Tag Archives: Agriculture

article 3 months old

Expect Further Gains In Ag Commodity Prices

By Chris Shaw

2010 was marked by widespread, weather related downgrades to production in agricultural markets. This meant an erosion in global stockpiles to historically tight levels. As Commonwealth Bank agri commodities analyst Luke Mathews points out, this combined with resilient demand, saw prices surge higher over the year.

Price strength has been broad based, reflecting a tightening in both grain seed and oil seed supplies and low stocks in sugar, cotton and coffee as well. This contrasts to the agricultural commodity price spike in 2007/08, when supply of soft commodities was still at comfortable levels.

Given the tightness in supply, Mathews suggests it is understandable the CBA Rural Commodity Price Index has moved beyond its 2007/08 peak, as food price inflation is real and has become a concern for policy makers worldwide.

At present, Mathews suggests high prices are needed to achieve two main objectives – the rationing of commodity demand and an increase in the planting area for most commodities. This second objective creates its own issue, as all commodities are chasing an increase in planted area, meaning the battle to achieve this additional area should be the most intense in history.

Given such an environment, Mathews expects strong agricultural commodity prices will continue over the next two years, with further gains possible in the first half of 2011 if the market is concerned about area planted or any La Nina related weather issues.

Within the agricultural commodity complex, Mathews favours corn, while he suggests global wheat prices have the potential to rally if production disappoints. Cotton prices have the most downside risk thanks to an expectation of a production rebound in the coming year.

Looking at each market specifically, Mathews notes while current global wheat supply is not particularly tight, this overlooks three important factors. The first is a higher than normal proportion of current supply is of poorer quality, making it only suitable for stockfeed.

As well, Mathews notes unfavourable weather means supply from major milling wheat exporters such as Australia, Canada and Russia is lower than normal, while the production outlook for the upcoming season is uncertain because of poor early season conditions in many markets.

Mathews expects global wheat consumption will increase by 1.7% in 2011/12 to a record 674 million tonnes, driven primarily by an increase in stockfeed use. A production deficit of around 15 million tonnes is forecast for 2011/12, meaning global stocks will be drawn down to 163 million tonnes.

This should push prices higher over the next 6-12 months predicts Mathews, though further gains beyond this timeframe may be difficult to achieve given current pricing appears to already account for a tightening in global availability.

Mathews is forecasting CBOT (Chicago Board of Trade) wheat prices in US cents per bushel terms of 809c in 2011 and 690c in 2012, up from 583c in 2010.

While corn has enjoyed two consecutive record crops globally, these have not been enough to satisfy strong grain demand growth of 3.4% per annum. This growth is being driven primarily by a booming ethanol market.

The strength of demand means global corn inventories are forecast to fall to a four year record low of 127 million tonnes, this supply issue being compounded by limited world barley supplies. The combination of tight supplies and production downgrades for the likes of Argentina leads Mathews to suggest corn prices are likely to remain strong.

Following the upcoming planting season Mathews sees scope for corn prices to moderate, though he is forecasting CBOT prices of 654c in 2011 and 552c in FY12 in US cents per bushel terms, which compares to a price of 434c in 2010.

Soybean inventories appear comfortable but Mathews notes consumption has grown by 4.3% per annum since 1990/91. This reflects increases in Chinese import demand of 15% per annum over the past five years.

This demand means inventory levels are not as substantial as they appear, and with La Nina likely to impact on crops in South America in particular, there is scope for supply to tighten further in the view of Mathews.

Prices should rise to reflect this, Mathews forecasting CBOT soybean prices of 1,254c in 2011 and 977c in 2012 in US cents per bushel terms. This compares to a price of 1,059c in 2010.

In cotton, Mathews notes the current strength in prices reflects very tight global stocks for the second year in succession, which is a function of resilient demand. China has been the driver of this, as its raw cotton imports rose by 38% in 2010/11, so pushing down US inventories.

Tight supplies mean production needs to increase in coming seasons, something Mathews expects will occur. This will rebuild inventories, so placing downward pressure on prices over the coming two seasons in his view.

In US cents per pound terms Mathews is forecasting cotton prices of 117.7c this year and 77.5c in 2012, which compares to a 2010 price of 95.8c per pound.

Higher cotton prices have helped wool prices, as has a decline in supply from Australia given an increased focus on sheep meat production. This shift suggests Australian wool production is unlikely to recover over the next few seasons, meaning a continued tight market.

Current high prices mean additional upside price potential is constrained, Mathews forecasting prices of $11 this year and $8.80 in 2012 in Australian dollars per kilogram terms. This compares to a 2010 price of $9.10 per kilo.

Sugar prices are currently high, Mathews seeing this as reflecting a continued tight supply market on the back of consecutive failed Indian monsoon periods and unfavourable weather in other producing regions.

India remains the main driver of prices in coming months according to Mathews, especially given dry conditions in Brazil suggest production growth in that country will stagnate. China is also becoming increasingly important on the demand side as it shifts to becoming the world's most important importer.

Sugar prices should remain well supported in the coming year in the view of Mathews, before coming under pressure in 2012 as the global production response intensifies. Mathews is forecasting sugar prices in US cents per pound terms of 25.9c in 2011 and 17c in 2012, compared to 22.6c in 2010.

The rain in Australia has allowed beef producers to rebuild herds following years of de-stocking, which resulted in lower production and higher prices. This rebuilding trend should continue according to Mathews, though higher feed grain prices increases the risk of some liquidation of the global cattle herd.

