It’s not often my personal macro outlook aligns with the folks at Goldman Sachs… but this time we appear to be singing from a similar hymn sheet.
In a note to clients today – the former Masters of the Universe are slashing their outlook for both commodity prices and by proxy – Australian miners.
Let’s take a look…
Metals & AUD Outlook
Let’s start with their forecast on mining commodity price forecasts (including the Aussie Dollar):
Over the next 2+ years – Goldies sees the Aussie Dollar hanging around the 74-75c mark.
I think it’s optimistic…
For example, I find this interesting especially when you look at the forecast for iron ore.
With respect to our largest export – they see the price falling from $67 (today) to $47 to $45 to $40 over the next three years.
An iron ore price of just $40 is not what folks like BHP, FMG and RIO have in mind.
And whilst I am sure they will tighten their (already tight) belts — a price of $40 will also leave our budget in a state of disrepair (or are we are that point already)?
Now we know the Aussie is a commodity based currency…
And in the past – where iron ore goes – so too does the little battler. So why would they think the Aussie dollar is likely to remain elevated as commodity prices drop?
Interest rate rises maybe?
Now if we look to our second largest export – coal (all forms) – they also see softer prices ahead. Again, one would assume this would impact the dollar.
Gold, Silver & Oil
We touched on the outlook for gold and silver only yesterday.
Goldies see these metals as pretty much “status quo” over the next 3 years – with silver getting a little bump from today’s price of below $16 to $21.
That flies in the face of the tape…
However, gold appears anchored between $1,200 and $1,250.
My view is this will be very much a function of what we see with the US dollar (and inflation).
The same weak outlook could be said for oil – not rising much above $50 (which sounds about right if the tape is any indication).
From mine, WTI looks range bound between $40 (on bad days) and $60 on a good day.
Question I have is how much longer will OPEC tolerate prices below $60/bbl?
Not long I imagine… as they can’t afford an oil price below US$80/bbl (largely opposite social reasons).
My view is the game of “chicken oil” between the Saudis and their North American competitors is probably hurting the Middle East more… supply cuts coming!?
Miners Outlook Equally Dim
With such bearish (dare I say realistic) outlook for metals and commodities – it’s not surprising to see Goldies ratchet down earnings forecasts (and share prices) for our leading miners:
Take Australia’s largest diversified miner – BHP.
This year they are forecasting earnings per share of 139.7 – down from previous forecasts of 149.6.
But let’s fast forward…
Next year they see earnings falling to just 136.6 and then for FY2019 — all the way down to 111.8.
Again, this is largely reflective of the iron ore price plummeting to lows of $40.
And if we look at FMG – as a pure-play on iron ore – their EPS forecast is set to plummet from 84c per share this year to just below 19c in 2019.
Assuming an aggressive PE of 12x for FMG – and you are talking a price of ~$2.40
Interestingly, they see gold miner Newcrest improving their earnings from today’s 61.2c per share to 96.5c in two years time – with a price target of $24.00 (from today’s price of below $20.00).
If you think about it – with a softer Aussie dollar (and assuming the gold price can stay above US$1,200) — that’s a solid profit equation for quality Australian gold miners (quality being the key word)
Fed and Rates…
In a separate note (from May), Goldies expressed some skepticism on the ability for the Fed to continue raising short-term rates.
Their main argument was opposite lower than expected inflation.
For instance, their chief economist Jan Hatzius has become distinctly less confident — citing inflation which has been undershooting the Fed’s 2% official target for most of this economic recovery. I quote:
- “The risk to our near-term funds rate view is now slightly greater, largely because the range of plausible outcomes has widened,”
- “We have shaved our subjective odds of a June rate hike to 80%, from 90% earlier, and have also become a bit less confident in a September hike,” Hatzius added.
- “If the outlook deteriorates significantly, the committee might simply delay any further tightening steps. And even a more modest deterioration could prompt the committee to pull forward the announcement of balance sheet runoff to the September meeting and delay the third 2017 rate hike until December.”
Well the June rate hike of 25 basis points has come and gone (they got that wrong)… however we will see what happens with September.
Again, much will depend on oil prices.
By way of example, last month I shared this chart: 5-Year Forward Inflation Expectations v’s Crude Oil:
The two datasets enjoy a very close relationship; ie lower oil will typically implies lower inflation.
PIMCO shared an equally cautious tone on the ability for the Fed to hike too aggressively:
- “The noticeable softening in inflation increases the pressure on Federal Reserve policymakers to explain their presumed plan to hike interest rates in June,” according to Tiffany Wilding, senior Vice President and US economist at the bond fund.
- “While still-easy financial conditions and a 4.4% unemployment rate could help the Fed craft a coherent story for June, continued weak inflation could complicate further hikes later this year.”
Again, it all comes back to inflation.
My (simplistic) view: keep your eye on oil as to the probabilities around any further hikes.
For example, if WTI Crude continues to remain below $50/bbl (which appears likely based on the tape) — it’s doubtful inflation will meet the Fed’s target – forcing them to hold.
Metals and Mining Index (XMM)
Before we close – I thought it would be interesting to check in with our Metals and Mining Index (XMM). This index represents the top 300 miners listed in our Index.
First the weekly chart…
2016 was a great year for our miners… rallying from extreme lows of 1630 to highs of around 3230 in January; ie gains were in the realm of 97%.
Obviously it’s impossible to time the exact bottom and top.
Using our method of moving averages – we would have joined the rebound around 2300; ie when the weekly moving averages signalled the knife had stopped falling in March of 2016.
And we would still be long this trade – with a trailing stop now set at 2700 (just below the last major low).
If we look up close – the XMM is now grinding through a new distribution in 2017. Let me illustrate:
From here, I think the XMM will grind in a sideways pattern until there is a catalyst for it to break either way (eg positive or negative data / stimulus out of China)
Shifting our lens to the monthly view – it paints a different picture.
Using this lens – the trends are far less “whippy”.
We see the long-term shift lower in December 2011 – with the price only recovering in January of this year.
For now the trend is bullish in the monthly lens – as prices gravitate towards the 10-month EMA.
Obviously GS see this trend reversing course over the course of this year and next – so we will see.
Putting it All Together…
Fundamentally I agree with GS’ sombre outlook for commodities and miners.
However, “90%” of the time trading purely on fundamentals has proven me wrong.
What I have learned is not to argue with the price action.
Price is truth. The rest is guesswork.
In this case, GS has a long-term bias to the downside however the tape is yet to agree. That’s not to say it won’t – but at this stage it’s premature.
Let’s continue to see if what they forecast materialises.
… trade the tape
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