Mining heavyweights BHP and Rio Tinto and more specialised miners such as Whitehaven Coal may all have their fair values upgraded between 10% and 100% if prices for coal, iron ore and other industrial metals can hold onto their breakneck pace of gains in 2022, according new analysis published last Thursday.
Fair values are on hold at this time, but upgrades will come if prices remain this way for much longer, said Mathew Hodge, director of equity research.
“If the prices stay where they are, there is clearly upside to fair values and valuations in the market,” he says.
“We make no changes to any of our fair value estimates for the miners at this stage but plan to take a potential supply shock into account in our valuations shortly, where appropriate.”
Russia’s invasion of Ukraine and the ensuing sanctions have pulled essential supplies out of already-tight commodity markets and driven some ores to prices that are as much as 150% higher than they were a year ago. Hodge likened the supply shock to the 2019 failure of a Vale tailings dam that killed hundreds of people and sidelined more than 5% of iron ore supply for years.
Others in the industry are scrambling to update price forecasts in response. Investment bank Macquarie on Friday raised its price targets for BHP by 15% and Whitehaven Coal by 100%, following upgraded price forecasts for iron ore, base metals and coal.
Coal sees highest volatility
Thermal coal will probably feel the biggest brunt from potential supply disruptions, Hodge said. Russia is responsible for around 15% of international trade, and supply has also been affected by environmental issues. Newcastle thermal coal futures closed at US$418.75 per tonne on Friday up 76 per cent since the 24 February invasion. In 2021, the average price was US$137.
Fair value estimates for domestic producers Whitehaven Coal (ASX: WHC) and New Hope (ASX: NHC) would at least double if prices stayed at these levels for a year, Hodge says. London-based diversified mining titan Glencore (GLEN, -2.24%) would experience a 20% lift to its fair value.
Should coal prices ease to US$280 over the same period, Whitehaven and New Hope’s fair values would still rise by close to a half.
“Record prices well above US$400 per metric ton wouldn’t have to remain for long for fair value estimates to trend higher”, he says.
Iron ore and nickel also in focus
Iron ore is also vulnerable to supply disruption, with Ukraine and Russia accounting for 4% of global supply, or a little less than two-thirds of the volume lost when Vale’s tailings dam failed.
Should iron ore prices remain around US$160 through 2023, fair values for Fortescue Metals (ASX: FMG), BHP (ASX: BHP) and Rio Tinto (ASX: RIO) will lift by 10% to 30%, Hodge says. BHP would also stand to gain from elevated prices for metallurgical coal, which is used in steel making as opposed to power generation.
Other producers South32 (ASX: S32), Glencore and BHP would also benefit from "fair value uplift between 1-3% if last week's record nickel prices were sustained for a year." Hodge believes it is unlikely and described those prices as an “anomaly”.
Nickel trading on the London Metal Exchange is still closed after prices more than doubled to above US$100,000 a tonne last week in a short squeeze on Chinese metals tycoon Xiang Guangda.
Things could change quickly
There’s huge uncertainty over the longer-term effects of Russia’s invasion of Ukraine and the sanctions that followed, Hodge says. Unlike ordinary supply shocks, Russian production is intact, and a peace deal could allow it to flood back into the markets. Chinese buyers could also turn to Russian commodities and reduce demand elsewhere.
“It could change very soon, if things happen with Putin, or if we have some kind of truce and they [Western nations] agree to roll back the sanctions,” says Hodge.
As the so-called “weapons” of the pandemic are being turned against the new variant of the coronavirus, the response is affecting key manufacturing centers. Early this week, tens of millions were put on lockdown in the Chinese hubs of Shenzhen and Changchun and the supply/demand balance is already featured on the radar of traders. Just a week after commodity prices rose on news that Shanghai would be reopened from lockdown, many fell back on Monday as they added the new lockdowns to their outlook. Investors worry demand will slow in the commodity-hungry nation that chews up three-quarters of the world’s iron ore and half its copper.
The Bloomberg Commodity Index, which measures 23 commodities, dropped 2% on Monday. Iron ore fell 6.2% to US$144.90 a tonne. Brent Crude closed at US$106.90, 18% lower than peaks above US$130 per barrel reached last Wednesday. It’s still 11% higher than levels before the invasion.
“Price is set at the margin. If you’ve got tighter markets, small changes can have a big impact on price,” Hodge says.
“These prices are all generally in rarefied air, there’s no fundamentals holding them up. But if there’s more supply than demand or if demand falls, prices can fall a long way.”
