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10 Commodity Charts that Matter for ASX mining stocks

Thu 04 Jul 24, 12:38pm (AEST)
Mining and charts
Source: Shutterstock, Market Index

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Key Points

  • Stocks in the ASX Resources sector continued to underperform into financial year-end as banks outperformed
  • Major broker Morgan Stanley believes this creates an opportunity to “embrace” Aussie Resources stocks
  • They provide 10 key commodities charts that “matter” as far as building the case for investing in the ASX Resources sector

Those who follow my Evening Wraps will be all too aware of the S&P ASX Resources Index’s (XJR) underperformance into the end of FY24. Since its peak of 6180.7 on 22 May, the XJR tumbled nearly 11% to its 5506 low on 24 June and has only moderately recovered a few percent to 5660.

Moves like this are rarely a coincidence for Resources companies. They’re possibly the most transparent group of stocks on the market! It is not an overreaching generalisation to say they live and die by the prices of the commodities they’re digging or hoping to dig out of the ground.

In that period since late May, a promising rally in most base metals – led by a record-breaking run-in copper but supported by strength in iron ore and precious metals also – has turned sour. Copper prices are presently 12% off their highs, iron ore around 8%, and gold around 5%.

Copper LME Cash Chart 2 July 2024
Copper prices are presently % off their highs

A recent report from Morgan Stanley suggests investors in Aussie Resources stocks should stay the course. If anything, the broker believes that recent weakness in the sector creates opportunity.

At the centre of Morgan Stanley’s argument are 10 “Commodity Charts That Matter”. Let’s investigate each chart and what it means for Aussie resources stocks.

Chart 1 - RESOURCES VS BANKS

Exhibit 2 Morgan Stanley Research
Exhibit 2: Banks have significantly outperformed Resources in the first six months of 2024 by +27.6ppt. Source: RIMES, Morgan Stanley Research. Performance for the period Dec-31, 2023 through to and including June-27, 2024. (From: Morgan Stanley Research, “Commodities Matter”, 30 June 2024)

Morgan Stanley notes that their prior view investors should pivot from banks to resources “proved short-lived and ultimately too early”. That’s broker speak for “we got it wrong”!

Despite the lack of traction on their thesis so far, Morgan Stanley remains committed to their strategy of switching into resources, noting the risk-reward “remains compelling”.

Their main argument is their expectation the RBA will keep rates higher for longer, and this will adversely impact banking and financial stocks. On the other hand, commodity prices (Morgan Stanley has their favourites) are “still robust”, and this means commodity stocks should remain supported.

Chart 2 - BULL AND BEAR COMMODITY FORECASTS

Exhibit 4 Morgan Stanley Research
Exhibit 4: Morgan Stanley's 4Q24 price forecasts vs. spot – constructive on the commodities we care about. Source: Morgan Stanley Research. Note: Spot price as at 18 June 2024. Manganese excluded from order of preference given current extreme market dynamics. (From: Morgan Stanley Research, “Commodities Matter”, 30 June 2024)

This chart shows the upside/downside of Morgan Stanley's price forecasts for various commodities versus current spot pricing. The broker notes the outlook is “constructive on the commodities we care about” such as hard coking coal (“met coal”), iron ore, copper, aluminium and gold.

Morgan Stanley is clearly bearish on commodities such as lithium (15% forecast downside), uranium (8% forecast downside), nickel (6% forecast downside), and thermal coal (3% forecast downside).

Chart 3 - RESOURCES VALUE METRICS

Exhibit 6 Resources forward multiple. Source RIMES, IBES, Morgan Stanley Research
Exhibit 6: Resources forward multiple of 11.1x is at a 20% discount relative to its historical average of 13.8x since 1994. Source: RIMES, IBES, Morgan Stanley Research. (From: Morgan Stanley Research, “Commodities Matter”, 30 June 2024)

In this chart, Morgan Stanley points out that the forward price to earnings (P/E) ratio for the Resources sector is currently 11.1 times. This is a 20% discount to the sector’s historical average  (since 1994) of 13.8 times.

The general rule of thumb for P/E ratios is lower means better value. So Morgan Stanley is implying here that Resources stocks could be up to 20% undervalued by historical norms.

Chart 4 - RESOURCES EARNINGS CYCLE

Exhibit 7 Resources (Metals & Mining + Energy) earnings are currently at cyclical lows. Source RIMES, IBES, Morgan Stanley Research.
Exhibit 7: Resources (Metals & Mining + Energy) earnings are currently at cyclical lows. Source: RIMES, IBES, Morgan Stanley Research. (From: Morgan Stanley Research, “Commodities Matter”, 30 June 2024)

Aussie resources investors know, or are usually in the process of being taught, that commodity prices move in cycles. You don’t want to be on the wrong end of a commodity price cycle (um, lithium anyone!?), and whilst the old adage of “time in the market, not timing the market” might apply elsewhere, you generally want to get your timing right with commodity investing.

