Rising rates, tax loss selling fuel disconnect between share and commodity prices

Barry FitzGerald

Independent Journalist

The sell-off in nickel stocks like Centaurus, despite the metal price holding up, seen as an opportunity for longer-term investors. This is ditto for lithium shares.

A disconnect has opened up between metal prices and equity values as a result of the savage reset of equity markets to sharply lower levels.

The fear around what impact the inflation-fighting moves in the major economies will have on economic growth and metals demand is fair enough.

But the reality in the here and now is that commodity prices, particularly the metals needed for global decarbonisation, have been holding up well in comparison to the broad-brush dumping of equities.

And why wouldn’t metals being holding up? Decarbonisation is the biggest investment (and environmental) thematic of our times.

It continues to gather pace, with any protracted economic slowdown from rising interest rates only serving to delay the supply response needed to meet the metals required to electrify everything in coming decades.

It means that unlike the tech sector where buying on a 200 times revenue basis has rightly been abandoned, the miners producing hard asset commodities are likely to see a return of buying support to reconnect mining equities to underlying metal prices, particularly once this year’s elevated tax-loss selling is out of the way.

There were signs of all that emerging in Thursday’s market.

It seems those with an investment horizon extending beyond tomorrow are moving to take advantage of the confluence of events ( the broad equities sell-off, tax loss selling and the relative outperformance of metal prices) to begin nibbling at mining stocks at their cratered levels.

Centaurus Metals (ASX: CTM):

Nickel stock Centaurus (ASX: CTM) – and all the other nickel stocks - is an example of everything above. It rose 3.2% to 96.5c on Thursday for a market cap of $410m.

Its latest quote compares with $1.52 back in mid-April. Anyone would think the nickel price has tanked, which it hasn’t.

Sure the price is nowhere near the crazy levels of March when an almighty short squeeze involving China’s Tsingshan played out on the LME.

But the price is now settling into a groove that reflects the normalisation of trade in the key battery metal.

The overnight price on Thursday was $US11.60/lb. That is 38% higher than last (calendar) year’s average of $US8.40/lb, and 85 % higher than the 2020 average of $US6.26/lb.

Like most of its fellow nickel developers, Centaurus used a long-term price of $US7.50/lb in last year’s scoping study into the development of its Jaguar nickel sulphate project in Brazil’s Carajas region.

Jaguar is being advanced as a 20,000 tonne-a-year (44 million pounds) nickel sulphate producer, which obviously gives it extreme leverage to the nickel price.

Centaurus managing director Darren “Flash” Gordon gave a feel for just how extreme at the recent Resources Rising Stars conference on the Gold Coast before hopping on a plane for the long haul to this week’s PDAC conference in Toronto.

“Using $US11/lb (roughly the current price and up from $US7.50/lb with a US50c/lb sulphate premium used in the scoping study) you start to see the impact of that with NPV post-tax going out to $A2.5 billion (from $A1.1bn in the scoping study) and IRR of over 100% (52%),” Gordon said.

“That generates about $A500 million in EBITDA a year on that basis. You can run your own nickel price through these things and see what it looks like. But at that (EBITDA) level, that’s our current market cap (more, actually)."

“So is that the right valuation? I will leave that for you to decide.”

Given the turn upwards in the stock in Thursday’s market, it is clear that investors decided that the sell-off in the stock has been overdone, and it was time for some nibbling.

Centaurus is newsflow-rich in coming months. A resource update is expected in the third quarter and will be followed by the release of a feasibility study in the fourth quarter/early 2023.

Those two events lead into a final investment decision in the third quarter of 2023, subject to environmental clearance. First production will be possible in late 2024/25.

On the nickel price from here, it should be noted that some of the big-name investment banks reckon that the steep rise in battery grade material coming out of Indonesia’s energy intensive laterite projects stands as a challenge.

But that assessment does not come with an ESG qualifier. The Indonesian operations can spew out as much as 200 tonnes of carbon emissions to produce 1 tonne of metal. Battery makers in China can buy that if they want, and they will.

But European and US battery makers – and the end-user car makers – want their material much lower down the emissions scale to appease their ESG-mandated investors.

It is the sulphide operations that can do just that, with Jaguar expected to generate less than 5t of emissions per tonne.

Greater ESG considerations around where nickel comes from could well lead to bifurcation of the nickel market where low emissions nickel begins to command big premiums over the Indonesian stuff. At this stage, none of that has been priced into stock valuations. But it is coming.

Lithium in focus

Talking about big-name banks stirring markets with their at-times off-beam assessments, there is no greater example of that recently than Goldman Sachs’ call that lithium prices were about to tank.

The call that the lithium market would “pivot towards a prolonged phase of surplus starting this year” triggered a massive sell-off in lithium equities which then had to contend with the broader market sell-off in response to inflation/rising interest rates.

Talk about copping a double whammy. But again on a half-full view of things, there is good reason to think that the sell-off in the lithium stocks has been overdone. And like in the nickel stocks, there were signs of that in Thursday’s market.

Pilbara (ASX: PLS) put on 4% to $2.13 (its 52-week high was $3.89), Allkem (ASX: AKE) gained 1.5% to $10.28 (52-week high was $14.38), Liontown (ASX: LTR) rose 4% to $1.05 (52-week high was $2.19), and Core (ASX: CXO) put on 5.2% to $1.21 (52-week high was $1.67).

The Goldman call looks to have had more to do with supporting valuations of European and US car makers (i.e.cheaper lithium for their switch to EVs) rather than an outright attack on lithium prices. But the damage was done.

The good news though is that its underlying assumptions and assessments have been demolished by industry experts in the space, remembering that lithium prices play to a different set of rules because we’re talking about a speciality chemical more than a commodity that trades on terminal markets like the LME.

Leading industry expert Benchmark Mineral Intelligence (BMI) was one of those to take on Goldman, saying the call on a budding surplus was wrong.

“The lithium market will balance over the next few years, but it’s unlikely that an unprecedented ramp-up of marginal, unconventional feedstock will fill the deficit. It is also unlikely that demand will weaken significantly,” BMI said.

“It will be a touch-and-go market balance. But there will not be the structural oversupply that Goldman Sachs is predicting.”

Mind you, BMI did note that a “correction in the lofty spot market prices seen in China is likely”.

“However, the spot market price in China does not represent the true price of lithium in the market, and is often not the true price being paid by western battery majors,” BMI said.

It could have added it is also not the price received by the lithium producers for the bulk of their production, if not all in most cases.

“In these markets we expect to see a gradual ramp up in contract deals being settled with increasingly flexible, and more frequent, pricing mechanisms,” BMI said.

That’s another way of saying the producers are in line to receive more for their product as higher spot prices converge with lower contract prices.

“As the market wrestles between long-term supply security to fuel the lithium ion economy, and increasingly market-led pricing mechanisms to incentivise supply growth, the era of lithium market volatility is likely just beginning.” BMI said.

Let the nibbling begin.

5 stocks mentioned

Barry FitzGerald
Independent Journalist

One of Australia’s leading business journalists, Barry FitzGerald, highlights the issues, opportunities and challenges for small and mid-cap resources stocks, and most recently penned his column for The Australian newspaper.

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