You can’t keep a good sell-sider down. After downgrading Chinese property and upgrading the iron ore glut, Deutsche says buy the big miners. From Bloomie:
*Cyclical weak Chinese steel demand creates unique buying opportunity
Our recent trip to China uncovered high levels of property inventory.
However we believe the property market (and steel demand) is near to a cyclical low, and the iron ore price will recover in 3Q. In terms of Fe supply, we expect an extra 250Mt to be displaced and for high cost Chinese domestic mines to permanently close. We have downgraded our Fe price forecasts to the US$90-105/t range for the next 3 years. The Australian iron ore stocks are actually pricing in this band already. We think the recent weakness has created a unique buying opportunity in the majors before the August financial results. Rio is trading on a FCF yield of 6-8% and is discounting just US$65/t LT Fe.*Property market weakness weighing on Chinese steel demand
We are downgrading our China steel production forecasts by c.20 – 30Mt over the next 3 years, due to weakness in the property market. The current inventory levels (c.18 months) may take a year to whittle down, and require 10-20% price cuts, which is the key reason for our steel production downgrade. However, we continue to forecast positive Chinese steel production growth (+2.8% in 2014 and +3.5% in 2015). We also think property sales are showing tentative signs of stabilising, with an improvement likely in 4Q14. The reduction in our Chinese steel volumes pushes the iron ore market into more of a surplus from 2014 onwards. In order to restore the market balance, we estimate 250Mt of curtailments or project delays are required by 2016. This will likely come from further domestic Chinese mine closures and limited Indian ore exports. We now expect iron ore to average US$104/t in 2014, US$96/t in 2015 and US$90/t in 2016.
There is going to be a second half rally in iron ore prices. At some point, steel mills will have to rebuild moderately in preparation for the Q1’15 inventory build and Pilbara cyclone season. But it’s much more likely to be Q4 than Q3 so this call looks early to me. Indeed I still see significant risk of a drop to $80 and below on further destocking if steel production keeps slowing.
But Deutsche has it backwards on what to buy. The Chinese property slowdown very obviously has a structural dimension to it. It’s being brought on deliberately by authorities as a part structural reform. I don’t expect any rescue unless things get really bad and even then it is likely to be temporary. Therefore the looming opportunity to buy is a short term cyclical bounce and the best upside for that will be the battered juniors. The majors may look good in free cash flow and DCF valuation terms but that doesn’t matter a damn if sentiment keeps sinking like it is. In the end they’ll win but not before the whole complex is hammered.