Mathews is forecasting beef prices in Australian dollar per kilogram of $3.70 this year and $3.40 in 2012, which compares to a price of $3.60 per kilo in 2010.

article 3 months old

Material Matters: Copper, Iron Ore, Coal And Oil, And Strategies For 2011

By Chris Shaw

The Bougainville copper mine was closed in 1989 following sabotage by the Bougainville Revolutionary Army and it has remained closed since, awaiting peace on the island before the project can be re-started.

Bougainville Copper ((BOC)) shares have remained listed, with Rio Tinto ((RIO)) still a major owner with a stake of 53.6%. This equates to around 18c per Rio Tinto share at current prices, making it a marginal asset for the global mining giant.

But over the past six months shares in Bougainville Copper have risen threefold and are now trading at more than $1.60, which equates to a market capitalisation of better than $600 million. The gains have prompted DJ Carmichael to ask if the project could at some point have more value for Rio Tinto.

Assuming around US$3 billion in capex to get the mine up and running and to replace old infrastructure, and factoring in historical indicative cost data inflated to today's dollars and current spot prices for copper and gold, DJ Carmichael suggests it is possible to justify a valuation for Bougainville of around $5.00 per share.

This would only equate to about $0.55 per Rio Tinto share, while DJ Carmichael notes the project would be marginal at best if more conservative long-term forecasts for copper and gold were applied. In the broker's view this analysis highlights a major issue for copper producers, in that it is cheaper at present to buy existing production or do nothing than it is to build new projects to bring additional production to market.

According to DJ Carmichael this means either copper consumption will decline, copper project construction costs will fall and/or the copper price will rise further. Until one or more of these things occurs, the broker suggests there is little incentive for copper players to look at new projects.

Given Rio Tinto is a diversified resource play and the Boungainville project is relatively minor in terms of impacting valuation for the company overall, DJ Carmichael retains its Buy rating. The rest of the market agrees as the FNArena database shows Rio Tinto scores a perfect eight-for-eight Buy ratings. The database shows no coverage of Bougainville Copper.

Turning to iron ore, Macquarie suggests as marginal Chinese domestic production is at the top end of the global cost curve an understanding of this market is important to gaining insight into the outlook for iron ore prices generally in coming years.

On Macquarie's numbers, when there is a need for 300mtpa of domestic iron ore on a 62%Fe equivalent basis, the cost structure of the industry in China offers support for seaborne prices at around US$120 per tonne.

When sourcing iron ore Macquarie expects the Chinese to buy whatever is available on the seaborne market, then use its domestic material to fill any gap. With the absolute volume of domestic iron ore required expected to stay around this year's level, cost support should remain at the top end of the domestic cost curve in the broker's view.

By 2014 and 2015 new iron ore supply should moderately outpace demand, so reducing China's domestic material requirements. By this time though cost inflation at domestic miners will have pushed up support prices, so what would be US$70-$80 per tonne cost support this year looks more like US$100-$110 per tonne in 2015 on Macquarie's numbers.

This implies cost support at volumes of 280-300mtpa of domestic material will have risen to around US$149 per tonne by 2012 and to US$170 per tonne by 2015, though Macquarie doesn't expect by 2015 China will require as much domestic ore to meet its needs.

To reflect this Macquarie expects average iron ore prices will trade in a range of US$130-$150 per tonne CFR China out to at least 2013 and above US$100 per tonne into the second half of this decade.

Moving to coal, BA Merrill Lynch notes hard coking coal prices have settled at US$225 per tonne for the first quarter of 2011, up from US$209 per tonne for the final quarter of this year. The price settlement is slightly above the broker's forecast of US$220 per tonne and BA-ML expects further gains to US$240 per tonne in the second quarter of next year.

In the thermal coal market BA-ML expects China's imports will increase by around 20% in 2011, this increase coming at the same time as global supply is coming under pressure from heavy rains in Australia, Columbia and Indonesia.

While BA-ML is forecasting thermal coal prices of US$110 per tonne in Japanese financial years 2011 and 2012, the combination of restricted supply and stronger seasonal demand from the northern hemisphere leads the broker to suggest price risk is to the upside.

Deutsche Bank has similarly taken a more positive view on thermal coal prices, lifting its price forecasts through 2013. The changes see a 5% increase in the broker's 2011 price forecast to US$115 per tonne, a 12.5% increase in 2012 to US$135 per tonne and a 20% increase in 2013 to US$120 per tonne.

As Deutsche notes, the fact both China and India are growing increasingly dependent on the seaborne thermal coal market is only now becoming better understood by the market in general. In both countries, growing power demand is outstripping existing infrastructure, so forcing both countries to look overseas for supplies.

This is occurring at the same time as producers such as Australia and Indonesia are being impacted by adverse weather conditions, which is bringing about a tightening in the market globally. Deutsche Bank is forecasting a deficit in the global thermal coal market of 28 million tonnes in 2011, an expectation that should support prices going forward.

Best placed among Australian producers to benefit from this in Deutsche's view is Whitehaven Coal ((WHC)), as 60-70% of group sales are in the thermal coal market. Having lifted its coal price forecasts Deutsche has also made minor increases to its earnings estimates for Whitehaven, which produce an increase in price target to $7.00 from $6.90 previously.

