Given the growing uncertainty over the sustainability of the global economic recovery, base metals are expected to take the brunt of resource stock exposure to commodity price falls this year (base metals include copper, aluminium, lead, nickel and zinc, and exclude gold and silver).

Fuelling this fear are recent efforts by China’s Central Bank to cool the world’s fastest-growing major economy – by moving reserve requirements 50 basis points – and mounting speculation the US economy could enter a double-dip recession by mid-year.

On the flipside, energy stocks are rapidly surfacing as the sweet spot for resource stock investors in 2010.

While myriad variables make it difficult to accurately gauge future commodity prices, it’s generally regarded that base metals (defined above) will feel the pain of future price corrections before bulk commodity stocks where deterioration of markets is less apparent until contracts are renewed. Bulk commodities include gold, silver, gas, oil, coal and iron ore.

This is the underlying sentiment from a commodity review by Wilson HTM completed last week. According to the investment group’s resources business director, Keith Williams, the market is demonstrating a willingness to take major bets on the mining sector benefiting from a global economic recovery.

But when it comes to energy stocks, he says the market refuses to place similar bets until reserves are sufficiently proved up – with the most acute examples currently existing within the coal seam gas (CSG) space. “While it’s currently hard to see anything in base metals that reflects good value, energy stocks are the ones where the greatest value lies as a sub-sector within resources,” says Williams. “A lot of these stocks have significant projects that are waiting to be priced-in.”

Given the sizable upside to their price targets, Wilson HTM has buys on seven of the nine midcap energy stocks that it covers, with Comet Ridge (COI), Bow Energy Ltd (BOW), Molopo Energy Ltd (MPO), and Arrow Energy (AOE) displaying the greatest upside at 188, 97, 67 and 53 percent respectively.

With oil expected to range-trade between US$70 to US$90 this year, David Wall energy analyst with Hartleys says the potential upside from ‘betting on oil’ far outstrips potential downside (of around 10 percent). “Timing your entry before reserves are fully priced-in means you can no longer ‘buy & hold’,” advises Wall. “The trick is to sell two thirds of your holding, before move onto the next opportunity.”

While energy mid-caps and majors could deliver 25 percent and 50 percent upside respectively, he says the ‘blue sky’ from junior explorers, like Otto Energy (OEL), First Australian Resources (FAR), and Sun Resources (SUR) could be 150 percent-plus for investors.

Meantime, while the benchmark London Metals Exchange Index continues to rise, Williams says lingering uncertainty over near-term demand looks to be setting up base metals for an inevitable correction. Given the renewed speculation over ongoing demand, especially following its spectacular (153.2 percent) run-up in 2009, Williams says stocks heavily exposed to copper – a leading indicator of general economic strength – look more at risk to price falls in 2010 due to stockpiles and greater inventories. He says signals of changing market sentiment towards copper stocks can be seen in some share price movements, with Oz Minerals (OZL) and PanAust (PNA) down around 7 percent since late December.

According to RBS Morgans models, there’s no data to support commodity prices at current levels. But while they expect a moderate to minor correction, it’s not expected to arrive until the second half of 2010.

Based on his assumption that commodity prices are being driven more by ‘macroeconomic punts’ on a global recovery than fundamentals, Roger Leaning the stockbroker’s research head views copper as less overvalued than aluminium, nickel and zinc. “Within the current market there are concerns across the board, but the bigger risk isn’t global recovery, but the ongoing sustainability of China’s consumption which relies on the continuation of Beijing’s fiscal and monetary stimulus,” says Leaning.

And while it’s a difficult market in which to gauge prices, he claims that other base metals like aluminium, nickel and zinc look particularly shaky, especially given their short-term over-supply.

While there are pockets of value across the resources food-chain, Leaning says it has become a stockpickers market in which ‘pure plays’, especially explorers have the greatest risk of correcting. “Within this market, investors looking for exposure to resources are encouraged to stick to the big end of town, and that means BHP, Woodside, Oil Search, and Santos,” he says.

Leaning favours bulk commodity stocks, following reports that large price increases are currently being discussed of between 20-30 percent in iron ore and 30-40 percent increases in both thermal and coking coal – on the back of Chinese import demand. He says there’s still upside to be found in both Macarthur Coal (MCC) and Centennial Coal (CYE). “Prices for the next Japanese business year – which sets the tone for the bulk commodities – suggest at least a 20 percent increase for coking coal prices,” advises Leaning.

Meantime, Williams expects Chinese buyers to view any downturn in commodity prices this year as a prime opportunity to pick-off Australian quality assets at discounted prices. “Even though the global recovery may not be as conclusive as initially envisaged, it remains ‘game-on’ for M&A activity,” says Williams. “Iluka Resources (ILU) Whitehaven Coal (WHC) and Citadel Resources (CGG) likely to attract potential acquirers this year”.

Energy stock upside (Midcaps), Wilson HTM

Stock  Price  Upside to share price target
Beach Energy (BPT)  97c  14%
Comet Ridge (COI)  33c  188%
Arrow Energy (AOE)  $4.39  53%
Bow Energy (BOW)  $1.45  97%
Molopo Energy (MPO)  $1.44  67%
AED Oil (AED)  66c  42%
AWE (AWE)  $3.08  1%
Horizon Oil (HZN)  39c  33%
Nexus Energy (NXS)  31c  45%

Please note that TheBull.com.au simply publishes broker recommendations on this page. The publication of these recommendations does not in any way constitute a recommendation on the part of TheBull.com.au. You should seek professional advice before making any investment decisions.

 

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Correction or rally – where next for the US?

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