Nickel's road to recovery?

If it was any other metal that had risen by 10 per cent over the past three weeks to a three-month high it would be making headlines.

The fact that the metal in question is nickel is widely seen as just another false dawn – or is it?

Notoriously erratic, nickel has been dogged by a combination of oversupply and sluggish demand for the past three years, falling from more than $US9.50 a pound in mid-2014 to as low as $US3.80/lb last year, a level at which an estimated 40 per cent of global production is loss-making.

Four recent events, plus a little help from by-products such as cobalt and copper, have helped dispel some of the gloom enveloping Australia's once booming nickel mining industry. They are:

• A slow decline in stockpiles of the metal, and a forecast the slide will continue as loss-making mines exit the market.
• The 10 per cent price rise, which has lifted nickel from $US4.01/lb on July 7 to $US4.42/lb (as of Monday, July 24) on the London Metal Exchange, which is close to a three-month high.
• Cautiously optimistic nickel market analysis from Macquarie Bank earlier this month headlined: “Nickel price seeks a floor”.
• A surprisingly confident feasibility study released last week by Panoramic Resources into the possible reopening of its Savannah nickel mine in WA, which was mothballed 14 months ago.

Despite the increasing flow of good news about nickel, and several mines aided by cash flow from cobalt – one of the new generation of so-called technology metals – investors are only cautiously returning to ASX-listed nickel stocks.

Panoramic, for example, has risen modestly from 20c to 21.5c since unveiling its “robust” study and potential redevelopment of the Savanah mine, with most of that rise occurring early this week as news of the rising nickel price reached investors.

Western Areas, one of the few small miners to ride out the prolonged downturn thanks to its low-cost operations, presents a more interesting situation. Its share price has risen significantly over the past few weeks, and in less than one week, has climbed around 22 per cent from $1.90 on June 19 to recent trades taking place around $2.32.

Most of that rise pre-empted the release of Western Areas' quarterly activities report on July 25, which included free cash flow of $63.6 million from the production of 25,996 tonnes of metal at a cash cost of $2.38/lb (about $US1.79/lb).

Despite the encouraging trend evident in commodity and equity markets, nickel remains a risky business with surplus capacity readily available to fill any surge in demand.

BHP also continues to post losses in its Nickel West business, which is being kept alive to stave off an estimated $1 billion in closure costs.

Macquarie Bank values Nickel West at negative $US1.18 billion, roughly the cost of cleaning up the mess left by almost 50 years of operation in WA.

In last week's production report for the 2017 financial year, BHP said Nickel West lifted output by 5 per cent to 85,100 tonnes in the 12 months to June 30, probably at a loss, given the average price received of just $US4.63/lb.

BHP's decision to persevere with Nickel West is an example of the problems confronting nickel. This is because the business accounts for around 4 per cent of annual global nickel output, but is being kept alive not for profit, and instead, to avoid a heavier loss through closure.

Other sources of nickel believed to be operating at a loss include the New Caledonian mines of the Brazilian iron ore producer, Vale, and some of the low-grade “nickel pig iron” miners which ship low-grade NPI ore from the Philippines and Indonesia to China.

Politically controversial, the NPI business has been switched on-and-off over the past two years amid claims of it causing environmental damage. It is currently on, in both countries, which should mean increased exports of the raw material.

For investors, Western Areas is perhaps the most interesting nickel stock to watch because it also has the dubious distinction of being one of the most heavily shorted stocks on the ASX. Just over 17 per cent of its issued capital is currently short-sold.

A rising share price and big short position are generally seen as incompatible, which puts Western Areas in the centre of a classic tug-of-war between investors with positive and negative views of the stock, and the wider nickel sector.

Independence Group, another prominent nickel producer, also has a case of being heavily short-sold, at around 14 per cent. And Independence Group has not only ridden out the downturn, but actually expanded during it through the development of its Nova project.

The company has not enjoyed a share price re-rating, and sits at around $3.26, which is roughly where it was a month ago.

Macquarie's nickel market analysts forecast a decline in global stockpiles of the metal this year and next, shrinking what was a 908,000 tonne surplus in 2015 to 766,000t by end of next year, during which time the price is tipped to rise to around $US4.76/lb.

If that future price tip is correct, then some of the smaller mothballed nickel mines could resume production, with Panoramic's Savannah mine an example. Panoramic estimates the all-up sustaining cost of a redeveloped project would be $US3.40/lb, a cost aided by the by-products of copper and cobalt.

Followers of the nickel sector probably feel they've been here before, where a price rise is quickly followed by a price fall, as surplus metal dampens the market and drives the price back to the $US4/lb level, or lower.

Will it be different this time? Perhaps is the only answer.

For a continued revival in nickel there needs to be a combination of push from mine closures and a pull on stainless steel, which is the demand driver and major market for nickel.

Until positive long-term trends become clearer, nickel mining companies will probably remain short-term trading opportunities, especially if short-sellers are forced to cover their exposure, leading to a price spike in stocks such as Western Areas and Independence – followed by a crash back into the cellar.