Just saw this before leaving for the day and found it interesting
'Fatigue' in metals group could yield quality stock picks
By: Dorothy Kosich
Posted: '10-AUG-06 05:00' GMT © Mineweb 1997-2006
RENO--(Mineweb.com) Although copper prices reached a four-week high Wednesday due to the Escondida labor disputes, commodities investors may soon discover that "an air of fatigue, if not despondency, has enveloped much of the metals group."
While "commodity prices are excellent across the board, and appear well-supported," Citicorp analysts wrote, the mining industry is not without its problems. In its "Metals & Mining Prospects" report released Wednesday, Citicorp declared that "we do not expect prices to rise from current spot levels (gold excepted.)"
As the challenging macro environment cools, however, it will not prove hostile for metals. In fact, Citigroup believes that it will favor "quality, best-of-breed names, over the turnaround stories that dominated in the early, commodity momentum phase." Citigroup analysts picked Newmont Mining among gold mining stocks, and Arch Coal, CONSOL Energy and Foundation Coal among the coal mining stocks.
Worldwide copper is struggling with a series of supply-side outages, as a dogfight has developed during copper ore contractor negotiations between mining and smelting companies in Asia. Theses events follow a series of at least 16 shortfalls totaling 317 kT year to date, according to Citigroup analysts.
In the meantime, nickel is suffering similar woes as mergers and acquisition activities among nickel producers may be ending, and workers settle in for potentially months-long strike at Canada's massive Voisey's Bay nickel mine.
COPPER COMMODITIES
Since total exchange copper inventories hit a high at the beginning of March, they have declined 21.8% to currently stand at 162 k. Citigroup explained that the total stock ratio, including estimates of metal held by producers and consumers, still stands at a "extremely low level" of 2.6 weeks consumption vs. 4.6 weeks as of last December. Citigroup estimated at least 330 kT of copper has been lost to supply disruptions since the beginning of this year. In addition to labor disputes, copper markets face "falling grades worldwide, a dearth of large new mines in the near term, water shortages in northern Chile, and a leftward lurch in LatAm politics," according to the metals analysts.
Citigroup forecasts that exchange copper inventories will not be restocked to a meaningful level until 2009. Meanwhile, they predict that the current market deficit will continue through this year, roughly balance out in 2007, and again fall into deficit in 2008. "Our sense is that the question of demand destruction and substitution, is more relevant than replacement value and the timetable for new mine capacity adds."
Copper-smelting margin negotiations generally take place around the end of the year although some contracts are currently being negotiated. NikkoCitigroup analysts suggested earlier this month that "the major obstacle to (smelter) negotiations is that BHP Billiton is campaigning for benchmarks that would support contract terms of greater advance to mining companies."
Soaring copper smelting costs (TC/RCs) prompted Escondida's operator BHP Billiton to propose restructuring terms on new smelting contracts to remove "price participation" (PP). Japanese and Chinese smelters have opposed this move because it would impact margins. However, Citicorp doubts that BHP Billiton will be successful in abolishing PP in its contracts. "If the smelters are successful in retaining price participation in the new TC/RC structure," Citigroup wrote, "this implies that industry participants expect supplies of copper concentrate to increase, with negative implications for the copper price."
TC/RC is the amount paid by mining companies to have their copper ore processed by a smelter into a saleable metal. Since copper ore supply is not keeping abreast of demand growth, the spot market TC/RC is declining. PP is a smelting margin added to TC/RC, which fluctuates in tandem with the LME copper price, according to NikkoCitigroup of Japan. A rise in copper price improves margins, while a fall in the price depresses earnings.
"While we expect that demand for copper, particularly in developing nations, will continue to expand steadily, "NikkoCitigroup metals analysts in Japan suggested, "we think that delays in copper mine development and realignment in the industry are leading mining companies to adopt strategies aimed at boosting their share of output, so that, while their price bargaining position may actually improve, it is not likely deteriorate."
NICKEL COMMODITIES
Citigroup asserted that "nickel miners are running flat out, and even a modest supply-side outage could have profound implications." The great risk to nickel over the long term is under-supply and substitution, they added. In the short-term, the initial impact of the strike on the new Voisey's Bay nickel/copper mine will be somewhat muted by large stockpiles and in-process inventories. However, Brazil's CVRD has announced it will delay its two nickel development projects until at least 2009 due to permitting and capital cost overruns.
Year to date, nickel prices have increased 110% due to higher stainless steel production. Meanwhile, LME nickel inventories have fallen 84% to stand at 6 kT since they hit a high at the beginning of February. "Debate continues as to whether the nickel market is truly in balance, or whether tight supplies are capping demand and forcing substitution through the price discovery process," the analysts wrote.
Citigroup said stainless steel demand and aerospace and gas turbine nickel applications will keep nickel demand strong. The analysts' nickel forecast for 2006-2008 are $7.68/lb, $7 and $4.50. Quarterly price forecasts are $8 for the remainder of this year.
GOLD COMMODITIES
Citigroup analysts feel "gold is at the crossroads, having corrected sharply from highs above $714 per ounce set mid-May. ...Gold is now wrestling with classic questions on inflation, interest rates, and currencies--and new ones on the cyclical context, asset class correlations, the physical market and the role of miners."
The analysts remain positive on gold, "based on a mix of supply/demand and macro/monetary catalysts." Citigroup gold forecasts for 2006-2008 are $632/oz., $700 and $750. "We would not be surprised to see a test of the gold highs of $850/oz," they added.
COAL COMMODITIES
While admitting that coal company earnings were dismal, Citigroup remains supportive of coal markets and "believe there is a positive, multi-hear thesis for the coal group, based on mining capacity constraints, transport bottlenecks, think utility stockpiles, the possibility of natural gas returning to the $10/MMBTU range, and above-trend global steel production."
With the hot summer temperatures spiking energy demand even higher, analysts feel coal inventories are likely to see a significant drawdown. Meanwhile, metallurgical coal markets appear to be tightening with a production push at steel mills.
