Iron ore and gold have been the strongest commodity performers in 2019 so far, but many of the largest miners are over-priced, says Morningstar's Mat Hodge.

Buoyant global demand for iron ore and coal since 2016 has maintained high commodity prices, with coal the more appealing of the two.

Hodge, a director of equity research at Morningstar, says the relatively mild Northern Hemisphere winter and additional Chinese supply has stopped thermal coal prices rising too high, and sees more room for price growth. This could particularly favour lower-cost producers such as Whitehaven Coal (ASX: WHC) and New Hope Corporation (ASX: NHC).

"With prices starting to eat into the cost curve, and additional supply from China being relatively high cost, we think there is longer-term support for the thermal coal price and emerging value among the coal miners we cover,” he says.

Whitehaven and New Hope were trading at discounts of 20 per cent and 30 per cent to Morningstar's fair value estimate as at midday today.

In contrast, Hodge believes the iron ore miners are overvalued.

“There’s a broad separation between the iron ore miners and the remainder of our coverage. The iron ore miners – BHP (ASX: BHP), Rio Tinto (ASX: RIO), Fortescue (ASX: FMG) and Vale, on average trade at a 30 per cent premium to our fair value estimates, while the rest of our coverage is at a slimmer 3.8 per cent premium,” says Hodge.

He says many miners will remain under pressure over the shorter term, including aluminium and thermal coal miners: “Aluminium consumption growth has slowed with lower global economic growth and the trade tensions."

EVs, renewables powering higher demand

Some industry commentators are more upbeat on the outlook for lithium and graphite, where oversupply is keeping downward pressure on prices for both the commodities and the companies that produce them.

In addition to Australia's biggest export earners of coal and iron ore, Australia has large reserves of copper, nickel, nickel, lithium, cobalt and bauxite – the ore from which aluminium is produced.

Stronger global demand for these commodities, stemming from both cyclical and structural factors, has contributed to significant price increases since 2016.

Electric vehicle uptake is one of the structural factors cited by the Reserve Bank of Australia in its recent report, Outlook for Non-ferrous Metal Exports.

“Rechargeable lithium-ion batteries used in electric vehicles (and other applications) contain materials derived from a range of commodities, including lithium, nickel, cobalt, manganese, graphite and rare earths," says the report.

The greater use of lighter-weight metals such as aluminium and copper in the construction of EV car bodies is another longer-term demand driver.

The RBA report also refers to expanding global demand for renewable power from wind, solar and hydro-electric sources as longer-term positives for Australian producers of these and other materials.

“Australia is well placed to meet some of the increase in global demand for these commodities. Around 20–25 per cent of known global reserves for bauxite, lithium, nickel and zinc are located in Australia, and around 12 per cent for copper.”

UBS agrees that EV production will boost demand for some commodities but notes caution.
“Longer term, we do see EV penetration lifting as governments around the world mandate changes to automobile usage.

"We also note that despite many promises being made by this sub-sector, such as those relating to when a project will start to the recoveries it will achieve, most operators have failed to deliver to plan. As such, we advise caution on operators who are still in the early stage of development and production”.

Nickel and copper appeal, says UBS

But over the medium term, further uplift in prices is expected for nickel and copper, and some stockbrokers are favouring miners of these minerals.

After a strong run up this year, nickel prices are forecast to average US$14,400 a tonne by 2021 after averaging US$12,800 a tonne in 2019, according to a June quarter report from the Department of Industry, Innovation and Science.

While copper prices have fallen in recent months, as a result of lower consumption in China and concerns about the health of the world economy, the trend is expected to turn around as expanding consumer markets lead to a supply deficit and higher prices.

The copper price is forecast to rise to US$7,750 a tonne in 2021 from an average of US$6,480 a tonne in 2019, according to the Department of Industry, Innovation and Science. In contrast, the report predicts falling prices for lithium on oversupply.

UBS says it “likes” stocks exposed to these two metals given supply and demand fundamentals are strong, but it has downgraded prices for lithium and graphite miners.

“Underperformers have been stocks exposed to graphite and lithium where weak pricing and production issues continue to weigh on the names," says UBS - singling out name like Syrah Resources (ASX: SYR), Galaxy Resources (ASX: GXY), Orocobre (ASX: ORE).

“We have downgraded lithium-graphite names to Neutral from Buy following 16 per cent to 19 per cent cuts to our price forecasts due to oversupply,” says UBS.

“Looking into the third quarter of 2019, we prefer base over bulks because with the de-escalation of the trade war, assuming an agreement is reached between the US and China, should see an unwind of the speculative positions in the base metals, which have taken a hit relative to bulk commodities.

“These include Oz Minerals, Antofagasta, Southern Copper Corporation, Independence Group and Freeport-McMoran. Glencore is the leveraged diversified play."