Metals start to feel gravity
| PORTFOLIO POINT: Market fundamentals, in the form of rising inventories, could reassert themselves in the next few months to dent copper and nickel’s rise. |
Commodity prices have continued to surprise most experts across the globe, and securities analysts at ABN-Amro, Citi, GSJB Were and Macquarie – to name just a few – have recently again increased their price forecasts as the gap between daily spot prices, listed commodity futures and analysts’ forecasts remains firmly in place.
Rio Tinto (RIO): Merrill Lynch has a preference for Rio Tinto over BHP Billiton. An absence of any nickel exposure as well as a relative larger importance of iron ore easily explains why. Rio Tinto is also expected to announce capital management initiatives whereas BHP already did earlier this year. The broker's price forecast for the upcoming annual iron ore negotiations is for a rise of 8% only. Outside the big producers, the broker believes best opportunities are on offer through Mount Gibson and Murchison, while Atlas Iron is regarded as "an interesting play".
Macarthur Coal (MCC): The outlook for coal prices looks strong on a three-year view, Merrill Lynch believes. As this is yet to be reflected in price forecasts elsewhere, the broker foresees market upgrades to prices for the next two to three years. In Australia, best leverage is considered through BHP Billiton for coking coal, through Macarthur Coal for PCI, and through Centennial and Felix Resources for thermal coal.
BHP Billiton (BHP): Short nickel, Merrill Lynch advises investors in the resources industry. The broker currently does not recommend any stock with leverage in Australia, but says it would consider looking into buying back into the sector after the pending price correction. Nickel separates Rio Tinto (no exposure) from BHP Billiton (exposure).
Oxiana (OXR): Merrill Lynch is not keen on buying stocks with exposure to copper and aluminium either. Both markets are seen as "controlled" by hedge funds. However, the broker would be buying shares of Alcan and Alcoa as the ongoing consolidation for aluminium producers is seen as far from over and the current developments are likely to attract corporate interest from BHP, Rio Tinto as well as from Anglo American, CVRD and Xstrata. It has to be noted that Oxiana Resources, often mentioned as a potential takeover target by other experts, is completely absent from the Merrill Lynch list of potential targets.
Bolnisi Gold (BSG): If Merrill Lynch's view proves correct, the current takeover proposal for silver and gold company Bolnisi Gold is unlikely to be approved by the company's shareholders. The broker believes the stock is significantly undervalued and the "merger" proposal currently on the table does little to alleviate this. In addition, the next few years should see strong earnings growth for the company.
Over the past four years, such a wave of price increases steadfastly pushed up share prices of commodity producers as their earnings forecasts, and often valuations too, receive a boost from increased product price forecasts. As mid-year approaches more securities experts are expected to increase their commodity price forecasts.
Whether this will lead to further rises for shares of BHP Billiton, Rio Tinto, Newcrest Mining and others remains to be seen.
The mining and metals research team led by Vicky Binns at Merrill Lynch said on Tuesday that a broad-based price correction in share prices of leveraged companies in the sector is likely to occur in the next three to five months. The prediction is based on the assumption that traded metal prices, such as nickel and copper, will correct in the short period ahead.
The higher than forecast spot prices for most metals so far in 2007 has again opened up the debate among economists and resources analysts whether speculative funds rather than underlying market fundamentals are driving spot prices these days. Merrill Lynch, while remaining firm advocates of the (stronger for longer) Super Cycle theory, weigh in by stating traded base metals are still dominated by "too much hype and speculation". However, as underlying market fundamentals in the form of rising inventories are anticipated to come to the surface more prominently in the months ahead, the speculative bubble is believed to be ready to burst, and lower prices should follow.
Lower prices for base metals lead to lower share prices for companies with leverage, Merrill Lynch states, even if it could be argued the market never priced in the elevated spot prices in the first place.
Merrill Lynch firmly believes resources companies continue to deserve investors' attention, but preferably through exposure to bulk commodities such as iron ore and coal (coking and thermal), as well as uranium, platinum and gold. If anything, the broker believes selling out of nickel exposure seems the right thing to do with the anticipated pending price correction estimated in the order of 50% from recent record levels. Spot nickel retraced more than 13% last week.
Merrill Lynch is far from the only one that believes nickel is ready for a significant price fall. Commodity specialists at GSJB Were, for instance, reported this week that nickel is their least preferred metal: "Fundamentally, we believe that the outlook for nickel has weakened appreciably, because of a modest softening in demand for nickel from stainless steel in the short-term, and the rapid build in Chinese ferro-nickel production in the medium term."
The case for bulk commodities is built on the expectation that this year's tighter than expected market for iron ore and coal is likely to last at least two more years and most securities analysts have so far only adjusted their price forecasts for the upcoming Japanese fiscal year. Merrill Lynch anticipates that current consensus forecasts for price falls in the years beyond 2008 will gradually shift north, almost securing a constant stream of support for producers of these products.
A similar scenario should develop in the uranium sector. At the last quoted weekly price indicator, of $US138 a pound, spot uranium is already significantly above most Australian brokers’ average price forecasts for the whole year. So far there have been no indications of any price falls anytime soon. Merrill Lynch has now lifted its price forecast for this year to $US105 from $US85 previously, but this is likely to be raised again shortly.
Last week, resources specialists at Macquarie completed their update on the uranium industry. Not only did the analysts significantly raise previous price forecasts, Macquarie now also believes spot uranium could surge as high as $US200 a pound over the next 16 months.
The investment case for gold and silver is partly based on eroding producer margins. Apart from supportive factors, such as anticipated lower central bank sales, ongoing dehedging by producers and continuing growth in investment demand, Merrill Lynch analysts have observed how operating costs for most major producers are rising, a trend they believe will continue.
The broker says it is obvious the large global gold producers need to increase their reserves of low-cost ounces. They will do so through buying smaller rivals. Mergers and acquisitions will soon become the dominant theme in the sector, the analysts believe, and it will affect share prices of Australian gold producers as much as those overseas.
The broker believes likely targets in Australia include Newcrest, Lihir and the China-based Sino Gold.
Silver’s story is widely considered to be similar to gold's, but underestimation and not consolidation will drive share prices for producers of platinum, palladium and rhodium, the broker believes. The analysts lifted their product price forecasts following Platinum Week in London four weeks ago. Merrill Lynch has buy recommendations on all platinum stocks under coverage: Anglo Platinum, Aquarius Platinum, Impala, Lonmin and Northam.
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