We believe that many commodities markets have been oversold as investors remain focused on poor demand prospects and are reluctant to acknowledge the continued problems experienced in supply. While markets are likely to remain volatile over the next month or so, we believe that potential upside into 2009 isconsiderable. Preferred commodities include: ntural gas, oil, thermal coal, uranium, gold, silver and platinum.
Poised for a rebound
Commodity prices have corrected sharply over the past two to three months as fears regarding global growth have intensified and investment funds have withdrawn capital from the asset class. Oil and natural gas prices are down about 20% and 35% respectively; precious metals have also been hit hard as inflationary fears have waned and the US dollar strengthened; gold, silver and platinum are off roughly 15%, 30% and 30% respectively. Industrial metals continued to weaken. We believe that there is growing evidence to suggest that much of the concern regarding global consumption growth is now largely factored in to current commodity price levels and that the supply issues which have been a key causal factor in pushing prices higher over the past several years are being ignored. We believe that, with lower commodity price levels, consumption could respond to more attractive pricing and recover modestly. Furthermore, the problems with respect to supply growth remain and are likely to be recognised over the next several quarters, potentially supporting higher pricing.
We maintain their view that the Chinese growth story will continue despite short-term weakness on the back of a market which is skiddish due to global market concerns. MRE believe that Chinese construction will be invigorated post-Olympics which should drive demand for steel products. The long-term resources story of supply constraints and robust demand should entice investors to stick with quality, large, liquid companies that have strong balance sheets, strong cash flow and strong EPS growth such as the large global diversified miners.
BUY: BHP, RIO, WPL
COMMODITY OUTLOOK
ENERGY
Oil/Natural Gas (positive)
Several new factors are contributing and adding to our conviction that oil prices are close to finding a bottom (and perhaps a range around $120/b):
■ Last week’s modest increase in price was the first after four straight, steep,weekly losses
■ Repeatedly, in the last few days, the US dollar value and oil prices have moved up together – rather than moving in near perfect opposite direction for much of the preceding two weeks
Thermal Coal (positive)
Thermal coal markets appear to be recovering after selling off from US$195/t to US$155/t (Newcastle fob price) over the past two months; now trading at about US$162/t. We expect catalysts to remain broadly supportive over the next several quarters.
■ Vietnamese exports are likely to fall following damage to port facilities in July; removing about 5mt from the market this year.
■ Chinese exports are likely to fall significantly as the government seeks to prioritise domestic supply for power production following steep declines in utility inventory levels and the prospect of increased winter demand. The Chinese government recently applied a 10% export duty for thermal coal and we expect an export quota to be introduced over the next month or so which should further constrain the ability of Chinese coal producers to sell into the seaborne market.
■ Indian imports are likely to grow significantly given increased power production problems, partially a function of poor thermal coal availability.
Uranium (positive)
Trading activity has picked up significantly over the past quarter as prices appear to have bottomed at US$57/lb., uranium now trades at about US$64.5/lb. Continued supply side problems (recently evidenced by a further delay to Cameco’s Cigar Lake mine due to water problems), and strong long-term fundamentals could see further strength in the market in our view.
Precious Metals
Gold (positive)
The correction in the gold price from all-time highs above $1000/oz to a recent low of $775/oz has triggered the strongest physical demand for gold our vault staff have seen in twenty years. Demand – mostly for jewellery – is strong from Indian, other Asian, Middle Eastern and some European clients and comes after a period of 12 months of unusually weak physical gold demand. Investment and speculative positions held on the US and Japanese futures markets are greatly reduced although ETF holders of gold remain mostly resolute. With a solid floor around $800-820/oz we believe gold will trade towards $900/oz over the next month or two and could trade much higher still.
Silver (positive)
Silver has sharply underperformed gold over the past two months, evident when looking at the gold:silver ratio which increased to the highest seen since late 2006 at about 62. We believe speculative and investor selling was behind this move and silver is likely to outperform gold on any rally in precious metals. But this is only due to speculative buying. We have seen much less fundamental demand in silver than in gold so our view that silver will out-perform gold is not a high conviction call. Silver is a more volatile metal than gold, especially during corrections and investors should be aware of this.
PGMs (positive)
The prices of platinum, palladium and rhodium crashed in July and August as investors and speculators exited long positions in these metals. In addition to the general commodity sell-off, sentiment towards PGMs was specifically damaged by concerns about slowing global vehicle sales and a lack of production interruptions during the South African winter. Although supply and demand balances for all three metals look less supportive than three months ago, we still forecast a deficit in platinum. Now that the disinvestment pressure has eased, we expect platinum and rhodium to recover some lost ground, although neither are likely to recapture the euphoric highs of about $2300 and $10,000/oz, at least not this year. Palladium will probably trade higher in sympathy, although the metal is less supported by supply and demand fundamentals and more by investment demand.
Copper (negative)
Copper prices remain well above our estimate of marginal industry costs (US$1.75/lb. or US$3,900/t), furthermore we expect Chinese destocking of copper to continue over the next several months which could continue to put pressure on pricing. Copper represents our least preferred metal over the shortterm. Nevertheless we expect prices to recover in 2009 as long-term supply-side constraints are once again factored in by the market.
Iron Ore (negative)
Inventories at Chinese ports remain relatively high, this combined with domestic iron ore production growth of 8% ytd, slowing steel consumption within China (which could lower iron ore requirements near-term) and growing production from Australian producers (such as Fortescue Metals) has tempered our enthusiasm for iron ore. We expect that over the next several months spot iron ore prices could continue to weaken (spot prices are currently about 35% higher than contract prices (landed in China). We currently forecast a 10% increase in contract prices for 2009.
Steel (negative)
We forecast steel prices to peak in Q308 and to soften by €100/t into 2009. Nevertheless, we expect prices to be supported given: inventories are close to normal rather than excessive; slower but robust demand from developing world (65% of total demand), high raw material prices to drive continued steel supply discipline as prices fall; marginal industry cost indicate HRC price support at around US$750-800/t.
