Well, whoever would have guessed: it seems that even a ‘super-cycle’ is still a cycle.
Every time we see sustained high commodity prices, supply reacts; and producers commit to new projects. This new supply tends to come on to the market at the same time, with a predictable impact on the price. Hence the saying, “the best cure for high commodity prices is high commodity prices” – which works in reverse, too.
We’re seeing this situation all over again, as the driver of the commodities ‘super-cycle’ of the 21st Century – China – begins the process of transforming its economy from one driven by fixed asset investment and exports, to domestic consumption. Beijing has set a target GDP growth of 7.5%, down slightly from 2013’s estimated 7.7%, and well down on the double-digit rates of growth that were common in the 2000s.
China’s economy growing by 7.5% still requires a lot of commodities inputs: that’s what new BHP Billiton chief executive, Andrew Mackenzie, was thinking in an August 2013 speech, in which he said that the mining giant expected the move to a consumer-driven economy in China to drive even stronger growth in the demand for commodities used in energy, energy transfer and food production, such as natural gas, coal, copper and potash.
Mackenzie said the expected move of 250 million more people from the Chinese countryside to the cities over the next 15 years was a major factor in BHP’s expectation that global demand for commodities would grow by up to 75% over that period. By the end of that time, he said, Asia’s middle class would approach three billion people in number – all consuming more than they were now.
On that basis, the long-term outlook for commodities prices is strong. But in 2014, markets are dealing with the usual wave of supply that arrives in the wake of sustained high prices. And despite an upbeat global economic growth forecast from the International Monetary Fund (IMF) – a forecast recently upgraded for the first time in two years – last week’s news that Chinese manufacturing activity fell in January, for the first time in six months, put commodity prices under pressure again.
However, it is not only commodity prices that matter to Australian commodity producers: there is also the US dollar exchange rate. A falling Australian dollar increases the revenues and cash flows of Australian producers, which will help to cushion their earnings if commodity prices come down in 2014.
One by one, let’s look at the situation in each of Australia’s major export commodities.
Now Australia’s largest export earner, iron ore has grown massively as an industry on the back of the fact that Australia provides nearly 40% of China’s iron ore needs. When China’s steel-hungry economy was running on all cylinders, in 2011, the iron ore price reached record levels at US$181 a tonne.
A year later, though, with the economic downturn in Europe, (China’s biggest customer) savaging export demand, China’s economy began to slow and iron ore slumped below $US90 a tonne. By February 2013, it was back up to $US160 a tonne. Then it fell in a heap again, to $US115 a tonne by mid-June, on renewed concerns of a slowing growth in China.
At present, iron ore is trading at US$124.30 a tonne – better than expectations six months ago – but down 7% for the year so far. Analysts expect that price to come under pressure this year, as the market absorbs about 100 million tonnes of new Australian supply, and China cuts back its steel production to ease over-capacity and pollution – which leads to a build-up of stock-piled ore, weakening demand for imports. Australia’s Bureau of Resources and Energy Economics (BREE) tips an average price this year of $US119 a tonne: longer term, many forecasters expect a double-digit iron ore price.
Diversified bulk producers BHP Billiton (BHP) and Rio Tinto (RIO) are major players in the iron ore market – the commodity generates more than half of BHP’s earnings and more than 80% of Rio’s earnings – but the pair has earnings streams in other commodities. The two are considered under-valued against the 2014 analysts’ consensus target price: Rio Tinto by 23%, and BHP by 11%. Australia also has iron ore producers Fortescue Metals (FMG), Atlas Iron (AGO), Mount Gibson Iron (MGX), BC Iron (BCI) and Gindalbie Metals (GBG): the best value of these appears to be Atlas, with 15% upside to the consensus target price, and a 2.8% dividend yield.
Prices for coking (steel-making) coal have fallen by 60% from the peaks of two years ago, as the Chinese steel mills try to get coal suppliers to absorb weaker steel prices, and supply increases. Seaborne coking coal exports are expected to grow by about 11% in 2014 and Australia accounts for about three-fifths of that trade.
In the seaborne thermal (electricity) coal market, prices are approaching four-year lows, as miners boost production and improving Chinese domestic supply reduces the nation’s imports. Analysts say thermal coal prices could even have been lower than they are if 2014 had not started with severe winter conditions in North America.
The spot price of thermal coal at Newcastle has fallen from $US136.30 a tonne in January 2011 to $US85 a tonne. Hard coking coal has performed even worse, falling from about $US300 a tonne in early 2010 to $US143 a tonne.
The boom prices for coal saw a wave of new supply, much of which is now unprofitable. Coal is over-supplied globally, and that is depressing the price. But Peabody Energy, the world’s largest private-sector coal company, recently estimated that an increase in global steel production will need an extra 150 million tonnes a year of coking coal by 2017.
On the stock market, only Whitehaven Coal (WHC), which produces a mix of coking and thermal coal, offers attractive value on analysts’ consensus target price: it is currently priced with 37% upside to the target price.
