for longer US rate environment and the risk of a deeper recession for developing markets, in Citi’s view.

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