Near-term risks for commodities are increasing, the Swiss bank said, with the US Federal Reserve turning more hawkish and China taking action to deflate commodities such as selling strategic base metal reserves.
Expecting these factors to accelerate the unwinding of the ‘reflation trade’, the Swiss bank downgraded the Anglo-Aussie mining giant to ‘sell’ from ‘neutral’ in a note to clients on Monday.
Rio’s share price is now estimated by the bank’s analysts to discount an iron ore price of $80-90 per tonne versus UBS’s long-term price forecast of $65 per tonne.
While the FTSE 100 company generates significant cash flow and shareholder returns are expected to stay elevated in 2021, in the analysts’ view current free cash flow and dividends “are not sustainable as we expect the iron ore price to fall by more than 50% (from above US$200/t to around $90) over 12-18 months”.
At a more ‘normalised’ iron ore price, the analysts said they do not believe RIO’s valuation is “compelling”.
Giving more detail, they added: “We believe iron ore is approaching an inflection point as: (1) China is taking action to deflate commodity prices (incl steel); in our opinion, the exceptionally high steel price is the key reason why iron ore price is close to all-time highs; steel demand is also set to moderate in 2H with China tightening credit (note).”
Furthermore, Brazilian iron ore supply is lifting with shipments from Vale up 14% so far this year and Chinese iron ore port inventory now higher than the last two years.
In the medium-term, the UBS team sees three major headwinds that will drive iron ore prices back to the cost curve nearer $65/t: around 160mln tonnes of latent capacity to be added by the mining majors over three years and another 30Mt from juniors; China’s aims to lift steel scrap supply from circa 220Mt to 300Mt by 2025, this displacing around 90Mt of iron ore demand; the Simandou iron ore project in Guinea, which could add roughly 200Mt from 2025-30.