In contrast Macarthur Coal ((MCC)) has no thermal coal exposure, so Deutsche makes no changes to its forecasts for that company. Following the sector review Deutsche rates Whitehaven and Macarthur as Holds, while the FNArena database shows respective Sentiment Indicator readings of 0.3 and 0.1.

Both BHP Billiton ((BHP)) and Rio Tinto have relatively little leverage to thermal coal prices, so Deutsche has made only minor changes to forecasts and price targets for the stocks. It continues to rate both BHP and Rio Tinto as Buys, while Sentiment Indicator readings for both companies according to the FNArena database stand at 0.8 and 1.0 respectively.

On oil, BA-ML now sees the global oil market as moving to a tighter balance than previously expected, this due to ongoing demand strength that continues to outpace supply growth. To reflect this, the broker has lifted its oil price forecasts to US$78.90 per barrel for this year and to US$87 per barrel in 2011 for West Texas Intermediate, up from US$77.70 and US$85 per barrel respectively.

BA-ML has also lifted its long-term oil price forecast to US$85 per barrel from US$80, while it has increased its long-term AUD/USD forecast to US88c.

These changes mean some adjustments to earnings estimates and price targets across the stocks in BA-ML's Australian oil coverage universe, with targets increased in all cases except for Roc Oil ((ROC)) where there is a minor cut.

On a relative basis BA-ML's preferences in the sector remain Woodside Petroleum ((WPL)) and Oil Search ((OSH)), which also reflects greater challenges for Santos's ((STO)) new projects when compared to the other two companies.

As a final summation on the outlook for commodities in 2011, BA-ML has offered its top themes for the coming months. For those worried about inflation or sovereign debt defaults, continued investment in gold, silver and platinum is recommended.

In terms of preferred bull cycle plays BA-ML is most positive on copper, oil and coal, with further gains and in some cases record prices seen as likely during the course of the coming 12 months. Gold should also move higher, but with downside risks growing the broker suggests investors at least consider some downside protection when investing in commodities. One way to achieve this may be via commodity index options, which look inexpensive in the broker's view.

With respect to which commodities could underperform next year, BA-ML's picks for best shorting candidates are natural gas and wheat, the former due to record inventory levels and the latter thanks to an expectation production of other grains will soon start to normalise. 

article 3 months old

Food Inflation Hits Australia

By Rudi Filapek-Vandyck

Experts' views on global inflation have pretty much centred around higher food prices in China, wages pressures in Australia and the absolute lack of inflation in Europe and the US. The latest independent survey into inflation in Australia, however, suggests the case for global inflation is not that simple and not that clear cut. The november inflation gauge by TD Securities and the Melbourne Institute suggests inflation remains on an accelerating upward path in Australia, and rising prices for fruit and vegetables were among the main culprits, together with "communication" and rising rental prices.

The TD Securities–Melbourne Institute Monthly Inflation Gauge rose by 0.4% in November, after a 0.3% rise in October and a 0.1% rise in September. In the twelve months to November, the Inflation Gauge has now risen by 3.9%, following a 3.8% rise for the twelve months to October. Economists at TD Securities report November marks the fourth consecutive month that the gauge has been at or above the 3% upper band of the RBA's inflation target.

Contributing most to the overall change in November were price rises for fruit and vegetables and communication. These were offset by falls in prices for audio, visual and computing, holiday travel and accommodation, and meat and seafood. The price of automotive fuel increased marginally, while rents increased by 0.6%, the highest monthly increase since May.

The trimmed mean of the Inflation Gauge rose by 0.3% in November, following 0.2% increase in October. In the twelve months to November, the trimmed mean rose by 3.0%. TD Securities notes November is the second consecutive month that underlying inflation is at or above the upper band of the RBA target.

Annette Beacher, Head of Asia-Pacific Research at TD Securities, is quoted in the press release as saying: "Our TD-MI monthly Inflation Gauge gave the correct signal that inflationary pressures remained contained in the September quarter, but this goldilocks story is fast losing relevance. Now we have two months of evidence that upside inflation pressures have emerged in the final months of 2010. Our preliminary calculations suggest that headline inflation rose 0.9% for the December quarter, or 3.2% higher than a year ago, and underlying inflation rose 0.8% in the quarter, for an annual rate of 2.6%.”

“As the RBA took a pre-emptive stance against future inflationary pressures by shifting to a restrictive monetary policy stance last month, we expect the RBA to remain on the sidelines for the next few months. However, with inflationary pressures already building, the next move remains up for interest rates in Australia. While we cannot rule out a 25 basis point increase to 5% in Q1 2011, allowing for the RBA’s "flexibility" now it has achieved restrictive monetary policy, means this timing can easily slip into April or May without compromising the Bank’s anti-inflation credentials”.

article 3 months old

Nufarm’s Improving, But Risks Remain

By Chris Shaw

At its annual general meeting yesterday Nufarm ((NUF)) guided to earnings for the first half of FY11 of $10-$20 million, which was on the back of first quarter sales and gross margins coming in above those of the previous corresponding period.

Guidance was somewhat disappointing in the view of Credit Suisse, as given full year consensus forecasts were around $93 million in net profit after tax terms Nufarm would need deliver a record second half for these expectations to be met.

As Credit Suisse points out, historically Nufarm generates about 70-75% of its earnings in the second half of the year, so even at the upper end of the guidance range for the first half the implication is for full year earnings of only around $74 million.

