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Picking the right commodities play

Broker reports editor |  06 April 2014  |  Portfolio

PlaySophisticated super investors make sure they have something invested in the mining sector, which is very much responsive to China. It involves assessing supply and demand patterns and picking macro-economic trends. Credit Suisse comments that the world is moving, albeit lethargically, out of an extraordinary period of central bank largesse. It says that may create some headwinds to asset prices and potentially an increase in volatility:

"In that environment, the importance of fundamentals should continue to re-emerge. We believe the performance of individual commodities will increasingly be driven by idiosyncratic supply and inventory cycles, and lags in responding to the near - term IP cycle. Over coming quarters we expect:

Crude Oil to stay well supported thanks largely to supply dynamics. Upward risks may begin to dissipate through the latter part of the year.We remain structurally bearish and expect prices to slip below $100/t at some point in H2.

Copper to stabilize in the short term as China pessimism ebbs, but we think prices could slip further in Q3 before the market slowly starts to tighten.

Aluminium market to establish a floor under a price not far below $1,700, but subsequent gains are likely to be slow.

Nickel and Zinc -- medium term bullishness.

Gold to resume its downward trend as central banks edge from ultra accommodative towards moderately tighter monetary policy. Production losses to finally help. PGMs diverge from gold and make further gains, but demand growth for platinum remains sorely lacking."

Super investors looking for a potential double whammy can consider overseas commodities plays. The potential for a decline in the $A may provide more than tw trading opportunities: one the play on the future of commodity prices, the other a currency play.

For those who want to stay concentrating on the Australian market, Credit Suisse assesses copper prospects, which is also often a gold play as well:

"¦ For our Australian operating copper companies, all have exposure to gold revenues. Credit Suisse's global (equities) team has now aligned together in its gold commodity price assumptions and forecasting. In our view, fundamentals remain largely unchanged since the last commodity update and we reiterate our gold price forecast price level of US$1,300/oz flat.
¦    Only minor adjustments have been made to our house AUD/USD forecasts.
¦ All earnings, target price and rating changes are driven primarily by changes made to our gold assumptions (up). A summary of the changes are shown below in Figure 1.
¦    Our preferred exposures are PNA and OZL, both moving to OUTPERFORM ratings from Neutral and Underperform, respectively. When we run current spot currency and commodity prices through our models, PNA is our sole copper exposure where the NPV is greater than the current share price (as at 1 April close)."

Here are the reccomendations for individual stocks:


The copper price appears to have settled in a lower band:

Copper is very much subject to the vagaries of the Chinese financial markets, as The Economist points out:

"China consumes about 40% of global copper production. But not all of that goes straight into manufacturing or construction. Chinese companies have also been using copper as collateral for their hard-currency loans: “buy, store, hedge and pledge” in the words of one trader. That has led to an overhang, with far more of the metal stockpiled than users need. Any change in the conditions that created this stockpile can have a big effect on the price.

A sign of this is that when the Chinese economy slows, as seems to be happening now, with manufacturing activity weakening for a fifth consecutive month, those stockpiles rise. CRU, a metals researcher, now says the copper-market surplus this year will be four times bigger than it previously estimated, with forecast production outpacing demand by 140,000 tonnes.

Chinese data are notoriously opaque, so judging the real health of the country’s copper-consuming industries is hard."

Both copper and iron ore are showing signs of parallel weaknes, perhaps reflecting a slowing of the Chinese economy:

Credit Suisse says mineral sands may also be looking attractive. It is forecasting a global deficit of 181kt of zircon in 2014, which should be sufficient to shrink inventories to 140kt, close to a normalised level. But it is predicting price recovery will be slow, so investors will have to be patient:




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