Commodities: Still waiting on China
About the author:
- Author name:
- By Adrian Prendergast
- Job title:
- Senior Analyst
- Date posted:
- 13 June 2023, 7:00 AM
- Sectors Covered:
- Mining, Energy
- The current selloff in resources has removed the previous over-optimism we saw towards China’s near-term growth potential.
- We now see sentiment swinging too far the other way, presenting opportunities to accumulate quality sector exposures at a discount to recent levels.
- Our commodity compass (page 3) sees iron ore in a surprisingly strong position in terms of having found a floor, with LNG and met coal not far behind it price wise.
- While we see strong long-term fundamentals for copper, oil and lithium chemicals (hydroxide/carbonate).
- Our preferred sector exposures amongst large caps are: BHP Group (ASX:BHP), Mineral Resources (ASX:MIN) and Santos (ASX:STO). While in small caps some of our key picks include Karoon Energy (ASX:KAR), Whitehaven Coal (ASX:WHC), Strandline Resources (ASX:STA) and Panoramic Resources (ASX:PAN).
Resources strategy update
The value offering in resources has started to improve with the broad selloff continuing, but we are still missing a vital ingredient with Chinese growth remaining depressed.
The current selloff follows a late 2022 surge in share prices across the resources sector, driven by what we saw at the time as over optimism towards the prospects of a China recovery. Not that we are China bears, we just do not like paying upfront for a demand recovery without being able to see it.
Interestingly, we now see investor sentiment has having started to swing too far the other way and as a result starting to uncover some attractive opportunities across the sector.
Overall we remain cautious on our expectations of a return to growth for China, but equally we believe this is priced into resource equities, leaving us confident that we see value in the sector but preferring safety over upside potential.
Iron ore found a floor? We have a positive view on iron ore, that is a contrarian call. While China’s property market is a critical demand driver for steel, and still depressed, we see enough demand from peaking infrastructure activity and other baseload consumption to see demand near balance against supply. We see this as likely to see iron ore supported within a stable range of US$100-$120/t in CY23 (above the highest cost production in the market at ~US$100/t).
Hard not to love copper. Recent supply additions, and a pullback in manufacturing and construction activity, has seen copper come under some pressure. Although copper prices have continued to perform a lot better than some other metals. While the short term might remain volatile, we remain robustly bullish on copper’s long-term fundamentals (declining average grades mined and limited new supply, against a backdrop of rising copper intensity that is likely to be supercharged by the electrification mega trend).
Coal in solid long-term shape. The recent selloff across thermal and met coal prices has been sharp, and in the case of thermal coal we see some further short-term downside to prices. This remains a stark contrast to long-term fundamentals for the coals, where ESG pressures and other sector headwinds has seen supply increasingly constrained.
Preferred sector exposures
While we see value being uncovered we also are expecting the volatility to continue in the short term as markets impatiently await a China recovery. As a result we are most optimistic on commodities where we see:
- Reduced downside risk (i.e. at or near a floor price) such as iron ore, LNG and met coal.
- Strong long-term fundamentals (such as copper, oil, coal and lithium chemicals).
Amongst large caps our top preferences include BHP (most preferred), MIN and STO. While in small caps some of our key picks include KAR, WHC, STA and PAN.
We expect shareholder returns to remain a key focus amongst large cap resource players. Driven by earnings or cash flow, these dividends could be volatile, but we expect them to remain comfortably above the market.
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