The hope of Credit Suisse is the new guidance proves to be conservative, otherwise the stockbroker expects cuts to consensus earnings forecasts for the full year. Some peers do see guidance as on the conservative side, as BA Merrill Lynch continues to forecast an interim net profit of $24 million.

RBS Australia viewed the guidance as better than expected, its forecast for the first half being for a profit of $15 million. As the operating environment for the company appears to be improving, RBS has lifted its estimates post the result by about 19% in FY11 and by 26% in FY12.

In earnings per share terms RBS is now forecasting 33.8c this year and 42.4c in FY12, which is broadly in line with consensus forecasts according to the FNArena database of 32.3c in FY11 and 42.2c in FY12.

Deutsche Bank remains well below consensus with EPS forecasts of 20c in FY11 and 26c in FY12, which may reflect the broker's approach of taking interim financing fees and strategic review costs below the line and refinancing costs above the line. Even though they are at the bottom of the market with their forecasts, Deutsche does expect earnings in both the first half and for the whole of FY11 will be better than for the previous corresponding periods.

With respect to Nufarm's strategic review, Deutsche Bank sees the process as tracking to expectations, the recommendations to date including a stronger presence in higher margin segments, a rationalisation of the product portfolio and moves to exit underperforming markets. Some cost savings and efficiency opportunities have also been identified.

While some benefits should accrue from the strategic review, the other positive for Nufarm in RBS's view is a much improved operating environment. Soft commodity prices are rising and better seasonal conditions are supportive of strong demand for agricultural chemicals.

As well, RBS suggests the successful debt refinancing and improved operating environment should help restore some investor confidence in the company. Here Credit Suisse is more cautious, as while it suggests the worst is now likely behind the company, a bullish recovery already appears to be being factored into the share price.

On Credit Suisse's forecasts, Nufarm is trading on an earning multiple of about 15.7 times in FY11, which it notes is above the generic crop protection company average of 10-12 times. This premium comes despite a poor track record, uncertain weather conditions and potential management and board changes and so is difficult to justify in the broker's view.

As a result Credit Suisse continues to rate Nufarm as an Underperform, while the FNArena database shows the company is rated as Buy and Sell four times each. Deutsche Bank sides with Credit Suisse and has a Sell on the stock, this largely a valuation call given Nufarm is trading at a 45% premium to valuation on the broker's numbers.

RBS counters by upgrading Nufarm to Buy from Hold post the AGM, seeing better confidence in the company's outlook and scope for a greater than expected earnings rebound and possible corporate activity as reasons to be more positive on the stock.

BA-ML also has a Buy on the stock, expecting Nufarm to recover as market conditions normalise given the strength of the company's distribution channels, product offerings and branding power. Prior to the Nufarm AGM, Macquarie had upgraded to Outperform from Underperform, suggesting the successful debt refinancing will allow the company to better exploit improving operating conditions.

Post the AGM, the FNArena database shows a consensus price target on Nufarm of $4.64, which is up from just below $4.50 prior to the AGM update. Targets range from Deutsche Bank at $3.30 to BA-ML at $5.50.

Shares in Nufarm today are slightly higher and as at 10.30am the stock was up 4c at $4.84. This compares to a trading range over the past year of $3.20 to $11.38 and implies downside of around 3% to the consensus price target in the FNArena database.

article 3 months old

Material Matters: Aluminum Vs Silver, Ag Commodities And Bulks

By Chris Shaw

According to RBS the top commodity trade for 2011 is to be long aluminium and short silver, as the aluminium:silver ratio has moved to a level where silver is at its most expensive for the past 23 years.

Looking at each metal, RBS notes aluminium prices have been left behind by the recent gains in copper but this hides improving fundamentals for the metal. World demand growth for aluminium should be more than 15% this year, with year-on-year growth to be the best for 30 years.

The potential launch of some physically-backed Exchange Traded Funds (ETFs) for aluminium and the fact a number of high cost smelters in Europe in particular could close due to high power costs should also support prices, RBS seeing scope for the metal to play catch up with copper going forward.

Since the 1970s, RBS notes, copper prices have traded at around 1.5 times those of aluminium but this ratio has blown out to about 3.7 times now, so on a risk-reward basis aluminium now looks attractive in the broker's view.

Silver has enjoyed strong gains this year, even outperforming gold year-to-date. Back in February one ounce of gold would buy 70 ounces of silver but now the ratio has fallen to just 50 ounces of silver, as silver has risen to 30-year highs in nominal terms.

But the gains are partly reflected glory from rising gold prices and with RBS expecting gold to trade lower in 2011, and with the silver trade being crowded as shown by high ETF holdings, the broker has some concerns and sees lower prices ahead.

Turning to agricultural commodities, Barclays Capital points out while much attention has been paid to the demand side of the equation thanks to growing emerging market buying, the supply side has been somewhat ignored.

Given demand growth has lifted domestic consumption levels, emerging economies have increasingly looked to curb exports to ensure domestic supply. As Barclays notes, this has had the impact of tightening global balances in a number of commodities such as sugar and cotton.

Weather has also played a role, Barclays pointing out poor conditions in Russia have forced a banning of grain exports until the 2011 harvest, while the Ukraine has also imposed a grain export quota. The overall impact has been that while production has risen in emerging markets, and strongly in some cases, there has not been similar increases in export levels.

For Barclays this implies trends in emerging market agricultural policy and export trends in agricultural commodities are increasingly worth watching closely.

