CIBC analysts recently forecast that base metals prices will remain high despite the current credit crunch, while the correction of equity prices “represents a strong buying opportunity.”
Author: Dorothy Kosich
Posted: Wednesday , 29 Aug 2007
RENO, NV -
In a recently published industry update, CIBC World Markets suggested that base metals prices should stay high despite current investor fears of slower economic growth.
Meanwhile, CIBC declared that "the recent correction in base metals equity prices represents a strong buying opportunity. With an average pullback of around 30%, most equities are trading at a discount to our long-term NAV estimates."
CIBC analysts Cliff Hale-Sanders and Terry K.H. Tsui said, "The primary question facing investors in the base metals sector is whether the current credit crunch in the U.S. capital markets will result in a lowering of the overall global economy, pushing the metals markets into surplus and re-basing commodity prices."
As problems in the housing and sub-prime mortgage markets have spread, investors are much more fearful of risk, and worry that these issues could result in a modest reduction in global growth rates, which could return commodities to a surplus, bringing the recent bull run to an end, they suggested.
"If metals prices remain robust, as we believe, valuations for base metals equities look very attractive at current levels and we would look to add positions in this environment," Hale-Sanders and Tsui said. "We view this correction as another bump in the road (maybe bigger than one would like) and a buying opportunity."
The analysts noted that the "spectacular bull run in metals prices" has not only been driven by strong base metals fundamentals, "but also by rampant speculation caused by excessive liquidity and leverage within the capital markets as investors tried to take advantage of tight market conditions. With this environment now possibly set to change, there has been a significant unwinding of positions."
Despite the current market turmoil, the analysts said they believed metals prices will remain "well above historical averages until at least 2009 as metals supply growth remains restricted during this period, barring a collapse in demand. Inventories are also expected to remain near historical lows, which should support high metals prices given the potential for ongoing supply disruption."
Nevertheless, CIBC isn't as bullish about "the potential absolute level of metals prices." In the analysts' opinion, "it is hard to envisage a fundamental need for metals prices to move materially higher on an average annual basis to entice new supply."
"If one assumes, as we do, that global demand is positioned to remain positive, albeit at slightly lower growth rates than in previous years, then the global mining industry is likely to continue to struggle to develop new sources of metal supply to catch up to demand despite record-high prices," according to Hale-Sanders and Tsui. "As such, this price cycle appears to have more legs than previous cycles."
CIBC asserts that the mining industry "is well behind in terms of adding new supply and, therefore, we are unlikely to see the traditional boom-and-bust price cycle in the mining sector. ...This, of course, assumes demand remains strong. If demand levels wane, new supply may not be required."
Current metals prices are providing mining companies "significant and abnormally high profit margins from which to grow their businesses and prices remain more than high enough to act as an incentive for new entrants," CIBC noted.
"While it is next to impossible to say if prices have already peaked or are just pausing on their long-term uptrend," the analysts said, "we are confident that prices are set to remain well above historic averages and should result in a sustained period of profitability for the mining sector."
"This period of sustained robust cash flows, combined with low multiples being ascribed to the sector, leads us to believe the stocks are positioned to be re-rated in the market in the next 12 to 24 months."
"In summary, we view the outlook for metals demand as remaining health for the next several years, barring a global recession, which would curtail demand and, in doing so, impact supply-side constraints," the analysts concluded.
So far unscathed, are commodities next to fall?
A funny thing has happened on the way out of risky, volatile, speculative investments. Commodities have gotten off virtually unscathed. So far.
The benchmark for global commodity performance, the Reuters/Jefferies-CRB Index, closed at 320.18 yesterday, down a modest 1.8 per cent from its recent highs of two weeks ago, which coincided with the peaks in the equity markets. It is actually up almost 1 per cent since the equity selloff began in earnest last week.
Commodities are benefiting from the fact that the financial market tumult has not, to date, been an economic story. The economic fundamentals underpinning demand for raw materials and fuels remain relatively solid, especially outside the United States, while supplies of many commodities remain tight. That continues to lend support to commodity prices even as financial markets attempt to adjust for a non-economic threat, namely growing credit risks.
"Fundamentals do matter. It's really that simple," said Bart Melek, global commodity strategist at BMO Nesbitt Burns.
Of course, those credit risks do have the potential to spread to the broader economy, slowing spending and demand in a wide range of areas. But while equity investors seem nervous about such a possibility, commodity traders, it would seem, are a more confident breed.
