- Commodity prices forecasts revised
- Chinese copper consumption may moderate
- Nickel to move into surplus in 2012
- Platinum price headwinds at US$1,850 per ounce
- Europe and commodities demand
- Downside risk for Chinese oil demand

By Chris Shaw

To reflect a continued worsening in the global economic outlook, Citi has downgraded global GDP growth estimates to 3.1% in 2011 and 3.2% in 2012. This has flowed through to cuts in forecasts for all the base metals, though at current spot levels Citi suggests there is little downside for aluminium prices given the spot price is below that of the high cost marginal producer.

Any downturn in developed economies should be weathered by the higher growing developing economies, so Citi doesn't expect significant weakness among the bulk commodities given demand is being driven by emerging market economies.

Preferred is thermal coal given its exposure to booming demand from India and China and recovering demand from Japan, as well as the expectation thermal coal will see a rise in its share of the world's electricity generating capacity.

While Citi still likes the medium-term outlook for gold it now appears the easy gains have already been made, with a breather expected in the shorter-term. This implies on a risk-weighted basis there are currently better opportunities among the bulk commodities.

In summary, on a 12-month view Citi remains bullish on thermal coal, iron ore, palladium and crude oil, while a neutral view applies to aluminium, metallurgical coal, nickel, gold and platinum. Citi continues to be bearish on steel, copper, zinc and lead.

Citi's adjustments saw cuts to base metal price forecasts of of up to 15% and coal price forecasts of around 1%. Goldman Sachs has also reviewed its commodity price expectations on the back of the recent profit reporting season in Australia. Goldman Sachs has also factored in issues such as signs of faltering demand for raw materials from both the US and Europe.

Given raw material demand from China and other emerging markets is holding reasonably well, Goldman Sachs continues to take a positive view on those commodities that are supply constrained. As well, the emergence of cost inflation is supportive for commodity prices in the view of Goldman Sachs as it raises the 'cost support level'.

A further supportive factor is interest rates in the US are likely to remain low for an extended period of time, while further economic stimulus is likely to be introduced. As this should see the US dollar remain weak, Goldman Sachs sees an environment supportive for US dollar commodity prices.

Forecasts have been adjusted across all the metals and bulks, though Goldman Sachs notes changes for the base metals, platinum group metals and rare earth metals have been little more than a marking-to-market process.

More significant changes are for iron prices to now remain above US$150 per tonne through 2013 and for higher metallurgical coal prices from 2012 to 2015. Gold price forecasts have also been increased through the first half of 2013, with mid-2013 now seen as an inflection point for that market.

Goldman Sachs has made no changes to long-term price forecasts in any markets. Order of preference sees copper preferred in the base metals and aluminium still the least favoured, while gold, mineral sands, platinum group metals, rare earths and crude oil are the broker's preferred tier one commodities.

In terms of how this plays out with respect to stock choices, Goldman Sachs continues to recommend BHP Billiton ((BHP)) as a Conviction Buy among the iron ore, coal and uranium exposures. This reflects the view the company has the best strategic position with respect to early/mid and later cycle commodities.

Elsewhere, for iron ore exposure Goldman Sachs rates both Fortescue Metals ((FMG)) and Rio Tinto ((RIO)) as Buy, while Hold ratings are ascribed to Atlas Iron ((AGO)), Mount Gibson Iron ((MGX)) and Murchison Metals ((MMX)).

In coal, Goldman Sachs has Buy ratings on Macarthur ((MCC)) and Bathurst Resources ((BTU)), with Hold ratings on Whitehaven ((WHC)) and Aston Resources ((AZT)). Among uranium plays Goldman Sachs prefers Paladin ((PDN)) over Energy Resources of Australia ((ERA)) but has Sell ratings on both stocks.

In the base and precious metals sectors Goldman Sachs has Conviction Buy ratings on Iluka Resources ((ILU)) and PanAust ((PNA)). Among others, those favoured in order of commodity preference are Mineral Deposits ((MDL)), Base Resources ((BSE)), Sandfire Resources ((SFR)), Lynas Corporation ((LYC)), Aquarius Platinum ((AQP)), Kingsgate Consolidated ((KCN)), St Barbara ((SBM)) and Teranga Gold ((TGZ)). Each of these stocks is rated Buy.

Having been in contact with its contacts in the Chinese market and following a review of recent data, Macquarie suggests 1H11 Chinese copper demand was actually stronger than it appeared. While Chinese refined copper demand fell by 7% in year-on-year terms for the first seven months of 2011, Macquarie estimates real consumption of copper units actually grew by 7% in year-on-year terms.

