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The bulk metals of iron ore and coal have had plenty of support this year and gold has rallied as investors seek safe-haven assets. Now base metals are getting overdue attention.
My preference is nickel and I outlined a bullish view on Western Areas (WSA), a specialist nickel producer, in July for The Switzer Report. The stock is up slightly since that report and some good judges believe it and other base metals stock will go higher this year.
To recap, the nickel price had been in the doldrums for much of this decade. Nickel peaked above US$28,000 a tonne in early 2011 during the commodities boom. By early 2016 nickel traded below US$8,000 as demand eased and supply of lower-quality nickel grew.
LME nickel historical price graph – long term
Source: London Metal Exchange
Nickel bulls for years have protested the metal is undervalued. Supply reached a multi-year low this year because of underinvestment in new production and signs of a slowing global economy. Nickel is used in stainless steel, so is sensitive to Chinese demand.
The bulls are finally taking charge. Nickel prices have rallied to a 16-month high and are testing important price resistance on the nickel chart. If the price convincingly breaks through its 2018 high, the rally could go a lot further, using technical analysis.
Nickel has several tailwinds. Indonesia, a key nickel exporter, has reiterated its could bring back its nickel ore ban earlier than expected – a move that would reshape nickel’s global supply/demand and balance, and potentially support a higher nickel price.
A lower-than-expected Australian dollar, thanks to recent interest rate cuts and expectations that more will follow, is another positive. A lower Australian dollar relative to the US dollar, in which most commodities are priced, is good for the Australian-dollar nickel price and our exporters generally.
LME nickel historical price graph – short term
Source: London Metal Exchange
Less considered in nickel’s rally is rising demand for it from producers of electric vehicle (EV) batteries. The big hope for nickel is the EV revolution and soaring demand for batteries in the next five years.
Early EVs used lithium-ion batteries made of lithium iron phosphate and lithium manganese oxide. There was no nickel. A lower battery life meant a reduced driving range for EVs and a reason for people not to buy them.
Second-generation lithium-ion batteries use nickel manganese and cobalt, creating higher energy densities and thus a longer driving range. Overseas research shows nickel is quickly gaining a higher share of EV batteries relative to other metals.
China this year lifted the minimum EV range needed to quality for its subsidies, supporting demand for longer-range EV batteries that use nickel. China is the world’s largest EV battery manufacturer, accounting for about half of global EV sales.
The EV boom is in its infancy. In 2016 just under one million vehicles (or 1 per cent of global auto sales) were plug-in EVs, notes JP Morgan. That will rise to 8.4 million by 2025.
By 2040 about 30 per cent of the global passenger fleet will be electric, forecasts Bloomberg. If that is even half correct, demand for EV batteries and nickel in them will rise sharply.
Of course, looking too far ahead with commodity demand or being seduced by megatrends is dangerous. Nobody knows how the supply side of nickel will respond as higher nickel prices inevitably encourage producers to expand production to meet demand.
More telling is BHP this year deciding to retain its Western Australian nickel business, when the market had earlier expected it to divest the operation. The mining giant clearly sees a bright medium-term outlook for nickel, presumably for its leverage to the coming EV boom.
Smaller nickel producers have also reported new supply agreements with Chinese companies. The potential is for our miners to negotiate offtake agreements at more favourable terms as offshore buyers, cognisant of low nickel stockpiles, look to lock in supply.
What matters now is whether stockbroking analysts start to factor higher nickel forecasts into their modelling, and boost earnings forecasts and nickel company valuations.
One of this market’s best judges of resources stocks, Macquarie Group, this week said the “continued strength in nickel prices has resulted in significant upside risk to our earnings forecasts for Independence Group, Western Areas and Panoramic Resources”.
Were Macquarie to use the nickel spot price in FY20 forecasts - spot nickel prices are 31% above its forecasts - those stocks would have earnings upgrades of 100% or more. Oz Minerals and Sandfire Resources would have 25% or more at higher nickel prices.
Care is needed with talk of sharply higher nickel prices being used in valuations. Nickel is a relatively smaller commodity market and its price can be volatile. Indonesia accounts for about quarter of global nickel output and can make sudden changes in policies around resource bans. Nobody knows for sure if it will follow through will full implementation of an ore ban.
Moreover, China is by far the world’s largest consumer of nickel. Given this potential volatility, analysts are right to use nickel prices below the spot price in their valuation models.
EV battery demand for nickel, while potentially significant over the coming decade, is a small part of overall nickel use. Most nickel is still used for stainless steel.
Caveats aside, I have seen instances over the years where analysts used commodity price forecasts that were far too low and it took too long to lift them. When they did rise, the miner’s forecast earnings and thus its implied valuation, leapt – that’s “upside earnings risk” in action.
The context for nickel’s gains this year is particularly interesting. The global economy is slowing amid the United States-China trade dispute and there is US$15 trillion in sovereign bonds with negative yield, which some see as a signal of potential economic distress. That should be a poor backdrop for nickel and other commodities, yet the price is rising.
As Macquarie noted, the mood at the recent Kalgoorlie Diggers and Dealers forum for base metals producers and explorers was largely subdued. That suggests to me that the market is too bearish on nickel and it could surprise on the upside.
As to stocks, Western Areas is my preference, as outlined previously in this report.
Chart 3: Western Areas (WSA:ASX) chart
Independence Group (IGO) has had a good run this year after beating production forecasts at its and still looks interesting. It has the Nova nickel/copper project and owns 30% of the impressive Tropicana joint venture on the edge of the Great Western Desert. Both operations are capable of beating production forecasts in FY20.
If you like the prospects for gold this year, as I do, Independence appeals. The stock is not cheap: Macquarie’s target price of $5.90 compares to the current $5.59. But it could go higher as gold and nickel continue to rise and the Australian dollar edges lower, which I expect.
Chart 4: Independence Group (IGO:ASX) chart
Speculators could also consider the small base metals stocks Panoramic Resources (PAN:ASX) or Metals X (MLX:ASX). I have not done enough work on either recently to form a view and will consider them in coming weeks.