Hot Money Monday: Here’s Morningstar’s outlook on commodities, and its four favourite stocks

Morningstar casts an eye over current trends in commodity prices and reveals four mining stocks investors could consider in today’s market.

Four stocks are up and running strongly, says Morningstar. Picture: Getty Images

• Commodity prices fluctuated in Q3

• ASX mining companies are financially strong, says Morningstar

• Morningstar’s top picks include Iluka, MinRes, and Whitehaven 

In Q3, we saw some ups and downs in commodity prices. Gold has been on the rise, but most other commodities initially dropped before starting to bounce back.

This recovery was largely due to China stepping in late in the quarter and announcing some market-moving stimulus to support its struggling market. 

Overall, commodity prices are still higher than they’ve been in the past, and there’s solid backing for this trend going forward, says research firm, Morningstar.

First, Morningstar believes that mining companies are in a strong financial position right now.

Most companies are focused on returning value to shareholders through dividends and share buybacks. However, with prices looking good, many are also eager to expand, which has led to more mergers and acquisitions. A notable example is Glencore’s recent purchase of a majority stake in Teck’s coal business.

On the investment front, many miners are ramping up their spending, says Morningstar. Many are positioning themselves for growing demand for copper and nickel, driven by the ongoing transition to cleaner energy. This means more money is going into extending existing mines and exploring new opportunities.

As for shareholder payouts, while there’s been a slight decrease due to these increased investments, returns are still attractive.  And investors in iron ore and coal companies are generally seeing better dividend yields than those in gold.

According to Morningstar, some coal companies, like Whitehaven Coal (ASX:WHC) and New Hope Corp (ASX:NHC) , are still seen as undervalued, possibly because many investors are wary of coal. 

“On the other hand, iron ore miners Mineral Resources (ASX:MIN) and Vale are also among the cheapest and will likely benefit as they increase iron ore sales volumes,” wrote Morningstar.

Outlook for commodities

Morningstar has provided an analysis of the future dynamics of supply and demand for each commodity, outlining how various factors could influence the overall landscape.

IRON ORE

The Chinese housing market is facing serious challenges, which is affecting steel demand.

Home prices are falling, and this puts pressure on property developers who are already deeply in debt. 

Steel production in China has softened dramatically, and China’s steelmakers are facing financial pressures.

Although China's government is trying to help by cutting mortgage rates, and iron ore prices have stabilised recently after recent stimulus announcements, Morningstar says the impact is likely to be limited.

The research firm says this situation has led and will continue to lead to reduced premiums for high-grade iron ore and smaller discounts for lower-grade varieties. 

METALLURGICAL COAL 

As the largest exporter, Australia is set to see increased metallurgical coal output due to improved weather conditions. 

And limited scrap availability and modest coal reserves mean that demand, especially from India, is likely to grow. 

Government policies, such as higher royalties, could restrict supply, which might drive prices higher. 

Additionally, environmental concerns are prompting major miners to limit production, contributing to a restrained supply outlook.

“As many investors lump metallurgical coal in with thermal coal for ESG purposes, major miners are reluctant to increase supply. We forecast only modest supply increases across our coverage,” said Morningstar.

COPPER

Copper prices remain stable, bolstered by hopes for more stimulus in China and strong demand from the US as interest rates stabilise. 

With China consuming over half of the world’s copper, any additional government support could further lift prices, says Morningstar.

However, long-term demand might face challenges as manufacturers seek to use less copper, particularly in electric vehicles. 

Supply issues in key countries like Chile and Peru, coupled with rising production from new mines, could create a balanced market moving forward.

“Even so, as new mines such as Quebrada Blanca 2 and Kamoa-Kakula ramp up, global mined supply is set to grow,” wrote Morningstar.

GOLD

Gold prices have increased as central banks, particularly in the US, begin cutting interest rates. 

Lower real interest rates reduce the opportunity cost of holding gold, making it more attractive to investors.  Geopolitical tensions and fiscal concerns also support higher prices. 

While jewellery demand, especially from China and India, remains strong, central banks are diversifying their reserves to bullion, which could sustain demand. 

“Gold production has recovered from the Covid-19-induced hiccups in 2020 when mining output was restrained or temporarily curtailed. 

“We forecast more modest future mine supply growth across our coverage,” said Morningstar.

NICKEL and LITHIUM

Nickel prices are stable but face oversupply issues, particularly due to increasing lower-grade nickel production from Indonesia. 

This could pressure higher-cost producers in Australia and New Caledonia. Long-term, battery demand is expected to become the main driver for nickel, reducing reliance on stainless steel.

