Fortescue cracks a new correction low below $14 as UBS declares “don’t buy miners now!”
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UBS View: Start of the commodity down cycle – too early to Buy the miners
In June (Topping out) we highlighted that we did not believe we were at the start of a commodity ‘super-cycle’ and, even though the demand outlook appeared solid, fundamentals were not strong enough to support prices at elevated levels. What’s changed? The outlook for commodity demand has deteriorated as: (1) Evergrande’s financial issues have triggered a slowdown in China property sales (note); (2) Power shortages & power rationing in China (to meet the 2021 energy intensity target) has slowed industrial activity materially since July (note); (3) The post Covid demand impulse in developed markets has peaked as reopening drives a shift in spending from goods to services. Offsetting this are the near-term supply constraints in smelting/ refining in China due to power shortages/ rationing. The macro backdrop for commodities has also deteriorated with inflationary pressures pushing central banks closer to policy normalisation/rate hikes. In our view this is not the backdrop for a sharp recovery in commodity prices; we expect prices fall further over the next 12mths.
Commodity prices & mining stocks have corrected in 3Q21 – is it time to buy?
Not yet. Mining stocks rarely go up/ outperform in a falling commodity price environment regardless of ‘what’s priced in’ (as seen with the iron ore miners which have generated negative TSR over the last 3-6mths despite very cheap spot valuations, record earnings & record shareholder returns with the June results). In general the miners are well positioned for a commodity price downturn with balance sheets strong, capex contained and capital discipline largely intact. However, with commodity prices falling & costs rising (energy, labour, consumables), the sector faces negative earnings momentum, consensus earnings downgrades and lower cash returns with 1H21 the high watermark for earnings, FCF & dividends for most miners. Whilst the recent
pullback may have unearthed long-term value in certain stocks, in our view it is too early to buy the miners. We remain underweight the mining sector with predominantly Sell or Neutral ratings across UBS global mining coverage.
Commodities: Thermal coal, nickel, aluminium & lithium more resilient
Our ‘preferred’ commodities are likely to be more resilient (i.e. go down less/ stayelevated for longer then expected) rather than offering upside vs spot. Thermal coal prices are likely to positively surprise in 2022. Nickel & lithium will be supported by strong EV related demand medium-term. The structural outlook for aluminum has improved but we do not think spot prices are sustainable (even though China supply is set to remain constrained near-term). Fundamentals for iron ore are challenging and we see further price downside (albeit we acknowledge this is quickly becoming consensus). Gold provides a hedge against inflation risks but rising yields & policy normalisation should drive lower prices.