In this chart, Morgan Stanley points out that in terms of earnings revisions, Resources and Energy stocks appear to be the low point of their cycle. Note the extreme saw-tooth pattern in the chart confirms the cyclical nature of earnings for commodity stocks.

Perhaps, if you squint, the blue and beige lines are turning up?

Chart 5 - IRON ORE (INDIAN DEMAND)

Exhibit 8 India-s increasing pull on iron ore imports; no longer just opportunistic. Source WBMS, Eikon, Morgan Stanley Research
Exhibit 8: India's increasing pull on iron ore imports; no longer just opportunistic. Source: WBMS, Eikon, Morgan Stanley Research. (From: Morgan Stanley Research, “Commodities Matter”, 30 June 2024)

The next couple of charts relate to one of the commodities Morgan Stanley’s “cares about”, iron ore.

Usually, when you think about iron ore demand, you think about China. Certainly, right now, it is by far the biggest consumer globally. But, in this chart we can see that the demand from India is growing again.

Morgan Stanley points out that in the past, India’s imports of iron ore tended to be “opportunistic”, that is, increasing when the iron ore price dips. The broker believes that as India’s steel industry continues to grow at a rapid pace, this is less likely to be the case going forward.

Chart 6 - IRON ORE (RISING COST CURVE)

Exhibit 9 Iron ore costs are still on the rise, keeping trough levels supported. Source Wood Mackenzie, Morgan Stanley Research
Exhibit 9: Iron ore costs are still on the rise, keeping trough levels supported. Source: Wood Mackenzie, Morgan Stanley Research (From: Morgan Stanley Research, “Commodities Matter”, 30 June 2024)

There’s a bit going on in this chart, but the gist of it is that Morgan Stanley has observed that the cost of production along with various other costs required to get iron ore to market is increasing. In theory, this should help keep “trough levels supported”

Chart 7 - COPPER

Exhibit 11 Chile-s and Peru-s copper output is barely holding onto YoY gains, despite new mines. Source Bloomberg, Morgan Stanley Research
Exhibit 11: Chile's and Peru's copper output is barely holding onto YoY gains, despite new mines. Source: Bloomberg, Morgan Stanley Research. (From: Morgan Stanley Research, “Commodities Matter”, 30 June 2024)

Turning to another commodity Morgan Stanley “cares about”, copper. In this chart, the broker notes that growth in output from major producers Chile and Peru is “barely holding”, despite the addition of new mines. (Note this year’s production is the incomplete dark red line).

Chart 8 - GOLD

Exhibit 12 Gold tends to show upside after rate cuts. Source Bloomberg, Morgan Stanley Research
Exhibit 12: Gold tends to show upside after rate cuts. Source: Bloomberg, Morgan Stanley Research. (From: Morgan Stanley Research, “Commodities Matter”,30 June 2024)

Gold is another commodity Morgan Stanley “cares about”. In this chart, the broker notes that gold tends to rise after US interest rate cuts, citing 7 historical examples.

The general consensus is that the Federal Reserve will start cutting US interest rates as early as September, with most brokers and economists expecting further cuts in 2025.

Chart 9 - ALUMINIUM

Exhibit 13 Aluminium market balance, price outlook – tight conditions. Source IPAI, WBMS, Wood Mackenzie, Bloomberg, Morgan Stanley Research
Exhibit 13: Aluminium market balance, price outlook, mt; US$/t – tight conditions. Source: IPAI, WBMS, Wood Mackenzie, Bloomberg, Morgan Stanley Research estimates (e). (From: Morgan Stanley Research, “Commodities Matter”, 30 June 2024)

The final of Morgan Stanley’s favoured commodities, aluminium, features in Chart 9. Here the broker notes that the market is forecast to be in deficit out to 2026. The aluminium price is expected to be supported over this time, rising from around US$2,200/t to around US$2,400/t.

Chart 10 - LITHIUM

Exhibit 14 Lithium supply-demand balance (kt LCE) – oversupplied. Source Wood Mackenzie, Company Data, Morgan Stanley Research estimates
Exhibit 14: Lithium supply-demand balance (kt LCE) – oversupplied. Source: Wood Mackenzie, Company Data, Morgan Stanley Research estimates. (From: Morgan Stanley Research, “Commodities Matter”, 30 June 2024)

Lithium is one of Morgan Stanley’s bear case cohort. For a detailed overview of the broker’s lithium analysis, including key demand and supply factors plus price forecasts – check out this article from earlier in the week.

I’ll just note here that Morgan Stanley is forecasting large and growing supply surpluses in the lithium market until 2027, and then declining surpluses out to 2030.

Written By

Carl Capolingua

Content Editor

Carl has over 30-years investing experience, helping investors navigate several bull and bear markets over this time. He is a well respected markets commentator who specialises in how the global macro impacts Australian and US equities. Carl has a passion for technical analysis and has taught his unique brand of price-action trend following to thousands of Aussie investors.

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