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Despite severe commodities correction, Citigroup insists mining supercycle will survive

Citigroup metals analysts say they regard current mining/metals conditions “to be a severe correction amid a secular bull market” that possibly may come back even stronger.

RENO, NV - 

Citigroup cut its global copper and aluminum forecasts Tuesday and Wednesday, but still remains positive on coal, copper and gold.

Global Metals & Mining Analysts Alan Heap and Alex Tonks said forecasts for 2009 have been reduced by ~20% as a result of slower demand growth.

"We remain most positive on the coal markets and copper. Negative on nickel and zinc," the analysts said.

North American Metals & Mining Analysts John H. Hill, Graham Wark and Paul Cheng said, "We are cutting copper and aluminum forecasts from aggressive, Street-high levels. For next year we expect copper at $3.65/lb (prev $4.75) and aluminum at $1.30 (prev $1.80). These are well above current spot and futures curves."

Despite the cuts, the North American analysts said, "Copper is well-positioned due to supply-side constraints, which span shortfalls are current mines, delays at mega-projects, and contract cancellations by host government." However, the analysts declared, "Aluminum has been a disappointment, as Chinese energy shortages have eased and smelter cuts were less-than-advertised, while demand from construction/transport is imploding."

The North American group said it cut forecasts for 2009-10 "to reflect China slowdown, dis-inflationary developments, and the short/medium term impacts of the U.S. financial crisis."

Nevertheless, the Global Citigroup team insisted that the commodity super cycle will survive. "It is important not to lose sight of the long term picture. We regard these conditions as a correction (albeit a severe correction) in a secular bull market. The drivers of the super cycle-urbanisation and industrialization in China and supply restrict-are intact. It is just that this super cycle as previous super cycles has shorter term business cycles super imposed on it

"Indeed the next up-cycle could be ever more powerful than its predecessor," Heap and Tonks asserted, "because when global economic activity recovers demand will be amplified by restocking, and supply will be even more constrained after cutbacks closures and project postponements."

Heap and Tonks observed that speculators and investors are leaving commodity markets. "It is notable that both long and short positions are being liquidated and we interpret this as part of a broad de-risking tactic rather than a negative view on the relative performance of commodities."

"In addition commodity positions are being liquidated as banks unwind house positions (Lehman Bros). LME stocks of aluminum increased sharply as physical positions were sold. Holdings in the commodities indexes were liquidated because of counter party risk (AIG is the administration of the second largest commodity fund," they explained.

Hill, Wark and Chen said they regard current conditions "to be a severe correction amid a secular bull market for [Mining] M/Metals. Demand-side drivers from BRIC-country industrialization/urbanization remain intact, while supply continues to be constrained by resource scarcity, infrastructure bottlenecks, and the forces of resource nationalism."

"Indeed, the next up-leg for the M/Metals could be even more powerful than its predecessor because when global economic activity recovers, demand will be amplified by re-stocking while supply is pinched by mine cutbacks/closures and project delays," they suggested.

In their analysis, the North America Metals & Mining Group lowered the target price for Freeport-McMoRan Copper & Gold from US$138 per share to $90 per share, reducing third-quarter EPS by 30% to $1.38 /sh.

Teck Cominco's target price was cut from Cdn$55 to Cdn$41/sh. Nevertheless, the North American group noted that the downside from lower copper forecasts "is more than offset from accretion assuming full ownership of the Elk Valley (BC) Coal assets with that transaction expected to close end-Oct."  However, earnings estimates for the third quarter have been cut from Cdn$1.76 to Cdn$1.30.

Meanwhile, the North American analysts also reduced the target price of Alcoa from $50/sh to $30/sh "to reflect lower estimates due to lower aluminum forecast, FX impact, cost escalation in key input as well as lower valuation multiples.

The Citigroup Global Metals & Mining Group outlined several main factors, which prompted them to reduce commodity prices forecasts, "in some cases very sharply." They include:

Copper-The market is still in deficit despite slower demand growth, "and as a result we expect prices to remain well above trough cycle level. The flipside is that if something should go wrong with the outlook the downside risk to prices is large. Copper's bellwether reputation also means that sentiment would be severely damaged."

Aluminum-The energy crunch in China is abating for now. "We had expected an electricity shortage to induce Chinese authorities to force smelter closures."

Nickel-"Continues to be challenged by supply increases and demand destruction. ...Demand continues to suffer as high nickel content stainless alloys are substitute by low and no nickel alloys."

Zinc-"Is in oversupply and trough prices are in prospect."

Iron Ore-"A string of adverse macro, steel and iron ore data points will make it difficult to force through a large price increase next year. Reduced forecasts of crude steel production in China have pushed the market into deep surplus in 2010 forcing prices lower. If the majors do not curb output as prices decline, pressure will fall on the marginal players."

Coking Coal-"Our coking coal forecasts remain unchanged. We are reducing our assumption of crude steel production globally. However the slower steel production growth in 2009 and 2010 continues to see the coking coal market being tight over the forecast time horizon. Supply constrains in Australia show little signs of easing."

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