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Weekly market update - 24th of June 2019

Written and accurate as at: Jun 24, 2019 Current Stats & Facts

The local market edged up +1.5% last week, with macro themes being the main driver. The gold price increased 4.5%, a significant uplift for the safe haven asset, which in turn helped gold miners such as Northern Star (NST, +10.9%).

The oil price, which had been drifting off gradually since late April, also saw some early signs of recovery. The Brent Crude price advanced 5.4% to trade at US$65/bbl: while US production continues to do well, global supply could become tight again should OPEC decide to extend existing production cuts when they reconvene in early July. In addition, the reignited tension between Iran and the US remains as a wildcard factor.

Long-term bond prices also rallied through the week: the US 10-year bond yield dropped from 2.09% to 2.00% over the period, before paring some of the decline and finishing the week at 2.06%. The latest round of central bank meetings, with the Fed signalling their readiness for interest rate cuts, and the ECB prepared to reintroduce monetary easing, saw cash investors make a quick exit of the term-deposit market to load up on bonds. Domestically, we also saw the Aussie 10-year yield drop to an unprecedented 1.28%. Although a lower bond rate helps underpin the Australian equity market, we are at this interesting juncture where many investors remain sceptical of whether interest rate cuts from the RBA are sufficient to turn the tide for the weakening domestic economy from here. This in turn has been dragging sentiment on domestic cyclicals. We believe some of this negativity is overstated, and continue to hold conviction in the likes of Nine Entertainment (NEC, -0.3%), JB Hi-Fi (JBH, -2.4%) and Qantas (QAN, -3.4%).

Elsewhere, Brazilian iron ore producer Vale announced that the operation at its Brucutu mine will resume within days, bringing ~20 million tonnes pa of global iron ore supply back online. Nevertheless, the commodity continues to trade at an elevated price level of US$109.5/mt. When combined with a weak Australian dollar, which remains sub US 70 cents, this is translating to very strong free cash flow generation from the Australian iron ore miners. In that vein, both BHP (+1.8%) and Fortescue (FMG, +0.8%) have outperformed the index strongly month-to-date (by +4.6%/+6.1% respectively), even though their performance was somewhat subdued last week. On the other hand, the other major iron ore miner Rio Tinto (RIO, -3.6%) underperformed: RIO downgraded its Pilbara production guidance last week by ~10mt due to some “mine operational challenges” at its Greater Brockman complex. This is going to negatively impact on the grade of the miner’s Pilbara blend, and its subsequent price realisation. Overall, we still see scope for the iron ore miners to deliver to the upside. At a price level of US$110-120/mt for the iron ore, even a period as short as six weeks could see these miners generate a massive amount of additional free cash flow from here.

Beyond the macro drivers, we also saw some weakness from the Industrial names over the week. Caltex (CTX, -10.5%) was sold off after it guided to a profit downgrade for 1H19. While the challenging trading conditions for CTX had previously prepared the market for this, investors were surprised by its magnitude. Some of the unknowns have come from the negative near-term impact from Lytton refinery outage being realised now; whereas the rest was ascribed to the lag in higher oil prices flowing through to the pump, creating a drag on its retail fuel margin. While the downgrade was disappointing, the ~5% earnings hit for FY20 seems disproportionate to the negative stock price reaction last week. Nevertheless, this dampened sentiment has spilled over to CTX’s peer Viva (VEA, - 10.2%), which is set to provide the market with its own update soon.

Also weighing on the market, market darling A2 Milk (A2M) was down -5.8% over the week as investors became wary about A2M’s inventory building, which coincided with the announcement by China's State Administration for Market Regulation (SAMR) to strengthen supervision of e-commerce activities between now and November. The recent initiative taken by the Chinese National Development and Reform Commission to encourage more infant formula to be produced domestically is also seen as an additional barrier for A2M to continue expanding its China presence. Mining services company Monadelphous(MND, -5.4%) also pulled back as management set a cautious tone in regard to new orders. 

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