Reading bank and broker projections for the industrial metals (formerly known as base metals) market is confusing. Some see higher prices in 2014 on the back of global economic recovery – assuming Chinese growth holds up – while some see lower prices, as high inventories and supply increases put pressure on the metals.
The market is concerned about a copper surplus in 2014, but surprisingly strong Chinese demand is prompting a rethink of pessimistic predictions. The single-largest copper user in the world is the Chinese power grid. State Grid Corporation of China, which is responsible for the maintenance and expansion of high-voltage transmission lines across most of China, says it plans to increase spending by 13% this year.
In nickel, the global supply of nickel more than doubled in 2013, to 180,000 tonnes. With supply outweighing demand, Danske Bank, for example, expects copper to end the year at US$7,228 a tonne (currently US$7,230); nickel to end the year at US$14,125 a tonne (currently US$14,620), and zinc to end the year at US$1,985 a tonne (currently US$2,033.75). But Goldman Sachs is more pessimistic on the industrial metals, saying the “strongest supply picture in years” will pressure some commodities, particularly copper. Goldman Sachs sees copper ending 2014 at US$6,200 a tonne.
The major exposures for investors to the industrial metals market are OZ Minerals (OZL), which owns and operates the Prominent Hill copper-gold mine and the Carrapateena copper-gold project, both in South Australia; Western Areas (WSA), which produces nickel at its low-cost Flying Fox and Spotted Quoll mines in Western Australia; Sandfire Resources (SFR), which runs the DeGrussa copper-nickel mine in Western Australia; and Sirius Resources (SIR), which in 2012 discovered the huge and high-grade Nova- Bollinger nickel-copper deposit in Western Australia’s Fraser Range. On analysts’ consensus target price, these are all presently under-valued: OZ Minerals by 8.6%, Western Areas by 26%; Sandfire Resources by 18% and Sirius by 46%.
Gold is the most unpredictable of all the metal markets, with supply and demand sometimes taking a back-seat to gold’s role as a currency and investment not correlated to share and bond markets. Gold did not have a good year in 2013, with the spot price losing 28%. But to put that in context, gold has more than doubled in value since the US Federal reserve started its quantitative easing (QE) program in 2008.
In gold’s favour is the fact that there is strong demand for the yellow metal in China, India and Japan. However the improving US economy and the ‘tapering’ – and eventual ceasing – of the Fed’s asset-buying program, may take away one of the major reasons for owning gold. Danske Bank expects the gold price in 2014 to average US$1203 an ounce for gold – significantly lower than the current price of US$1261.80.
For Australian gold stocks, the hammering over the last year has pushed many into bargain-basement territory: the country’s largest producer, Newcrest, has had a horror few years, but sits 7.5% below the analysts’ consensus target price. Evolution Mining (EVN) is 30% below target, Northern Star Resources (NST) has 24% upside to make up, while St. Barbara (SBM) and Regis Resources (RRL) show consensus upside of 16% and 24% respectively. Some of the ASX-listed offshore producers show more mouth-watering projected upside: Perseus Mining (PRU), which mines in Ghana, shows 64% upside, Mineral Deposits (MDL), which mines in Senegal, has 82% to make up, while Brazil/Ghana producer Troy Resources (TRY) is trading at less than half its analysts’ consensus target price.
Despite repeatedly receiving a new set of alarming Middle East headlines to bolster it, crude oil did not have a great year in 2013, with West Texas Intermediate (WTI) rising by 2% in US dollars and Brent, the North Sea benchmark, losing 5% over the year.
WTI has traded around US$100 a barrel for three years as weak demand has been offset by the old standby of Middle East (and African) turmoil. But a lessening in some of that turmoil is widely expected to be bad for the oil price in 2014, as Libyan shipments recover from near-collapse in 2013 and Iranian oil returns to the global market after the nuclear sanctions deal.
Further boosting supply is the continuing US shale revolution: Deutsche Bank expects US shale to add one million barrels a day to global supply for the third year in a row. If Chinese manufacturing and economic growth data were to disappoint throughout the year, the oil price would come under pressure.
In the liquefied natural gas (LNG) export market, spot prices peaked at $19.40 in 2013, as LNG replaced nuclear energy as Japan’s main source of power, following the meltdown at Tokyo Electric Power Company’s Fukushima plant in March 2011. Australia is increasing gas output, as are US producers, where shale extraction is driving a production boom. This increase in supply is likely to put LNG prices under pressure, particularly if Japan starts to re-boot its reactors.
Among the Australian petroleum majors, Woodside Petroleum (WPL) is trading close (1.8% lower) to its analysts’ consensus target price, with Santos (STO) and OilSearch (OSH) appearing to offer better value, at discounts of 12.6% and 15% respectively. But Woodside’s FY14 forecast yield of 6.04% outstrips Santos’ yield of 2.3% and OilSearch’s yield of 0.6%.
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