Front and centre among those bold commodity players are the speculators - in other words, the hedge funds. That's right, the same hedge funds that are being severely rattled by the prospect of tightening credit conditions, since much of their investing binge in the past few years has been financed with low-cost debt.
The hedge fund speculators had been piling back into commodities in the past few weeks, according to commodity futures market data from the U.S. Commodity Futures Trading Commission. Speculative long positions in oil and copper were at record highs last week, while gold speculative longs had risen to two-month highs.
Have the credit-risk-fuelled market jitters changed that? We'll get a much better idea today, when the CFTC releases fresh weekly data on traders' long and short positions. Analysts believe the hedgies have begun unwinding some of their bloated speculative long positions, but so far they have been selective and measured, going after commodities where they can liquidate the easiest and realize the best profits.
That may be why gold, for example, retreated almost $25 (U.S.) last week. Copper has also been in retreat, not surprising given that the yen carry trade - a key pillar in the global liquidity flood that markets fear is beginning to dry up - has been a major financing tool for speculative purchases of copper and other base metals.
There could be a lot more downside where that came from. Richard Bernstein, chief investment strategist at Merrill Lynch in New York, estimates that speculation accounts for more than 30 per cent of the current price built into market-traded commodities. If the credit crunch deepens, and heavily leveraged hedge-fund speculators are forced to liquidate assets to meet their obligations and financing needs, that's a lot of fat that could melt away from commodities.
"Short-term investors in other overvalued speculative assets, like commodities and emerging markets, should learn from the current mishaps in the debt markets. Supposedly liquid securities can rapidly become illiquid," Mr. Bernstein warned in a note to clients this week.
Martin King, oil commodity analyst at FirstEnergy Capital Corp. in Calgary, said oil could be in for an unwinding of speculative long positions anyway, in the wake of a sharp runup in fund buying since the end of May. He said crude prices could easily pull back $10 (U.S.) a barrel in the next two months on "normal seasonal unwinding." He suggested that additional selling linked to the credit market fears might deepen that correction to $15.
Which is not to say that the bull market for commodities is on its deathbed; the fundamentals are too strong for that. Still, a deepening credit crunch could well spell the end to the rampant speculation in commodities that has proven so profitable for hedge funds and, indeed, the broader investment community.
"True long-term investors should continue restructuring portfolios to accentuate undervalued higher-quality assets at the expense of speculative lower-quality assets," Mr. Bernstein said. "The liquidity driven, speculative tone to the financial markets the past five years is unlikely to be the tone of the next five years."
FREEPORT, BARRICK, NEWMONT WILL BENEFIT
Citigroup analysts on two continents hiked copper price forecasts Monday, asserting that “nowhere are the drivers and determinants of the commodity supercycle more clearly on display than in copper.”
Author: Dorothy KosichPosted: Tuesday , 24 Jul 2007
RENO, NV -
Highlighting a "super cycle shining on copper," Citigroup Global Markets metals analysts Monday revised their copper forecasts up to $3.50/lb in 2008 and $3/lb in 2009/2010.
The long-term copper price assumption was increased by 32% to $1.45/lb.
Based on their Australian counterparts' recent in-depth analyst of the copper supercycle released Monday, Citigroup metals analysts John H. Hill and Graham Wark of San Francisco and Sydney's Alan Heap hiked the target price for copper-gold producer Freeport-McMoRan (FCX) to $120/sh. The analysts also raised EPS estimates for mega-gold miners Barrick (AFX) and Newmont (NEM), based in large part on their copper operations.
In their report, "Copper-A Super Cycle Sheen," Citigroup Sydney, Australia-based Research Analysts Heap and Alex Tonks proposed that "the copper market is enjoying a repeat of its performance in the supercycles of 50 and 100 years ago. Demand is strong and supply is struggling to keep up. Structural change is underway in consequence."
The analysts defined a commodity super cycle as an extended period (10-plus years) of trend rise in price, "driven by a major economy as it urbanizes and industrializes." During the past 150 years, Citigroup indicated that there have been two previous commodity super cycles.
"We believe three factors will support high long-run returns: strong demand growth; a steep cost curve; and high barriers to entry," Heap and Tonks declared. "There is no shortage of large copper deposits, but they tend to be in regions of high political risk, and are low grade, thus increasing barriers to entry."
Citigroup asserts that the copper market will be close to supply demand balance until 2010. Meanwhile, they also forecast that copper prices will soften in the second half of this year "as the end of restocking by Chinese fabricators impacts the market, and strike concerns abate."