With respect to coal, UBS notes last week power generator Eskom and the South African government agreed a proposal to restrict thermal coal exports. The move reflects Eskom's inability to secure sufficient domestic supply for its generators.

Given Eskom uses around 120 million tonnes of South African production of 250 million tonnes of coal products, UBS estimates South Africa needs to lift coal supply by about 4% annually to meet expected demand growth.

Given the government appears unprepared to pay seaborne prices for new coal supply there is little incentive for domestic producers to deliver the additional product South Africa requires. This will threaten exports and so is bullish for ex-African coal producers in UBS's view.

Currently UBS is forecasting thermal coal prices of US$120 per tonne FOB for Japanese financial year 2011, which would be an increase of 22% in year-on-year terms.

Risk to this forecast is to the upside in UBS's view and among Australian producers the broker suggests Coal and Allied ((CNA)) is well placed to be a beneficiary of potentially higher thermal coal prices. Coal and Allied is rated as Buy by UBS, while the other three brokers in the FNArena database covering the stock rate it as a Hold.

Goldman Sachs is also turning more positive on coal, raising its price forecasts following meetings with industry participants in both China and Australia. The broker has also lifted its iron ore price estimates.

Even allowing for modest cuts to Chinese coal demand estimates, seaborne markets are expected to tighten further in 2011. Goldman Sachs expects this will push average annual prices in 2011 above those seen this year.

The largest increases are for hard coking coal, where Goldman Sachs sees a structurally tight market for some time. To reflect this the broker has lifted its forecast to US$240 per tonne for 2011 and 2012, which compares to previous estimates of US$226 per tonne and US$204 per tonne respectively. The broker's long-term forecast of US$160 per tonne is unchanged.

For thermal coal Goldman Sachs has lifted its average annual price forecast to US$111 per tonne for both 2011 and 2012, which compares to previous forecasts of US$103 and US$101 per tonne respectively. A long-term price forecast of US$80 per tonne is unchanged.

Similarly in iron ore Goldman Sachs has revised estimates higher, its average annual price forecasts now standing at U$153 per tonne for 2011 and US$140 per tonne for 2012, up from US$146 and US$124 per tonne previously. There is no change to the broker's long-term price forecast of US$75 per tonne.

The changes to forecasts for the bulk commodities means changes in earnings estimates for Australian companies operating in these markets, which has generally resulted in modest increases to price targets. In terms of an order of preference for companies exposed to the bulk commodities, Goldman Sachs favours BHP Billiton ((BHP)) as a Conviction Buy, Rio Tinto ((RIO)), Fortescue Metals ((FMG)) and Macarthur Coal ((MCC)). The latter three also are rated as Buys by the broker.

The FNArena database shows Sentiment Indicator readings for the four stocks of 1.0 for Rio Tinto, 0.8 for BHP, 0.4 for Fortescue and 0.1 for Macarthur.

The final word on commodities comes from Standard Bank in relation to oil futures. The bank suggests commercial hedgers currently are absent from the futures market, as the latest CFTC Commitment of Traders report showed a 23% drop in net long positions week-on-week.

When commercial hedgers are absent Standard Bank notes the oil market tends to trade in a more volatile fashion. This suggests some potential price swings in coming weeks, though the bank expects prices will remain in a trading range of US$75-$US$86 per barrel heading into the end of the year.

article 3 months old

Buy Commodity Price Dips

By Chris Shaw

In what has been something of a recurring pattern this year, commodity markets in recent weeks have again been hit by broader financial and economic worries. But as Barclays Capital notes, this time it has come when the commodities sector is being boosted by both a second round of quantitative easing (QE2) and strong underlying commodity demand trends and US economic indicators.

This leads Barclays to suggest the re-emergence of sovereign debt issues in Europe would have to take a severe turn for the worse to upset the current commodity price uptrend. Evidence of the resilience of markets can be seen in the large build up in speculative net long positions in the lead-up to the latest round of quantitative easing, as since July there has been a large increase in speculative interest in the agricultural, energy and industrial metal markets.

As well, while China is introducing additional measures such as interest rate hikes to control its economy, Barclays suggests the outlook for growth and for commodity demand as a result still appear quite favourable. This leads Barclays to the view that price dips are buying opportunities at present.

One factor in support of this view is the improvement in US economic indicators, Barclays pointing out US oil demand growth looks to be accelerating to its highest level in the recovery so far with early November numbers indicating an increase of 3.6% in year-on-year terms. Year-on-year gains are similarly impressive in metal markets, while Barclays notes inventory levels for the metals remain at low levels.

Chinese data is also supportive, Barclays taking the view recent numbers for industrial production, fixed asset investment and consumer spending all indicate a bottoming of the government induced slowdown in August, with a pick-up in activity since that time.

The other point made by Barclays is higher interest rates in China won't necessarily lead to lower commodity prices, as over most business cycles it is in the mature phase of expansion when capacity constraints are the highest and interest rates are moving higher than commodity prices tend to make the largest gains.

China is lifting rates but starting from an extremely low base in real terms, but even as rates are being increased overall liquidity conditions remain relatively good according to Barclays. With there still being significant flexibility with respect to the speeding up of development in infrastructure spending and low cost housing to boost growth if needed, GDP growth in 2011 of around 9% should still be achieved.

Taking a longer-term view, Barclays suggests QE2 is likely to accelerate some of the rebalancing process between nations with a current account surplus and those that are heavily indebted. This process is viewed as a positive overall for commodities demand, as faster growing markets will increasingly come to the fore as higher intensity users of commodities.

