Base Metals
The base metals sector has been down nearly -20% over the past three months amid an escalation in the trade conflict between the US and China which has instilled fears of weaker economic growth. Still, so far, ANZ analysts observe there has been little impact.
The analysts believe the selling of the sector has been overdone and expect prices will rally if trade tensions ease. Various premia for metals have started to push higher as China flags a more proactive stance regarding fiscal policy. The greater impact on trade comes from environmental constraints and supply-side reforms in China, but this has more effect on domestic output and, therefore, imports are likely to remain strong.
Platinum
The platinum market appears headed for another surplus in 2018. The main reason is falling demand in the European automotive market. Macquarie’s analysis of German diesel sales indicates that one of the factors cited for mitigating diesel’s decline, that it affects only small cars, does not really hold up. Still, the latest data suggests diesel’s share may be stabilising.
Supply of platinum actually fell slightly in the first half of 2018, indicating that weaker demand was contributing to the surplus. Automotive demand is reported to be -6% lower and mainly because of a slump in European automotive catalyst requirements.
Platinum bulls should not rely on an easing of the slowdown in diesel, Macquarie warns, even if it makes economic sense for many cars. Platinum is likely to recover but only in a significant way when car companies begin to use more platinum at the expense of higher-priced palladium. Macquarie is confident they will, but there is no evidence this is occurring as yet.
Steel/Iron Ore
Production from major iron ore producers remains strong but iron ore prices are stable, with the 62% benchmark hovering near US$68/t and the 58% ore index improving to around US$45/t.
However Chinese steel demand is even stronger and continues to be met by a rise in domestic iron ore production. Ord Minnett models a -50mt deficit this year, which will be satisfied by an increase in Chinese iron ore output to around 240mt to for 2018 from 190mt in 2017.
Approaching the winter season and production restrictions in China, the broker believes steel prices will remain well supported amid tight supply and high effective utilisation rates.
Chinese steel prices are at seven-year highs, Deutsche Bank observes, while iron ore prices are not, despite weaker-than-expected iron ore supply. Fortescue Metals ((FMG)) is downgraded to Sell from Buy as the broker believes iron ore is failing to fire and lagging the bullish pricing in the steel market. The broker observes the bottleneck has moved to the blast furnace from iron ore as a result of Chinese policies.
Major Miners
Deutsche Bank believes the easy gains have been made for the miners as FY18 sustained a rise in prices and FY19 promises challenges amid rising costs and capital expenditure. The broker acknowledges earnings are likely to remain reasonable and there is room for significant off-market buybacks.
Deutsche Bank envisages potential for buybacks of the ASX listing of Rio Tinto ((RIO)) up to US$4bn and BHP ((BHP)) up to US$10.7bn, as both deliver on promises to return the proceeds of asset sales to shareholders. While such returns are welcome, Deutsche Bank does not consider this a bullish signal to buy the sector.
Deutsche Bank suggests investors be selective for capital gains. South32 ((S32)) and Whitehaven Coal ((WHC)) are upgraded to Buy from Hold but the broker rates a majority of the market as Hold and downgrades BHP to Hold from Buy.
Among the diversified major miners, Credit Suisse retains a preference for Rio Tinto based on a more attractive valuation following recent falls in the share price. However, the gap is narrowing, as Rio Tinto lacks catalysts while BHP is a more interesting story for growth investors.
The path towards progressive upgrades to BHP’s valuation is becoming clearer. Credit Suisse flags an extensive suite of high-returning internal growth options but does not believe the market possesses sufficient detail to properly model these. The broker would welcome further disclosure on internal options.
Credit Suisse acknowledges there were examples at the recent FY18 results indicating how the company is beginning to invest in future growth but BHP has stuck to its US$8bn in capital expenditure guidance. US onshore expenditure is around US$1bn and drops off in 2020 and the replacement projects have not been specified.
In contrast, Rio Tinto, despite the lack of large-scale growth options and a heavy reliance on iron ore, is now comparatively cheaper on multiples, in addition to exhibiting higher free cash flow yields on a longer term basis. The broker finds the cash generation and likelihood of further cash returns an attractive mix for those seeking yield over growth.
