The Minesite Commodities Outlook For 2014

Copper ... downward trend?

Lord Weinstock, the legendary CEO of the General Electric Company, commenting on the projections for the year ahead, used to remind his audience that on day one the coffers are totally empty.

Everything to be earned that year has to be created from nothing even if the necessary infrastructure is in place.

So it is with any analysis of what lies ahead for commodities in 2014.

Nothing happens on its own. Metal has to be mined to be satisfy fresh demand from consumers.

But just because they bought a car last year does not mean they will buy another this year.

Fortunately it seems consumers are becoming more confident and are likely to increase spending in 2014.

The latest forecast from the IMF is for global economic growth in 2014 to average 3.6 per cent, which is substantially higher than the estimated expansion of 2.9 per cent in 2013.

Although the numbers used by The Conference Board are slightly lower – 2.8 per cent in 2013 rising to 3.1 per cent in 2014, the rising trend is the same.

Given that between one third and two thirds of metal demand is satisfied by recycled material it suggests that the mining industry can anticipate its market expanding by one to two per cent.

Not fantastic, but not bad in a generally sluggish world still overburdened with debt.

As with all data, these numbers need to be treated with a degree of caution. A small economy growing fast is not as important for consumption as a large economy growing slowly.

Here, metals are once again in the sweet spot because just under half of world growth now comes from emerging and developing economies, which includes China.

This group is forecast to expand at 4.6 per cent in 2014, a tad lower than the 4.7 per cent estimated for last year.

Even so, it is a lot faster than the 1.7 per cent projected for the mature economies, and that in turn is much higher than the predicted expansion of one per cent in 2013.

So while there may be much talk of the developed world picking up the baton of growth in 2014 relative to the developing world, the reality is that the action is still with emerging economies.

Moreover, not only are the emerging economies growing faster, but they also use more metal and recycle less scrap, as they have a smaller, and newer, stock of goods.

So even though it is popular to downplay the commodity sector, metals in particular have a lot going for them in terms of end markets.

Moreover, the industry has already drastically cut back its expansion plans so there will be a reduction in the amount of new material being supplied to the market.

Whether the industry has got that balance right will be the key determinant to how metal prices evolve over the year.

One metal where the market has already passed judgement is aluminium. It starts the year at US$1,802 a tonne but the forecast average price for 2014 has declined sharply from the US$2,550 predicted back in 2011 to the current consensus forecast of US$2,045 recorded by Bloomberg.

Much of this is due to the overcapacity arising from new plants in China and the Middle East. Given that Chinese demand is predicted to increase by 10 per cent in 2014 this enthusiasm is understandable.

Société Générale predicts world demand for aluminium will increase to 53 million tonnes in 2014 with 26 million tonnes of that coming from China.

The problem is that China is also forecast to produce 27 million tonnes, thereby creating a surplus.  On projected growth figures the long term outlook for aluminium looks good, but unless capacity is closed the short term does not appear favourable.

Copper has a much better fundamental structure than aluminium. Nevertheless, 2014 price forecasts have followed the same downward trend. The consensus for the year now stands at US$6,945 a tonne having been as high as US$7,800 a year ago.

At 21.7 million tonnes, this market is half the size of aluminium but is growing at 4.8 per cent a year.

Experts at Société Générale are fearful that the big expansion of mine capacity over the last decade will now start to overwhelm even this impressive level of growth and lead to rising inventories and weaker prices.

That said the metal starts the year with LME inventories of just 365,700 tonnes and prices at US$7,421 a tonne.

To achieve the consensus average for the year reported by Bloomberg implies prices falling to near US$6,000. If that happened Société Générale estimate that nearly 10 per cent of capacity, roughly 1.5 million tonnes, would be losing money.

That suggests that price level is a pretty strong floor, and it is hard to see prices going as low as that for any length of time.

Nickel starts the year at an already depressed price of US$13,975 a tonne, yet Société Générale forecasts an average price for 2014 of US$15,000 a tonne while ABN Amro thinks it will be US$15,500.

If either estimate is anywhere near the mark it implies that prices should rally sharply by about US$2,000 or maybe US$3,000 over the course of the year.

That view is supported by the analysis from the French bank that about 50 per cent of production is currently unprofitable.  Whether producers react by cutting production to reduce the surplus will be the key feature in the evolution of prices this year.

Société Générale makes no apologies for anointing zinc as its favourite metal. However, it could be argued that the current level of US$2,081 a tonne already discounts this favourable position. Indeed, the forecast average of US$2,040 from the French bank suggests that there is not much more to go for.

Iron ore remains by far and away the most important hard commodity for the mining companies. Fortunately Société Générale does not expect any major change in this market over the next few years, even though it will move from being in deficit to being in surplus.

It argues that the projected surplus in 2015 will only be 0.3 per cent of global demand and will not be material.  It therefore only expects a modest decline in average prices to US$110 a tonne (61% FOB Australia) from US$116 last year.

Prices of metals and mining shares already reflect the consensus view of the experts.  If prices move it will be because the consensus changes, either on fresh data or revised opinions.

All that can be said with any certainty is that metals are now mostly trading at close to marginal costs of production and that there is precious little hype in mining equity valuations.  That should be a good base to work from, at least in theory.