In the view of Barclays aluminium, coal, soybeans and corn should all experience a rising intensity of use in coming years, with industrial metals in general gaining from emerging market growth over the next 10 years.

Among the agricultural markets Barclays expects growth in wheat consumption is likely to be the slowest of any of the commodities in its analysis, while that of sugar and cotton is expected to slow significantly over the second half of the next decade. In energy coal is the clear standout beneficiary thanks to Chinese and Indian demand, while Barclays expects emerging market demand for oil and natural gas to be relatively slow.

article 3 months old

An Opportunity To Buy Graincorp?

By Chris Shaw

Grain storage and handling group Graincorp ((GNC)) yesterday delivered a full year profit result of $90.8 million in net profit after tax terms, which was broadly in line with market expectations. What caused the share price weakness, and post result the stock fell from around $7.75 to below $7.25, was weaker than expected guidance for FY11.

Guidance from management for the coming year wasn't specific but indicated the crop for 2010/11 is likely to be impacted by adverse weather conditions that will delay the harvest. The other key to guidance related to malt earnings and here the outlook was not as positive as had been expected.

As UBS notes, higher depreciation charges and adverse foreign exchange movements mean earnings from the malt operations in EBITDA (earnings before interest, tax, depreciation and amortisation) terms are now likely to come in at around $88 per tonne. This is down from around $110 per tonne achieved by the previous owners of the business.

The update has been met by cuts to earnings forecasts across the market, with RBS Australia lowering its profit forecasts for the company by 19.5% in FY11 and by 16.2% in FY12. Others have followed suit, Citi cutting its earnings forecast for FY11 by 13% and Credit Suisse by around 17% and 22% respectively.

In earnings per share (EPS) terms, consensus estimates for Graincorp according to the FNArena database now stand at 74.7c in FY11 and 65.7c in FY12. There remains a spread of forecasts, as Credit Suisse's numbers stand at 66.9c and 57.3c for FY11 and FY12, while JP Morgan's forecasts are 89.2c and 74.2c respectively.

The cuts in earnings estimates have seen price targets reduced, the FNArena database showing a consensus price target for Graincorp now of $8.38. This is down from about $8.60 prior to the FY10 result and is driven by UBS's target of $9.70, down from $10.30 previously. Next best is Citi with a target of $8.80, down from $9.30.

UBS continues to rate Graincorp as a Buy, pointing out even allowing for the new guidance on earnings there should still be solid growth in profits for the company in FY11. The other positive is core debt of around $50 million appears quite low, which offers potential for dividends to be increased going forward.

Most in the market agree, as the FNArena database shows Graincorp is rated as Buy four times and Neutral once. Citi suggests the sell-off in the stock post the FY10 result was an over-reaction as more favourable seasonal conditions suggest guidance is overly conservative. This should continue to underpin the share price.

The other attraction of Graincorp according to Citi is the potential for merger and acquisition activity involving the company. This view is shared by RBS Australia, who points out the low debt levels leave Graincorp well placed to fund any growth opportunities that may emerge.

The dissenting view comes from Credit Suisse, which suggests a lack of short-term positive catalysts for Graincorp is likely to see the stock underperform for the next several months. Goldman Sachs has a similar view, suggesting currently optimistic market assumptions for the company are likely to be tempered by the late harvest and concerns around grain quality.

Shares in Graincorp today are higher and as at 11.40am the stock was up 15c at $7.14. This compares to a range over the past year of $5.10 to $8.26 and implies upside of around 17% to the consensus price target in the FNArena database.

article 3 months old

Incitec Pivot At Start Of Upgrade Cycle?

By Chris Shaw

Fertiliser and agricultural chemicals group Incitec Pivot ((IPL)) delivered a positive earnings surprise yesterday, its full year profit result of $442 million coming in about 13% higher than consensus forecasts.

Citi saw the better than expected result as being driven by Project Velocity related cost reductions of $77 million and lower interest charges during the period. From a divisional perspective, UBS notes the fertiliser business outperformed, this thanks to a leveraging of improvement in soft commodity markets.

Project velocity is an attempt to improve operating efficiencies and lower group costs, RBS Morgans noting the target is US$204 million of benefits by FY12. The FY10 result shows some of these benefits have come sooner than expected, but fully realising the goals will require an improvement in volumes and so remains a challenge in the broker's view.

In terms of the outlook for 2011, Credit Suisse suggests positive earnings momentum should continue as Incitec Pivot at present is enjoying a combination of strong fertiliser prices, a solid soft commodity market, good hedging of currency exposure and a lower interest expense.

According to Credit Suisse, fertiliser driven market earnings upgrades for Incitec Pivot appear inevitable post the full year profit result and increases of around 10% are likely in the broker's view. RBS Australia agrees, taking the view the combination of improved seasonal conditions and rising fertiliser and soft commodity prices is likely to create a cycle of earnings upgrades for the coming year.

In the fertiliser market specifically, RBS Morgans notes the market remains tight thanks to strong demand and limited supply. Even allowing for recent increases to its fertiliser price forecasts, the broker continues to view risk to the upside. This is thanks to reports China may bring forward its export tax, which would reduce Chinese exports and so further tighten the global market.