On the other hand, lithium prices have dropped significantly due to oversupply, and are at multi-year lows. 

“We expect lithium prices will rise in 2025 spurred by supply cuts,” said Morningstar.

“Just as record high prices in 2022 incentivised strong supply growth, low prices halted investment by many producers. 

”This will cause global supply growth to slow in 2025, moving the market closer to balance. 

“Over the longer term, lithium prices will recover to the marginal cost of production, which we view as about USD15,000 per metric ton.”

ALUMINIUM and ZINC

Aluminium prices are steady, with China driving most demand and government stimulus providing support. 

There’s a projected increase in demand driven by electric vehicles and renewable energy.  

“In the long term, while demand for use in EVs and renewables should rise, this is likely to be minor for the next decade."

The zinc market, meanwhile, is likely to be in surplus in the near term on increasing supply from existing and new mines following a period of elevated prices, says Morningstar.

“In the long term, while demand for use in EVs and renewables should rise, this is likely to be minor for zinc for the next decade. 

“The zinc market is likely to be in surplus in the near term on increasing supply from existing and new mines following a period of elevated prices,” wrote Morningstar.

THERMAL COAL and MINERAL SANDS

Thermal coal prices have increased slightly but remain below last year’s peaks. 

“Demand for high-quality coal, such as from Whitehaven and New Hope, is likely to remain robust in Southeast Asia. It meets energy needs while reducing emissions versus lower-quality coals, such as those from Indonesia.”

However, supply constraints, influenced by environmental regulations, may keep prices elevated, Morningstar wrote.

For mineral sands, prices have decreased due to muted demand, particularly in the construction sector.

Producers are managing output carefully to maintain market balance.

“Over the longer term, maturing mines and a lack of large, high-grade, undeveloped resources are likely to support mineral sand prices," says Morningstar.

Morningstar’s top picks

Iluka Resources (ASX:ILU)

Concerns are growing about the lack of clarity on government support for Iluka's costly rare earths refinery at Eneabba, especially with reduced demand for mineral sands from slowing global property markets.

“However, we think additional government support is likely given the strategic nature of the refinery, with Iluka's likely increased capital contribution also manageable,” said Morningstar.

The refinery is also an option on higher rare earths prices. 

“And with net cash of around $150 million at end-June 2024, its solid balance sheet means it can ride out what we see as a cyclical downturn.”

Mineral Resources (ASX:MIN)

According to Morningstar, lower iron ore and lithium prices have driven MinRes down to fair value. 

“But we expect earnings to rise as its lower-cost, long-life Onslow iron ore mine ramps and as lithium prices recover. 

“While net debt of $4.4 billion is high, driven by hefty Onslow expenditures, we expect net debt to EBITDA to peak at levels around 4x before rapidly declining to more palatable levels closer to 1x around fiscal 2028. 

“This is assisted by the part sell down of Onslow's road access charge for $1.3 billion in first-half fiscal 2025.

Whitehaven Coal (ASX:WHC)

Whitehaven continues to be penalised for ESG concerns.

But its purchase of two metallurgical coal mines from BHP is a good one, says Morningstar, diversifying its production to roughly half thermal coal and half metallurgical coal. 

“Debt to help finance the purchase is manageable, though returns to shareholders are likely to be constrained until it is repaid," Morningstar said.

Meanwhile, new coal supply is restrained, affected by ESG concerns and opposition from regulators, which could bring longer-term price upside. 

“We think demand for metallurgical coal is likely to be persistent, while demand for high-quality thermal coal is also likely to be strong for at least the next decade, especially from Southeast Asia,” says Morningstar.

Vale (NYSE: VALE)

Brazil's Vale is suffering from increased government oversight since Brazilian President Luiz Inácio Lula da Silva assumed power in 2023, including pressure not to renew the contract of CEO Eduardo Bartolomeo. 

“While this is a risk, it is more than reflected in Vale's share price,” says Morningstar.

Despite its exposure to copper and nickel, Vale remains driven by iron ore.

“We forecast iron ore sales to rise to more than 360 million metric tons midcycle from 2028, up from about 300 mililon in 2023, lowering unit cash costs while modestly increasing average iron ore grades to about 64% from 63%, above the 62% benchmark.”

The views, information, or opinions expressed in this article are solely those of Morningstar and do not represent the views of Stockhead.

Stockhead has not provided, endorsed or otherwise assumed responsibility for any financial product advice contained in this article.

Originally published as Hot Money Monday: Here’s Morningstar’s outlook on commodities, and its four favourite stocks