Brokers are underwhelmed by the jump in the nickel price, which has risen 23% since recent lows in June and is sitting at around a one-year high of US$6.54/lb. Momentum is expected to slow and prices moderate.
Citi points out that standing in the way of this rally too early would have been costly. Nickel has moved from discount to over a 10% premium to marginal producer costs, a level which far exceeds the economic rationale of even a moderate 2019 deficit in the metal.
UBS, too, does not believe the move has any fundamental backing, although nickel remains one of the broker’s favoured commodities on a three-year view. Nickel is expected to US$8/lb in 2020, driven by a step-change in demand from electric vehicles, but the broker emphasises that demand from this source is not yet making a big impact.
Meanwhile, the stainless steel outlook, which drives two thirds of nickel demand, is mixed. In China, production of stainless steel is at record highs and so too is Chinese-backed Indonesian production. However, UBS points out, this appears to be displacing stainless steel production elsewhere. Stainless steel production in the rest of the world, which tends to procure higher grade nickel feed, is contracting.
Furthermore, China/Indonesian stainless steel appears well supplied by low-grade nickel units, which by itself is bearish for both the metal demand and the London Metal Exchange nickel price, UBS points out.
Last week, the Indonesian Ministry of Energy and Mineral Resources confirmed a ban on nickel ore exports from 2022. Citi struggles to believe that this is the sole cause of the rally as some are suggesting, as one statement is unlikely to convince the market that such a ban is set in stone two years hence.
Moreover, as learned in 2014, Chinese nickel pig iron output is unlikely to completely collapse if this were the case. At most it would temporary slow, but not derail, the pace of growth. As the cheapest and quickest nickel supply response, the broker suspects the ban is likely to merely relocate production to Indonesia.
Canaccord Genuity acknowledges new Indonesian supply will influence the outlook for the price over 2019 as Tsingshan, Delong and Jinchuan ramp up. The broker believes the lift in in nickel prices is reflecting recent supply disruptions from flooding in Indonesia, which provides 25% of global supply, combined with low stockpiles on the LME.
Yet, trade signals are mixed. Cancelled warrants, which can show whether consumers are resorting to the LME for physical nickel, are around 50,000 tpa and quite neutral, UBS highlights.
Another fundamental aspect that is not underpinning the price surge is the trend decline in inventory. UBS does not believe this is low enough to induce anxiety about oversupply. The steady decline does signal, nevertheless, the market has a small ongoing deficit, which is bullish for nickel and will matter in the next 1-2 years.
Furthermore, if electric vehicle demand suddenly stepped up, UBS would expect the nickel sulphate premium to lift. Instead it has contracted. Canaccord Genuity expects recent changes to Chinese electric vehicle policy are likely to reduce the assumed premium for sulphate.
As nickel is increasingly directed to growth segments, the broker likes those producers that have long life, low-cost sulphide projects and can drive value from exploiting downstream refining strategies.
This includes Independence Group ((IGO)), with its added exposure to gold, which remains the top pick over Western Areas ((WSA)). Canaccord Genuity notes CleanTeq ((CLQ)), a Class 1 developer, is likely to sell down up to 50% of its Sunrise project, aligning with a final investment decision by the December quarter of 2019.
Macquarie believes Western Areas has the most significant leverage to a rally in base metals. Nickel is currently trading 13% above the brokers first quarter FY20 estimates. Under a spot price scenario there is 38% and 59% upside, respectively, to the broker’s operating earnings forecasts versus its base case for Western Areas and Panoramic Resources ((PAN)).
So, what is the cause of the rally? There just appears to be a speculative shift in buying nickel, Citi asserts and, if the fundamentals do not warrant a further price spike, then this might provide an attractive opportunity for volume sellers.
Both the Shanghai and London exchanges have experienced a lift in open interest and financial buying. Financial operators have sought 90,000t of nickel on the LME since mid June, which UBS agrees is a large shift in sentiment and may not be maintained in the short term if not backed by fundamentals.
Citi believes volumes and reduced tightness in LME spreads will be the best indicators the rally is turning. The broker recommends the LMESelect 3M for tracking the cleanest real-time subset of LME activity. Slowing volumes will signal that buying is fading, whereas high volumes and limited price moves would signal active resistance.
The broker is also of the view that tight LME spreads have not been shared by the Shanghai exchange. Given the more volatile Shanghai positions Citi is looking for fresh open interest falling as traders bank profits.