Large Cap Resources
Credit Suisse retains a cautious view on 2020 yet notes, despite recent softness in commodity prices, equities have held up well. Major resource companies have benefitted from capital discipline and strong balance sheets.
Where the broker envisages upside, namely metallurgical (coking) coal and alumina, it remains constructive on the equities. However, particularly for Australian investors, BHP Group ((BHP)) and Rio Tinto ((RIO)) may be the safe plays until a trade deal between China and the US provides more certainty about the global outlook.
While a bearish house view on steel does not provide Credit Suisse with a strong upside conviction, BHP Group remains the preferred stock for 2020 among the majors, as there is potential upside for metallurgical coal. South32 ((S32)) appears best positioned, given it is trading around book value, but the broker’s forecasts for base metals imply material downside for earnings in the medium term.
Meanwhile, coal exposures such as Whitehaven Coal ((WHC)), Coronado Resources ((CRN)) and New Hope Corp ((NHC)) continue to suffer from falling investor demand as ESG (environment, social and governance) concerns have magnified over 2019 and this is unlikely to unwind in the near term.
Alumina Ltd ((AWC)) and Iluka Resources ((ILU)) have company-specific drivers to watch out for in the New Year which could drive sentiment although, in the interim, soft commodities for both mean upside potential is low.
Copper
Credit Suisse assesses the copper price may experience a bounce if there is a trade deal between China and the US, but demand growth may be slower to recover. Fundamentals are showing copper experiencing growing surpluses, an indication of lower prices.
The broker reduces forecasts over the next two years, expecting the copper surplus will become large by 2022. A price response is expected to force mine closures, subsequently reducing the surplus and allowing the price to recover in 2023.
Credit Suisse reduces demand estimates for this year and next, given poor macro data, and now expects a modest surplus in 2019 as opposed to a deficit. The broker reduces December quarter copper pricing by -10% and 2020 forecasts by -4% to US$2.70/lb. 2021 forecasts are reduced by -7% to US$2.50/lb and 2022 by -20% to the forecast low of US$2.15/lb.
Citi considers the main catalysts will be whether a trade deal materialises. The broker’s end-use copper market tracker reveals a second consecutive month of expansion in October, to the highest rate in seven months. This also matches a pick up in copper positioning on the London Metal Exchange/COMEX. Stronger end-use demand may also explain why speculators in China have been reluctant to build short positions.
Macquarie found a more upbeat mood on copper at the recent copper conference in Shanghai. Traders and speculators tended to favour copper for some upside amongst the LME base metal complex.
This is supported by the broker’s monthly survey of Chinese fabricators which are increasingly positive regarding orders from the construction sector. This contrasts with steel expectations and supports the assessment that strong property starts over the last few years are now transferring into completions and this will benefit non-ferrous metals at the expense of steel.
The broker finds the physical copper market is resilient with supply tightness at copper mines restraining the ambitions of smelters and leading to price stability in the face of the trade war.
Base Metals
Citi reiterates a positive 6-12 month view on nickel since current prices are consistent with a recession-like outlook for demand. The potential for demand to outperform this fairly low bar skews the price risks for nickel to the upside, in the broker’s opinion.
At spot prices of $14,400/t Citi estimates rising costs will squeeze margins to unsustainable levels and, as global demand growth is expected to improve, higher prices are required to prevent a run down in nickel stocks in the next 3-4 years.
Credit Suisse also expects supply balances for nickel should be tighter next year and increases price estimates to US$7/lb.
The broker drastically lowers price forecasts for aluminium on the threat of large surpluses and a view that supply needs to be shed. Slowing demand for aluminium has generated these surpluses and there remains too much capacity available, with even more coming online.
China has approved 46mtpa of aluminium capacity on expectations consumption will reach 42mtpa. But Credit Suisse believes this is a distant prospect, whereas extra capacity will come on line in the next couple years.
The broker points out closing and aluminium smelter is a serious decision and rarely taken, so these tend to keep operating even when making losses and now expects the price will stay at the current punitive level through the next two years and force obsolete units to close.
With production growth slowing prices could then rise in 2022 and 2023. For alumina prices, Credit Suisse believes the only direction is up from a floor of US$280/t. However, the Chinese winter is typically a weak period for alumina so little improvement in the price is expected until the second quarter of 2020.
Iron Ore
Morgan Stanley observes the spot price for iron ore is creeping back up to US$90/t and robust demand is keeping the market tight. The broker suspects, with momentum still strong and low inventory at steel mills, amid constrained near-term supply growth, the iron ore prices not ready to take a step down yet.
While there is a probability for Chinese construction to decelerate in the second half of 2020 the broker believes near-term activity will remain robust. Relatively warm weather has meant construction activity has not slowed down for the winter as yet, evidenced by higher volumes of rebar end-use procurement.
Steel production curbs are not being strictly enforced in the current heating season and Morgan Stanley does not believe such restrictions will be a significant drag on restocking. An increase in Chinese domestic iron ore supply up until October this year also appears to be running out of steam.
If the Simandou mine in Guinea ramps up to 100mtpa, as the winning consortium plans, Macquarie suspects the largest players in the market may respond by shrinking their production rates to at least mitigate the hit on prices.
Macquarie asserts the Singapore/China/France consortium promises to build a US$14bn mine-rail-poor complex in Guinea to deliver a massive 7% of additional supply of iron ore to the market over the medium term, just as China-led global steel production growth rates low and competitive steel scrap flows rise.
Because of the unusual structure of the iron ore market, the addition of Simandou could enhance consolidation. Alternatively, at 100mtpa, the project could be sufficiently large to marginalise a raft of smaller operations.
The broker flags the ability of the main operators in the market, namely Vale, Rio Tinto and BHP Group, to adjust their respective production rates to optimise long-term price outcomes.
If Chinese steel mills somehow exploit the emergence of the Simandou project then investors could be justified in being bearish on both the iron ore price and the growth in supply, although Macquarie considers this an unlikely bearish scenario.
Coal
At the Carbon Forum 2019 in Warsaw Macquarie observes the main talking point was the apparent disconnect between Chinese port restrictions and the strong growth in coking coal imports. The broker pointed out the traditional role of China as a clearing market and that strong imports did not necessarily reflect strong demand.
As a global markets slipped into oversupply China has been taking on more seaborne coal while demanding deep discounts. The broker notes metallurgical coal inventory remains high, particular at the ports.
Most traders expect Chinese exports of coke will continue to fall as more merchant coke plants close and industry overcapacity is reduced. The bright spot for coking coal is strong demand growth in Vietnam, Indonesia and Malaysia where cumulative imports have doubled in only two years.
While investment in new mine capacity has shrunk in western-oriented hub such as Australia, Colombia and the US, thermal coal is expanding in Russia. Russian thermal coal exports have increased by 11mt and metallurgical coal by 2mt this year. Key markets are in Asia but also Turkey and North Africa.
Macquarie notes growing Russian thermal coal exports are considered a threat for high calorie thermal coal and the PCI/semi-soft coking coal market but not necessarily for premium hard coking coal of which the country is short.
