Morningstar analysts still see significant risks for the miners and think the stocks overall are overvalued. Buoyant commodity and share prices do not reflect the inevitable shift in China’s economic growth towards less commodity consuming activities, and the market has taken too much comfort from the stimulus-fuelled recovery.
The underlying sources of instability – poor quality lending in China and growing leverage are yet to be addressed. We see the greatest overvaluation among the bulk miners – those exposed to iron ore, coking coal, and thermal coal. Prices for those commodities remain elevated.
The bulk miners have withstood the market volatility so far, posting share price gains on average since the end of June thanks to strong underlying prices for iron ore and coal. New Hope (NHC) has been a stand out this year, nearly doubling since March. Fortescue (FMG) has been the laggard, falling 17% since the end of June and its shares are now slightly undervalued. We still think Rio Tinto (RIO) is the most expensive of the large miners, reflecting the high exposure to iron ore where we are most bearish.
The main changes to our commodity price forecasts have been to incorporate higher near-term prices for coal and iron ore, due to strong seasonal demand from China and disruptions to their domestic coal supply, and the reduction in spot prices for some base metals such as nickel and zinc.
The key changes to our base metals’ forecasts are increased near-term aluminium and alumina price forecasts and lower lead, zinc and nickel spot prices. The latter have declined 15%, 3% and 10% respectively. The last few months have been volatile for base metals with copper selling off more than 20% from early July highs, only to recover some of the losses more recently. Overall though we’ve not made any changes to our near-term or longer-term copper forecasts.
Aluminium has yo-yoed on news around potential supply disruptions, tariffs and a broader economic slowdown in China and global trade. Nickel and zinc have sold off on concerns around supply, with China investing heavily in Indonesia to boost output and zinc supply responding to recent decade-high prices.
China Long Term Trends Weigh on Forecasts
We’ve increased our near-term bulk commodity price forecasts reflecting strong steel output this year and coal production interruptions in China. We’ve increased our metallurgical coal forecasts by 6% on average to 2020, for iron ore by 10% on average to 2020 and for thermal coal by just 3% in 2019.
However, longer-term we see the bulks as having the greatest downside as steel production in China slowly contracts and a greater proportion of steel is produced from scrap, at the expense of demand for iron ore and coking coal. We also expect China’s coal supply to normalise as environmental and safety disruptions work through and new mines are added.
Thermal coal prices have been very favourable, thanks to buoyant import demand from China. The hot summer created seasonally strong demand while a tightening in its own domestic supply on environmental and safety grounds necessitated demand from the seaborne market. Coupled with the weaker Australian dollar, thermal coal prices in Australian dollars are above the previous China-boom high.
Steel production has also been strong in the lead up to winter curtailments in China. This has supported iron ore prices. Metallurgical coal prices have also benefited from a reduction in domestic output from China as well as disruptions to supply such as the fire at North Goonyella.