Nevertheless, the analysts also suggested that a steeper cost curve to produce copper, increasing barriers to entry and strong demand growth "will support higher returns in the future." In the meantime, sustainable high copper prices "can be expected to attract new market entrants," they advised. "The Chinese are the most notable, driven by strong domestic demand, a shortage of domestic resources and a smelter industry which is short of supply."
SUPPLY/DEMAND BALANCE
Nonetheless, Citigroup's analysis suggested that the intensity of Chinese copper use may be peaking. "High production composition of income (i.e. an economy driven by manufacturing and exports, rather than the consumer and services) in China is the driver of the super cycle," the analysts put forward. "However, material composition of product is lower now: less copper is used in many applications than in the past. ...In China electricity intensity may be reaching a higher plateau."
Heap and Tonks advocated that "lower than expected supply has been the most important factor supporting [copper] prices above forecast levels. It remains a key uncertainty, both in the short and long term. Short term concerns center on the impacts of possible strikes. Long term issues center on the timing of new supply."
"We now expect persistent tightness in the copper market through 2009," the analysts advised. "From 2010 the market moves into surplus as supply increases to meet continuing strong demand growth. The smelter bottleneck also eases, allowing smelter utilization rates to recover."
"Our central forecast points to an excess in mine supply from 2012. In the forecast this is reflected in a build up of concentrate stocks, as there is unlikely to be sufficient smelter capacity to process the concentrate. If sufficient smelter capacity does become available surpluses would be expected to build in the metal market."
A higher proportion of new copper supply is expected to come from high political risk regions, including Central Africa, which Citigroup advises will add at least 10% of new supply "and potentially much more." Despite the risk, "large mining companies are increasingly comfortable operating in such regions however, relying on technology and surveillance to ensure the safety of personnel," the analysts indicated.
Citigroup advises that Chile will continue to dominate copper mine supply, but that Central Africa "is potentially a center of much greater future growth."
Citigroup was adamant in its assertion that "there is no shortage of large copper deposits," citing a recent Brook Hunt study identifying more than 100 projects with measured and indicated resources of more then 200Mt of copper at 0.68% Cu, equating to 25 years of supply. Of the 100 projects, 30 have more than 2Mt contained copper.
In its analysis, Citigroup projected costs forward to 2014, forecasting that the industry average cash cost of production will be 80-cents per pound.
Citigroup also forecasts "extreme tightness in the concentrate market continuing until the next decade as a consequence of modest growth in concentrate supply and increasing smelter capacity. TC/RCs will remain under pressure. ...Looking further forward, the market will ease after 2010 as concentrate supply increases, and assuming no new smelters are built beyond those already committed."
The analysts proposed that two critical issues will shape the copper demand outlook in the short and medium term: the Chinese inventory cycle and the U.S. economy." They suggested that U.S. demand may be bottoming even though housing is in a downturn and auto sector demand is also weak.
"Overall our demand forecast is for growth to average 5.1% year until 2010," Citigroup said.
U.S.-based Citigroup analysts Hill and Wark said, "We are re-setting copper forecasts significantly higher across the board to levels broadly in-line with the future curve and well above forecasts embedded in consensus earnings for the mining companies. "
"It is becoming clear to us that the legacy of a decade of under-advancement, frictional barriers to new capacity, and voracious demand in both developing and established economies have overwhelmed supply, while frustrating prophesies of imminent cycle surplus," they declared.
"We expect copper supply/demand to remain very tight and see little chance that inventories can be meaningfully rebuilt before 2010," they wrote. "Fundamental drives we point to include: 1) A higher/steeper cost curve; 2) Resource nationalism restricting access; 3) Increasing difficulty in permitting; 4) Shortages of equipment and technical staff; and 5) Falling ore grades and resource depletion."
Despite the declining Chinese intensity cited by their Australian counterparts, Hill and Wark advised that they expect Chinese demand will average 12% per year, and global trend growth will increase from 2.5% to 4.5%."
COPPER FORECASTS BENEFIT GOLD MINERS
Citigroup's analysis suggests that high copper price forecasts benefit gold mines, such as Barrick and Newmont, "who each have significant exposure. We continue to be ardent believers in gold, based on a mix of supply/demand and macro/monetary drivers. ...Our sense is that as investors query, ‘What's big, important, and profitable in metals, and where the shares haven't run?', the answer will be ‘gold.'"
Noting that the Freeport McMoRan Copper & Gold model is "heavily leveraged to copper" and commodity forecasts above $3/lb have had profound effects, the analysts said, "We are raising EPS estimates by 80-100% in 2008/09." Citigroup lowered target multiples for the New Orleans based mega-miner, but are taking the FCX target to $120/share.
