Nickel… first cab off the rank in resources revival

Legendary miner Mark Creasy again signals the trend in base metals with S2.

Summary: The merger of Sirius Resources and Independence Group shows signs that the price of nickel, a bellwether metal, is poised to move higher. The company will have the potential to appeal to international funds and the deal is backed by Mark Creasy, one of Australia’s smartest mining investors.  Some commentators have been promoting the nickel-uplift argument for the past two years, but a fresh batch of optimistic forecasts have emerged over the past few weeks from Macquarie and ANZ.

Key take-out: Although the deal is ahead of the forecast improvement in nickel fundamentals, at least it isn’t too late.

Key beneficiaries: General investors. Category: Base metals.

Merging nickel’s hottest stock, Sirius Resources, with Independence Group is more than a corporate play to create a new mid-tier miner. It’s also a comment on the awakening of the wider nickel sector which has a history of being first to flag a mining revival. The $1.8 billion deal announced earlier this week is a sign of things to come.

Notoriously prone to extreme price swings, nickel is a difficult metal to discover, process and trade, but it is also a bellwether metal like copper and often an early-mover in the cyclical shifts which affect the base metals complex, those materials with widespread industrial use.

In the Sirius Independence deal two forces are at work. There is demand from institutional investors for alternatives to the big two of mining, Rio Tinto and BHP Billiton, and there are signs that the price of nickel, after a series of false starts, is poised to move higher.

The first driver, creating a new business with exposure to industrial metals, is a reason for the success of BHP Billiton’s spin-off, South32, which has extensive exposure to a range of base metals, including aluminium and zinc, but no exposure to the faded-favourite of bulk commodities, iron ore.

With the enlarged Independence investors will have a stock driven by a mix of nickel, copper, zinc and gold and, significantly, no exposure to iron ore, or the other bulk commodity which has fallen out of favour thanks to over-supply and sluggish demand growth, coal.

The mix of commodities in Independence represents full exposure to a potential increase in global industrial production, which is the aim of the monetary stimulus programs of most governments.

How quickly demand picks up for base and precious metals is the primary risk associated with the Independence/Sirius merger to be known as S2, but there are three positive factors to offset the negatives of merging at a time of low metal prices.

  • Firstly, one of Australia’s smartest investors in mining, Mark Creasy, has backed the deal, not just because it has made him $600 million richer, but also because he recognises the changing landscape in investment markets (bigger is better) and the slowly improving outlook for base metals.

  • Secondly, a business with an expected market value of $2.7bn after the deal is complete has the potential to appeal to international funds (and international predators) whereas that might not be the case with two small Australian-focussed mining stocks.

  • Thirdly, optimism about the future nickel price is rising thanks to a developing supply/demand squeeze.

If there is a weakness in the argument supporting the Independence/Sirius deal it lies in the argument that nickel is overdue for a price lift, and when that occurs other nickel-exposed stocks, such as Western Areas, Mincor, Talisman, and Panoramic, will also benefit.

Unfortunately for promoters of the nickel-uplift argument they have been saying that for the past two years thanks to a belief that stainless steel demand (the primary use for nickel) is rising and that Indonesia, one of the world’s biggest producers of nickel, will stringently enforce a ban in the trade of unprocessed nickel ore to make a product in China called Nickel Pig Iron.

While trade in unprocessed ore has slowed, the effects on the wider nickel market have not been sustained with the price of the metal dropping yesterday to a 12-month low of $US5.69 a pound, which is 37 per cent lower than the $US9/lb price reached last September.

Undeterred by the failure of the nickel price to respond in a convincing way to widely-expected changes in supply, a fresh batch of optimistic forecasts have emerged over the past few weeks.

Macquarie Bank reckons nickel is one of the best-placed minerals to rise in price because of a need to develop fresh sources of supply in the next three to six months.

ANZ Bank agrees with Macquarie, noting last week that “nickel fundamentals are turning positive”.

Comments like that, based on an assessment of the underlying market, will have played a role in Independence offering what seem to be generous merger terms that value Sirius at $4.38 a share, a 35 per cent premium to the last price before the deal was announced.

What Macquarie sees in nickel is a commodity “where we are mining less than we are consuming every day” with stockpiles of nickel, either in metal form or as ore waiting to be converted into NPI, starting to decline and a current supply surplus flipping to a deficit over the next 12 months.

Two other minerals make Macquarie’s short-term supply shortage list: chrome and bauxite. Three are on a list where new supply will be needed in one to three years (zinc, platinum and copper) – with all other minerals on a three-year supply shortage list, or a more than five years list which includes iron ore and thermal coal, which for investors might also be called the no-go list.

ANZ’s view of nickel is summed up in the opening words of its research note that: “Signs are emerging that the long-awaited tightening in the nickel market is not far away. Three of the four indicators we’re following in the nickel market have turned positive.”

The four indicators used by ANZ are NPI inventories, NPI price, Chinese imports of another nickel-related product called ferro-nickel, and nickel stockpiles held in warehouses operated by the London Metal Exchange (LME).

The change from negative to positive has been noted in Chinese NPI inventories (falling), Chinese ferro-nickel imports (rising, as it is an NPI substitute) and NPI prices in China (rising).

“The missing link remains LME inventory,” ANZ said. “If LME nickel stocks start to decline, we would have greater confidence that the market has found a bottom, but until this occurs the upside to nickel prices is likely to remain limited.”

“We remain bullish on the medium term fundamentals but patience is still required.”

Patience does not seem to have been a factor in Independence moving on Sirius and while it might be ahead of the forecast improvement in nickel fundamentals management is also able to argue at least the merger isn’t too late.