This strength may not last though, as Macquarie suggests Chinese traders and consumers are becoming increasingly concerned about the macro outlook. The key question is can the Chinese deal with low inventory levels and so remain on the sidelines for a while longer?

In Macquarie's view they can, meaning real consumption growth should moderate in coming months. Assuming this proves to be the case, Macquarie expects copper prices are likely to stay range-bound over the remainder of 2011.

What could also impact on Chinese copper demand is the latest tightening of the reserve requirement ratio by the People's Bank of China (PBoC) to include margin deposits. The changes will make it more expensive for banks to fund letter of credit.

As Commonwealth Bank points out, since late in 2010 copper imports have been financed in part by trade letters of credit that provided access to short-term finance. The tightening of credit channels by the PBoC has seen copper stored in bonded warehouses fall.

The latest rule changes will make accessing credit even harder and so have some bearing on Chinese copper demand, but Commonwealth Bank doesn't see the changes as having a huge impact on copper prices.

The market may be expecting a weakening in Chinese demand to some extent, as Commonwealth Bank notes managed money has over the past couple of weeks turned net short on copper for the first time since October of 2009. CBA suggests this reflects concerns a slowing global economy will dampen metal demand.

With respect to nickel, Goldman Sachs notes ongoing supply disruptions and project delays have maintained a tighter market and higher prices for much longer than had been anticipated. Despite this, there are now signs nickel production growth is starting to accelerate.

As Goldman Sachs points out, greenfield ferro-nickel projects such as Onca Puma and Barro Alto are now being ramped-up, while nickel pig-iron production in China continues to grow and 2012 should see the start of commercial production from a number of HPAL projects.

This leads Goldman Sachs to suggest the nickel market should move into a substantial surplus in 2012, which supports a cautious view on the price outlook. Annual average prices are forecast to bottom out at US900c per pound in 2012 and 2013 before modest upside potential from 2014 as the market becomes more balanced.

Turning to the precious metals, Standard Bank suggests the current mix of supply side issues in South Africa, which include strikes and debates on mine nationalisation are continuing to provide support for platinum prices.

But some caution is justified in Standard Bank's view, as the latest Swiss and Chinese customs data are less supportive for platinum as demand appears to be slowing. This is likely to reflect both a seasonal slowdown in industrial activity and monetary tightening in China.

At the same time Standard Bank notes net speculative length in the platinum market is high and rising, suggesting a less bearish view. Weak underlying economic conditions are a counter to this, Standard Bank suggesting significant additional length is unlikely to be added at current price levels.

Factoring this in, Standard Bank is not a keen buyer of platinum above US$1,850 per ounce. The bank does suggest there is value on an approach to US$1,700 per ounce based on cost-of-production analysis.

Given recent volatility in the metals and mining sector BA Merrill Lynch has reviewed both the importance of European commodity demand and the price/book valuation measure to attempt to assess their relative influence and relevance in the current environment.

With respect to Europe, BA-ML notes demand from the region for major metals and seaborne bulk commodities demand has declined in the past decade to 10-16% from 25-30%. This means changes in demand across the region are less relevant than had been the case.

In the steel sector most valuation analysis is not done on a net present value basis, BA-ML noting price/book has long been regarded as a good valuation proxy, especially when earnings are less reliable.

While BA-ML's rule of thumb is a price/book of less than one should offer some valuation support, this has not helped Japanese or Australian steel mills so far this year. This implies price/book is of less significance when the market value of assets is substantially below book value, as is the case with BlueScope Steel ((BSL)) currently.

The measure is also of less significance when recent acquisitions have boosted the net asset case for a company and where the profit outlook is extremely gloomy. BA-ML's Ben Chan suggests book value has become increasingly less meaningful as a valuation measure for Australian steel plays, this reflecting drastic movements in both the Australian dollar and raw material costs.

These movements suggest on a foreseeable returns basis there would be little to justify a decision to invest in domestic steel capacity today, meaning Chan has little confidence in book value as a valuation tool for the Australian industry at present.

On oil, Deutsche Bank's analysis shows Chinese oil demand growth almost never exceeds GDP growth. The International Monetary Fund ((IMF)) is currently estimating Chinese GDP growth of 9.5% for 2012, while Deutsche's forecast is for 8.3% growth with a base case of around 6.5%.

Deutsche's figures imply oil demand growth of about 6-7% or around 600,000 barrels per day. But given the downside risks in the current global economic outlook, Deutsche cautions in a bad year Chinese oil demand may actually grow at something closer to 2-3% or around 200,000-300,000 barrels per day, rather than the consensus estimate of growth of closer to 500,000-600,000 barrels per day.