Meanwhile, the analysts suggested that the "aggressive valuation and commodity framework employed by Rio Tinto in its friendly bid for Alcan, casts Freeport in a favorable light. This is particularly true from the margin and relative resources scarcity perspective. While it seems premature for Freeport to be ‘back in play,' there might eventually be a good fit with CVRD or others."
Citigroup also hiked its EPS estimate for Barrick, particularly highlighting the "unsung yet highly profitable" Zaldivar copper mine in China. "With the global re-rating of the hard rock miners, Barrick's non-gold assets are increasingly attractive," the analysts said. "Also, gold has shrugged off the central bank sales and assorted pessimists, to regain the $670/oz level, while gold equity multiple compression appears to have run its course."
Finally, Citigroup also slightly raised EPS estimates on Newmont to reflect the impact of higher copper prices at the Batu Hijau mine in Indonesia. "This is offset by expectations for a flower ramp-up at the ‘new' Phoenix mine in NV. Material cashflows are unlikely before the PRB-fired power plant can supply cheaper electricity (-50%) in mid-2008."
Base Metals 2007 - Learning to live with volatility
Even such a short period as the past quarter has seen some remarkable changes in base metals prices – both up and down.
Author: Natixis Commodity MarketsPosted: Wednesday , 01 Aug 2007
LONDON -
Since Natixis Commodity Markets' previous quarterly report, there have been some incredible changes in base metal prices. No common theme really emerged in this period and the performance of nickel and lead stand out. The nickel price in late July is around 35% below the all-time high of $54,200/tonne set on May 16, while lead prices are now 120% above the low for the year. Supply disruptions have been the key driver behind lead's amazing performance so far this year. Lower supply and increased investment fund activity have also supported tin's recent advance, and the rebound in copper prices. Zinc prices have come under pressure despite LME inventories continuing to trend lower, while the aluminium market remains well supplied and prices have traded in a narrow range.
Global base metals demand remains "out of sync"
The de-synchronisation of the demand cycle has been a feature of the metals market for sometime. It is a positive feature, as we are not seeing the sharp reductions in global demand as consumption dips temporarily in many of the key consuming regions. For example, so far in 2007, the markets have generally taken in their stride the weakness in US demand, as consumption has been strong in Europe. This de-synchronisation of demand within Japan, North America and Europe is also taking place against the background of robust metals-intensive growth in China and India - a trend that certainly looks set to continue.
Substitution - mainly an issue for the nickel market
The lack of detailed end-use data for the base metals markets means it is difficult to quantify some of the substitution pressures. For most of the base metals, substitution has not been a major factor, with the exception of nickel, and to a lesser extent, copper. For nickel, the massive increase in prices is passed on directly - through the alloy surcharge system - to the consumer of stainless steel. As we have noted in our earlier reports, nickel's use by the stainless steel industry is being affected in two ways - the greater level of ferritic production (which contains no nickel), and in the emerging markets higher 200 series (which contains less nickel than the 300 series).
The alloy surcharge system also adds to the volatility in orders for stainless. Following the recent sharp correction in the nickel prices, alloy surcharges will fall dramatically. Therefore consumers and service centres are reluctant to place orders in the knowledge that stainless prices are falling.
Substitution in the copper market has been focused on plumbing, heat exchanger and wiring applications. For zinc, pressures have emerged in the brass and die-casting sectors, while aluminium has probably benefited from substitution at the expense of copper and tinplate.
Supply tightness is still a feature for most of the base metals
The supply side has been a key factor behind the bull market. The combination of structural tightness due to low levels of investment earlier in the decade, technical problems associated with high utilisation rates and increased labour disputes, have all constrained supply. The low level of treatment charges for lead and copper suggest that supply tightness is still an issue. For most of the metals, the pipeline of new projects is not that threatening in terms of additional supply. Zinc is at the other extreme, as a supply response to the period of high prices is starting to emerge.
Buffer stocks remain low
The recent trends in the lead market highlight the low level of buffer stocks. All the markets are still vulnerable to unexpected supply losses (or sudden surges in demand). The supply disruptions in Australia and lower exports from China quickly filtered through to the lead market, while strikes continue to support the copper price.
The economic environment is favourable for this stage of the price cycle
Typically high commodity prices are associated with extreme inflationary pressures, rising interest rates and the potential for a sharp contraction in the level of economic activity. Natixis Commodity Markets believes that the economic climate is exceptionally benign.