Given it was already above the market with its FY11 numbers, Credit Suisse has only lifted its forecast by 3.1% to a reported net profit after tax of $558 million. In earnings per share terms this means Credit Suisse is now forecasting 30.8c in FY11 and 35c in FY12, which compares to respective consensus forecasts according to the FNArena database of 29.2c and 30.5c for FY11 and FY12.

These consensus numbers have indeed been lifted post Incitec Pivot's full year result, as UBS for example increased its forecasts by 7% in FY11 and by 4% in FY12, while Deutsche Bank has lifted its numbers by 4-6% through FY12.

Earnings could still be somewhat volatile for Incitec Pivot, as RBS Morgans points out a US$10 perr tonne change in DAP fertiliser prices has an A$11.5 million impact on earnings before interest and tax (EBIT), while a US$10pere tonne change in urea prices has a A$4.8m impact on EBIT.

Currency moves are also an issue, as the broker estimates the transactional earnings impact is A$7.2 million for every 1c change in the AUD/USD exchange rate, while the translation impact is A$1.8 million for every 1c move.

With the increases in earnings forecasts has come an increase in price targets, the FNArena database showing the consensus price target for Incitec Pivot is now $4.04. This is up from $3.89 prior to the full year result.

There is a wide range of broker price targets, Credit Suisse leading the way with a target of $4.52, up from $4.10 previously. At the other extreme is Deutsche Bank with a target of $2.65, up from $2.50 previously.

Given its low target it is little surprise Deutsche Bank rates Incitec Pivot as a Sell, the broker estimating at current levels the stock is trading at a 42% premium to valuation and a 35% premium to its North American peers.

This is the only Sell rating on the stock, the FNArena database showing five Buy ratings for Incitec Pivot and two Hold recommendations. Credit Suisse and RBS both see increases to market earnings forecasts providing some support for the stock and so justifying their respective Buy ratings, while UBS suggests the stock is fair value, making its Neutral rating appropriate.

Shares in Incitec Pivot today are slightly stronger and as at 11.30am the stock was up 4c at $3.81. Over the past year the shares have traded in a range of $2.54 to $4.00 and at current levels there is implied upside of about 5% to the consensus price target in the FNArena database. Note: the consensus price in itself is negatively impacted by the low target set by Deutsche.

article 3 months old

Material Matters: Commodity Fundamentals Still Constructive, Some Caution On Silver Prices

By Chris Shaw

Commodity prices rallied further last week, with copper being pushed to an all-time high of US$8,980.50 per tonne, oil to a 25-month high above US$80 per barrel and grain prices to levels last seen back in September of 2008.

According to Danske Bank, last week's rally appears to show the conclusion of investors is further quantitative measures from the US Federal Reserve and reasonable US economic numbers are a positive combination for the commodities sector.

Also bullish for prices is the International Monetary Fund (IMF) warning in its latest World Economic Outlook the commodities “super-cycle” could be about to resume. This is a view Danske Bank happens to share, given Asian demand remains strong and market conditions are tight in several commodities.

While setbacks from time to time remain likely, Danske Bank cautions against investors taking too conservative an approach, as by waiting for a pullback in prices to enter the sector investors may miss out on what could be another leg higher.

Danske Bank even accepts its forecasts may have underestimated market sentiment, as oil for example looks like it could test US$100 per barrel much earlier than the late 2011 timetable it had previously expected. Similarly, some calls in the market suggesting copper may hit the US$10,000 per tonne level now don't look so far-fetched in the bank's view.

BA-Merrill Lynch is also bullish on commodity prices, looking for further gains next year from a combination of US quantitative easing measures, the introduction of Exchange Traded Funds (ETFs) boosting investor demand for some commodities and ongoing strong Chinese and other emerging market demand driving physical demand.

There remain some risks for the sector in BA-ML's view, including a potential recovery in the US dollar, excessive capital outflows to emerging market economies and the fact the current second round of quantitative easing measures is a policy front-loaded to the first half of 2011. This could create some uncertainty with regards to economic policy in the second half of next year according to the broker.

While bullish, BA-ML points out relative strength of fundamentals for the various commodities are likely to become more relevant next year and so drive prices. This suggests commodities where there are supply issues such as copper, platinum and palladium should outperform. BA-ML is particularly bullish on copper, expecting prices for the metal in 2011 could average US$11,250 per tonne. This compares to to a forecast average in 2010 of US$7,557 per tonne and is up from a previous forecast for 2011 of US$8,000 per tonne.

BA-ML has adjusted price forecasts for 2011 elsewhere in the commodities sector as well, lifting its aluminium forecast to US$2,600 per tonne from US$2,275 per tonne previously and for lead to US$2,775 per tonne from US$2,450 per tonne previously.

For nickel BA-ML is now forecasting an average price of US$25,750 per tonne in 2011, up from US$20,875 per tonne previously, while for zinc the broker's forecast increases to US$2,725 per tonne from US$2,550 per tonne.

Among the precious metals BA-ML has increased its 2011 average gold price forecast to US$1,425 per ounce from US$1,390 previously, while for silver its forecast has increased to US$29.50 per ounce from US$28.78. For platinum BA-ML's forecast has risen to US$2,000 per ounce from US$1,750, while for palladium the broker's average price forecast for 2011 has increased to US$775 per ounce from US$650 per ounce.

Goldman Sachs has added its view on the outlook for the base metals, noting for aluminium the fact the metal didn't rally along with the other base metals last week was likely due at least part to a second successive month of declining net new orders for mill products in October. This implies demand for aluminium semis has reversed somewhat since the summer.

