Why you should remain positive on commodities and Australian mining: Goldman Sachs

Given that the prices for crude oil, metals, grains and other internationally traded commodities have been climbing at the fastest rate since 1995, it’s easy to see why investors might have the jitters over investing in this space.

But despite near-term uncertainties on global growth and inflationary opex and capex pressures, Goldman Sachs outlines five key reasons why the broker remains positive on both commodities and the Australian mining sector.

Under-investment & supply side disruptions

For starters, the broker remains adamant the current low level of mining sector investment – the lowest in over two decades - remains the primary positive driver for commodity prices over the medium to long run.

A preoccupation by major diversified miners with maximising free cash flow (FCF) and shareholder returns, plus capex inflation and ongoing labour availability challenges are contributing to under-investment in production growth.

Supply side disruptions also remain prevalent across key commodities such as aluminium and zinc, coal, iron ore, and copper, while inventory levels remain at historically low levels.

Growth by acquisition not so easy

With fewer truly transformational M&A opportunities available to the major global bulk and base metal miners, Goldmans sees greater difficult for big miners to buy then grow production: Net effect is ongoing supply tightness.

Second half recovery

While Goldmans economists have cut global, US and China growth forecasts, the broker expects Chinese commodities demand to improve in the second half.

Due to government stimulus and higher infrastructure and property policy easing, the broker remains more bullish on base metals than bulks & lithium over the next 3-6 months.

Decarbonisation & green capex

Heightened investment in decarbonisation/green capex is expected to contribute to long run (2026-plus) theoretical market deficits for copper, aluminium, zinc, nickel, rare earths, lithium, and high-grade iron ore and ferrous scrap.

Valuation play & strong FCF

March quarter results suggest cost inflation is partly eroding high commodity prices.

As a case in point, sector costs are expected to increase 20%-plus year-on-year (YoY) in 2022 on labour, energy, chemicals, steel & equipment prices, and potentially by a further 10%-20% in 2023.

But that said, Goldman’s expects higher commodity prices to offset a larger part of the cost inflation - with sector margins well above historical averages.

As a result, the broker’s Australian mining sector 2023 earnings per share (EPS) estimates would be 20%-plus higher at spot commodity prices & FX.

Key stock calls

Within Goldman’s 17 mining & steel stocks under coverage, the broker continues to favour companies trading below or around net asset value (NAV) and with strong free FCF and balance sheets – notably BHP (ASX: BHP), Rio Tinto (ASX: RIO), South32 (ASX: S32),Coronado Global Resources (ASX: CRN), Whitehaven Coal (ASX: WHC) and BlueScope Steel (ASX:BSL).

The broker also favours stocks with high production and earnings growth, including Iluka (ASX: ILU),Oz Minerals (ASX: OZL) and Mineral Resources (ASX: MIN).

By comparison, due to relative valuation, Goldman’s remains Sell rated on Fortescue Metals (ASX: FMG) and New Hope Corp (ASX: NHC).

Alumina downgraded to Sell

Due to a near-term margin squeeze on higher costs and lower alumina prices, Alumina (ASX: AWC) has been downgraded to Sell from Neutral, with the target price cut to $1.60 from $1.86.

Goldman’s has decreased 2022, 2023, 2024 EPS forecasts by -34%, -21%, and -8% on higher costs at the San Ciprian alumina refinery in Spain on assumed sustained high spot gas prices.

The broker is also expecting higher power costs at the Portland aluminium smelter in Australia following a spike to wholesale power prices, and lower alumina prices reflecting a well-supplied seaborne market.

Alumina share price over 12 months.