Risk vs reward improving - conflict between China tailwinds & recession fears
In our view the risk vs reward for commodities overall is improving with prices typically down >10% from the 'China reopening' highs seen in Jan-23.
Most commodities remain elevated versus cost curves and incentive prices, but physical markets are still balanced, or tight. Looking forward we see conflicting demand and macro drivers with China reopening stimulus to support demand growth while the developed market faces a 'recession risk' which may drive weaker industrial activity. In our opinion, the iron ore market is structurally challenged while gold, lithium and high-quality coal will trade higher for longer; base metals have attractive long- term fundamentals and leverage to China reopening in 2H23.
Key Themes: China reopening vs Developed Market recession, supply outlook mixed, M&A
(1) China reopening momentum remains a tailwind for commodities. Recent data has positively surprised <who? the market> against our estimates and more stimulus support is expected. However, commodity intensity of China's economic recovery is likely to be lower versus previous cycles, particularly for early cycle commodities (steel and cement); the outlook for base metals is robust.
(2) Developed Market recession fears: China is the key end market (~50%) for metals, but US and Europe are not immaterial and we see downside risk to demand run rates in 2H23. Metals are also financial assets and slowing GDP and IP is unlikely to support positive near-term price momentum.
(3) Supply outlook is mixed with iron ore recovering, copper and aluminum constrained, and coal mixed.
(4) M&A activity is gaining momentum as miners pivot from cash returns to 'growth' and increasing exposure to energy transition metals. In our view M&A activity is set to increase and this will provide a valuation underpin for the miners with 'energy transition' exposure.
Commodities: copper, gold, coal, lithium resilient; iron ore still vulnerable
We mark to market our 2023-24 price estimates, cutting thermal coal after the extreme weakness in 1Q and lifting copper, iron ore and gold. In our opinion, base metals have compelling fundamentals with the current rate of capex deployment unlikely to be sufficient to match robust demand growth medium-term (supported by the energy transition); we see modest near-term weakness as a buying opportunity for copper, aluminum and zinc. We still favor gold as it is well-placed to benefit from falling US real rates. Thermal coal prices are finding a floor after the sharp correction in 2023 due to a mild winter and weak demand; we expect a resurgent power shortage to tighten the market in the autumn. Iron ore is most exposed to China and therefore leveraged to a stronger than expected recovery in the property sector ; prices have been resilient in 1Q23 but we expect fundamentals to weaken in 2H23 (and spot prices to fall) with supply growth to be sustained while demand from China steel production is likely to moderate.