Industry heavyweight Alcoa expects global aluminium demand growth will increase to 6.5% per annum over the next 10 years, Goldman Sachs noting this is based on a view global population growth will continue, there will be an increase in the rate of urbanisation of societies and energy conservation and environmental regulations will play an increasing role in the outlook for the metal.

Short-term, Goldman Sachs suggests demand for aluminium and the other base metals in the US market looks weak, so how demand holds up in other markets will be of importance. In this regard the broker notes there appears to be some de-stocking underway in China at present, as copper import tonnage for the year to October is well down on the same stage last year.

Goldman Sachs remains bullish on copper on a longer-term view, noting fundamentals remain constructive to higher prices. Supporting this bullish view is confirmation of further supply side issues, as for example the broker notes there are reports Chinalco has postponed the start of construction of its Toromocho project in Peru.

In looking at silver, Macquarie suggests while the belief the metal has favourable attributes as both a safe haven and an industrial metal is driving prices at present the reality is somewhat less positive.

ETF holdings of silver have grown strongly since the middle of the year and recent outperformance of the metal's price has seen this trend continue in recent weeks. While this boosts the investment argument for silver, Macquarie suggests the industrial metal outlook for silver is not as attractive. Production so far this year has been strong, meaning the fundamentals of the silver market are not as tight as for other metals.

As long as investors continue to accumulate silver in the belief the metal's industrial exposure is driving prices Macquarie expects the market will remain strong. If investor conviction starts to falter however, the broker suggests the strong growth in supply relative to fabrication demand growth may begin to put the silver price under some pressure.

article 3 months old

Material Matters: Trends Positive For Oil, Ag Commodities, And Coal

By Chris Shaw

The recent fall in US oil inventories appears to be accelerating, Barclays Capital noting relative to normal seasonal patterns the last seven weeks has seen oil product inventories in the US market decline by an average rate of 670,000 barrels per day.

Factoring in the latest figures sees Barclays estimate the US overhang of oil product inventories is now just 32.9 million barrels. This represents a fall of 18.8 million barrels over just the past three weeks and 29.9 million barrels over the past seven weeks.

At the same time, Barclays notes there has been further upside surprise in global oil demand, which has caused the group to lift its forecast for 2010 to growth of 2.02 million barrels per day. This is a little higher than the US Energy Information Administration forecast of 2.0 million barrels per day and would be the second highest rate of growth over the past 30 years.

With demand growing faster than had been projected in the market, Barclays suggests the only way some lower projections such as those of the OPEC Secretariat and the International Energy Agency can be credible is if the path of oil prices is significantly higher than currently expected.

As both these sets of projections imply fairly tight oil markets by the middle of this decade, and given its own view of considerable upside to demand forecasts in coming years, Barclays Capital remains of the view there is still significant potential upside for oil prices. As evidence of this, Barclays has a 2015 price forecast for oil of US$137 per barrel, with which it remains quite comfortable.

On a shorter time frame, Commonwealth Bank is similarly bullish on the outlook for oil prices, as it suggests the combination of falling US inventories and a likely US consumer recovery should boost demand further over the next 6-12 months.

This should further tighten the global oil market in Commonwealth Bank's view, which supports its expectation the oil price will lift closer to US$100 per barrel over the next year or so.

Turning to the agricultural commodities, Barclays Capital notes prices have continued to push higher in recent months on the back of ongoing production downgrades, strong demand, export curbs and declining inventories.

While the current high prices should act as an incentive to plant additional acreage in coming months, Barclays suggests it will be price attractiveness of crops relative to each other that decides the battle for acreage into the US planting season.

From a demand perspective, Barclays suggests the recent uptrend in Chinese grain imports is primarily a reflection of near-term supply concerns. Inflationary expectations moving higher on the back of higher food prices is also a serious concern in developing countries, Barclays highlighting this by noting it is causing governments to intervene or to put export curbs in place in various markets.

This combination of tighter balances, strong demand and more nervous markets should keep interest in agricultural markets high according to Barclays, especially given there are also some broader shifts in consumption patterns underway.

As with the agricultural commodities, stocks levels are also declining in the European and Chinese coal markets. Barclays again notes this is a result of a combination of demand continuing to surprise to the upside and ongoing supply issues. The supply side problems are a combination of infrastructure constraints and the impact of bad weather restricting supplies from Colombia, Australia and Indonesia.

Coal burn across Europe was again strong in October and Barclays notes it continues to run at a little above 2009 levels, so sustaining demand in this region. Chinese re-stocking has kept Asian demand solid as well, this re-stocking for winter again coming earlier this year than is usually the case.

Until this re-stocking process is complete, likely in the next few weeks, Barclays sees scope for further short-term upside to coal prices. Attendees at a recent Coaltrans conference tend to agree with this view as Barclays notes forecasts were for average prices to post further moderate gains in 2011.

The Barclays view is shared by Commonwealth Bank, which noted last week spot thermal coal prices ex-Newcastle rose above US$100 per tonne for the first time since June of this year. While price gains for Australian suppliers have been limited by the stronger Australian dollar, this upward pressure on thermal coal prices should continue in the bank's view given the market is entering the peak demand season.

In some cases the increases in demand have come early, as Commonwealth Bank notes for example demand in China is being boosted by the early onset of winter in some parts of that country. With major suppliers being hampered by heavy rainfall the bank expects markets will remain tight over the near-term, so supporting prices.