Aluminium
Aluminium prices have been remarkably stable in recent months. There is nothing in the current fundamentals to suggest that prices should move drastically away from their current range (either to the upside or the downside) in the summer months. Natixis Commodity Markets project a relatively balanced market this year, compared to last year's 357,000 tonne deficit, we predict 50,000 tonnes for 2007. However, given the strength in non-Western World consumption, we forecast the deficit increasing once more in 2008 to 250,000 tonnes.
The main bullish argument appears to be that the metals' underperformance could attract fund interest. However more likely in our view is for prices to drift lower due to seasonal factors. With inventories unlikely to approach the critical levels seen elsewhere in the sector, Natixis Commodity Markets projects an average annual price average of $2,750/tonne for 2007, dropping to $2,300/tonne in 2008.
Copper
A number of different and conflicting themes are affecting the copper market. Essentially they can be summarised as the demand side being weak and the supply side being bullish. Since April, these factors largely cancelled each other out with monthly average prices remaining in a $7,475-8,000/tonne range. The supply tightness is partly a function of strikes, but also due to a shortfall in concentrate output (reflected by low TCs). While the former may be temporary, the latter will take some time to work through the system.
Demand conditions have been weak all year in the US, while in China demand (imports of cathode) has eased reflecting the over-buying earlier in the year. Consumption is weakening in Europe but that is mainly for seasonal reasons. We believe demand will pick up but that it will be matched by higher supply. Given strike action we have raised our 2007 price forecast to $6,750/tonne from our earlier estimate of $6,350/tonne. In line with this we have also raised our 2008 forecast price to $5,750/tonne from $5,000 in our previous report. In terms of the supply-demand balance, we project a 50,000 tonne surplus in 2007 moving to a 160,000 tonne surplus in 2008.
Lead
The lead market has tightened considerably since our previous report as the production problems at the concentrate stage begin to bite. More recently the market appears to being supported by the imposition of an export tax by the Chinese government. Despite the amazing surge in lead prices, Natixis Commodity Markets has only made slight changes to the supply-demand balance. We have scaled back our estimates of Western World refined output due to the tight concentrate position. We have also reduced our projections of refined net exports from China. Lower supply is partially offset by weaker than expected consumption. The bottom line is that we are forecasting a 60,000 tonne deficit compared to our previous estimate of a 35,000 tonne shortfall. For 2008 we still have the lead market in a modest surplus.
We have, however, significantly raised our prices. Natixis Commodity Markets is now forecasting an average lead cash price of $2,400/tonne. We still view a lead cash price of over $3,000/tonne as ultimately unsustainable and project an average cash price of $1,900/tonne in 2008.
Nickel
We forecast a marginal surplus of 5,000 tonnes, on the back of a 0.9% rise in Western World usage counterbalanced by a 5.0% rise in supply. For 2008, we see this surplus expanding slightly to 15,000 tonnes with supply growth at 4.7% compared to 4.0% for demand. The increase in LME inventories so far in 2007 (in volume terms) has been quite small given the cuts in stainless output and the greater availability of scrap. This raises the question of whether off warrant stocks have been built up. From a fundamental standpoint, this suggests scope for further price weakness. As such, Natixis Commodity Markets projects an average annual price of $37,000/tonne in 2007, which should then fall to $27,000/tonne in 2008.
Tin
On the basis of lower than expected demand growth we have amended our supply-demand balance analysis to show a 2,000 tonne deficit compared to our previous estimate of an 18,000 tonne shortfall. LME stocks in late July, at around 13,000 tonnes, are largely unchanged from the beginning of the year. LME stocks dipped in the early part of the year when the disruption to Indonesian output was at its most extreme. Since then they have increased by around 5,000 tonnes. We expect that the increase in stocks will level off in the latter part of the year as demand starts to pick up after a relatively weak start to the year. In 2008, the market is forecast to show a slight surplus of 8,000 tonnes. This should lead to an average annual price of $11,000/tonne in 2008 compared to this year's projected outturn of $13,750/tonne.
Zinc
In the short-term there is the potential for zinc prices to rally in response to the on-going reduction in LME inventories. However, we would view such a move as temporary, with two key features during the remainder of the year likely to help bring prices lower. These will be an increase to Chinese exports of refined zinc and a sharp rise in mine production globally. For 2007 we project a price average of $3,500/tonne, and $2,900/tonne in 2008 as the market moves into a surplus of 125,000 tonnes next year.
