Commodities: Riding the super cycle Citigroup Smith Barney's preferred base metals going forward are Aluminum and zinc.
Commodities: Riding the super cycle
By: Barry Sergeant
Posted: '02-FEB-05 13:54' GMT © Mineweb 1997-2004
JOHANNESBURG (Mineweb.com) -- Rises in real metal and commodity prices have reversed their trend declines of the past 30 years, according to a major 260-page report by Citigroup Smith Barney, a division of Citigroup Global Markets.
For investors, the critical finding is that this trend reversal is likely to remain in place for some years, underpinning metals and mining stocks, and thus providing resources investors with the opportunity to “ride the super cycle.”
In the report, Citigroup Smith Barney hail a long-term metals and mining super cycle that has already seen the broader resources group move to the status of market leaders. It is a phenomenon not known for more than an entire generation.
The theme is continuing this year: so far, bar resources, global stock markets have gone nowhere. With global economic growth cooling this year and the US tightening interest rates, stock markets have lost direction, but a range of special circumstances apply to the resources sector.
For specialist investors at least, resources are seen as a sub-sector likely to outperform in 2005 – both in relative and in absolute terms. Toronto-based RBC Capital Markets recently stated that while earnings growth for mining stocks is slowing, “we believe that sustained strong earnings will drive out performance of mining shares relative to the overall equity market in 2005.”
Indeed, the resources bull market could remain intact for years. The finding that trend rises in real commodity prices have reversed the trend decline of the past 30 years is at the core of the Citigroup Smith Barney report, compiled by a team of nine analysts led by Alan Heap, out of Sydney.
Heap, a veteran analyst well known to institutional fund managers across the world, finds that a long-term mining and metals super cycle, combined with an extended current cycle, “will drive sustained earnings growth and outweigh conventional sell signals in a maturing cycle.” The so-called super cycle is seen as driving a sustained period of earnings growth, and delivering a “quality” of earnings not seen in the sector before.
Broad dollar-denominated metal and commodity prices have already experienced a bull run of three years, in inverse correlation to the dollar’s bear market. Citigroup Smith Barney say that the super cycle is driven by materials-intensive growth in China, in turn driving higher production, and, of course, costs.
Citigroup Smith Barney has found that despite increasing its long-term commodity prices and exchange rates, most of its 2007 metal and commodity price forecasts are above its long-term numbers. The finding is that in the current super cycle, demand will remain above trend, although slowing from the 2004 peak.
Previously, Citigroup Smith Barney had viewed the sector against a super-cycle background without fully embracing the quantitative implications in its metal and commodity assumptions, and therefore in its forecasts for company profits. While new supply from higher-cost projects will drive industry-average costs higher, importantly, long-term average margins will be broadly unchanged.
“The most important implication of the super cycle,” states Citigroup Smith Barney, “is higher long-term prices.” The report’s preferred commodities are bulks (iron ore, coking coal and alumina), two base metals in aluminium and zinc, and one precious metal, in gold.
In its “Key Commodity Price and Exchange Rate Changes,” the analysts’ most significant changes are found in respect of the rand-dollar exchange rate. Citigroup Smith Barney has cut this 12 percent for 2005, to R5.93 from R6.76; by 14 percent for 2006, to R6.32 from R7.33, and by another 14 percent for 2007, to R6.77 from R7.89. The long-term assumption is that the dollar will trade at R9.00.
As to equity preference, the favourites are picked according to Citigroup Smith Barney’s preferred commodities, and those with “quality earnings, strong free cash flow, growth, and capital management potential.”
Those making the grade among diversified and bulks resources stocks: BHP Billiton, Rio Tinto, CVRD, Arch, CONSOL, Centennial, Macarthur and Iluka. Anglo American, notable for its absence, is rated as “Hold, High Risk,” and has suffered, says Citigroup Smith Barney, “the full impact of the weak dollar, with our new rand forecasts and the strong euro offsetting the majority of the benefit from elevated commodity forecasts. The lack of Anglo’s exposure to bulk commodities (certainly when compared to BHP Billiton, Rio Tinto and Xstrata) has also restricted earnings and valuation increases.”
Staying with stock picks, for aluminium the thumbs up goes to Alcoa and also Alumina Ltd; for gold, it is Barrick, Newmont and Lihir, and for base metals, it is Freeport, Vedanta, Antofagasta and Zinifex.
For the next two years, there is “a considerable consistency to the earnings changes” of various stocks. Among the highlights: significant upgrades to Norilsk, Minara and Jubilee (nickel); strong upgrades to Antofagasta and Oxiana (copper); 20-30 percent upgrades to Alumina Ltd, and modest upgrades for BHP Billiton, Rio Tinto and CVRD (diversifieds).
As to rand exposures, Citigroup Smith Barney has implemented big downgrades in respect of exposure to South African costs: Lonmin, Anglo Platinum, Impala, AngloGold and Harmony. There have also been recent changes to the recommendations for South African stocks following changes in forecasts for the rand, and iron ore prices.
Kumba Resources, previously a “Sell” is upgraded to “Hold;” Impala (previously a “Buy”) is downgraded to “Hold,” as is Anglo Platinum (previously a “Buy”). Two stocks are downgraded to “Sell:” Northam (previously “Hold”) and Lonmin (previously “Hold”).