Commentary: BofA Merrill Lynch tweaks metal price forecasts

Bank of America Merrill Lynch has lowered its price forecasts for a number of commodities — including copper and iron that are heavily imported by China — but it also believes gold could bottom out this year, while nickel and zinc could rally in the second half of 2014.

“After years of talking about tackling economic slack, the Chinese government is now taking measures,” the bank wrote in a March 20 research report. “More recently this has been mirrored in bond defaults, and we see the risk that future financial products that are underwater may not be bailed out, with implications for credit markets and ultimately commodity demand.”

In the metals industry, this has manifested itself in various closures of excessive and unprofitable or polluting aluminum and steel-production capacity, the bank says, while in the financial sector, “to rein in the moral hazard on credit markets (i.e., lending to projects that shouldn’t really go ahead, with the authorities stepping in to bail out investors), China’s authorities could now decide to let some of these trusts default, which may destabilize the shadow banking sector.”

The fundamentals on China’s copper market “have been soft since late last year,” it says, and consequently the bank has lowered its average 2014 price forecast for the red metal by 2.7% to US$6,826 per tonne, or US$3.10 per lb. “Prices collapsed in March, as concerns over the health of the country’s credit markets and an unwind of financing deals escalated,” the bank states. “While prices have stabilized for now and strong short-covering rallies are possible near-term, we see a risk that copper may not rebound sustainably until third-quarter 2014.”

The bank has also cut its 2014 price forecast for iron ore by 8.3% to US$110 per tonne. “Iron-ore prices have collapsed in recent weeks on reduced buying from Chinese mills,” the bank explains. “Low iron-ore inventories at steel producers suggest the scope for further destocking is limited. Yet we believe the Chinese market is well supplied at present — also because iron-ore port stocks are at record highs.”

The bank expects steel production in China will rise 4.6% year-on-year in 2014 to 815 million tonnes, but points out that the increase is considerably lower than the 8.7% year-on-year growth seen in 2013. “Muted activity is largely driven by tighter credit markets and the strict implementation of measures to protect the environment, which have already led to capacity closures,” it writes. But the bank does not expect it to “collapse” due to “expectations of our economics team that Beijing will ramp up spending on infrastructure and social-welfare projects, including the start-up of 7 million units in social housing.” Overall, however, it sees iron-ore fundamentals remaining “challenged” as “China’s economy slows structurally as it rebalances.”

As for metallurgical coal, the bank argues that a good part of incremental demand from China will probably be sourced at home rather than from the seaborne market, and it has cut its average hard-coking coal price forecast by 14% to US$132 per tonne. Surpluses are also expected for thermal coal this year, and the bank has revised its average 2014 price forecast for Newcastle coal to US$74 per tonne, down from its previous US$82-per-tonne target.

On the flip side, the bank believes nickel and zinc markets are “rebalancing,” which could bring price gains for nickel in the second half of the year. It has raised its average price forecast for the base metal this year by 3% from US$7.07 per lb. to US$7.30 per lb. “Activity at stainless steel mills has picked up, with output at producers in World ex-China expanding visibly for the first time since 2010,” the bank writes. “This is one reason nickel premia have rebounded in Europe, the U.S. and Japan.”  

As for zinc, the bank has lowered its average price forecast from 98¢ per lb. to 96¢ per lb. for 2014, but also believes zinc is likely to move into deficit this year, which should be reflected in prices during the second half of the year.

“Heavily influenced by a lack of large-scale mine projects, zinc has been viewed as the metal with the strongest structural fundamentals for almost a decade,” the bank notes. “Yet, inventories hit a multi-year high in late-2012 and prices have barely traded above the marginal cost of production since. As a result, markets have taken a more agnostic view towards the metal. We believe this is not justified, as fundamentals have steadily improved. Our supply-and-demand model shows for instance that refined surpluses have declined every year since 2009. More recently, the gradual erosion of the supply glut has been partly reflected in falling LME stocks.”

As for gold, the bank believes prices will likely bottom out this year, driven by two dynamics that could bring new buyers into the market: demand from emerging markets and potential inflation. “Emerging markets have been trending higher structurally in recent years, which we believe will continue going forward as nations like China get more affluent,” the bank notes. And despite low inflationary pressures in advanced nations, “concerns that central banks could be misjudging the slack in the economy should bring new buyers into the market.” Gold prices should average US$1,300 per oz. this year, a 13% increase over the bank’s previous forecast of US$1,150 per oz.

The bank forecasts average silver prices this year will rise 13.2% to US$20.80 per oz., from its previous forecast of US$18.38 per oz.