Top large cap mining picks for 2010

With this in mind Macquarie has attempted to assess how important the mining sector is with respect to economic growth in Australia, especially given an expected surge in such investment in the 2010/11 financial year.

As Macquarie points out, mining now represents around one-third of total private sector investment, and while business investment should increase by 17% over the next year the increase in the mining sector should be 33%.

There remains some uncertainty around these plans, especially given the proposed Resource Profit Super Tax （RSPT）, which is causing some miners to reconsider their investment decisions. As well, questions with respect to the global growth outlook have seen some softening in business confidence levels, increasing concerns the rise in investment won't boost growth to levels previously anticipated.

But as Macquarie notes, a large portion of investment plans are either committed or under construction as there are around $110 billion worth of advanced projects in the minerals and energy sector. This is equal to total actual investment in this sector over the past decade.

With advanced minerals projects having an average three-year life span, Macquarie expects a sharp jump in project completions in coming years regardless of any weakening in confidence levels. It also suggests the proposed RSPT will primarily be an issue for projects at the feasibility stage rather than more advanced projects.

Looking at the big picture, Macquarie suggests if there were no changes to investment plans in the rest of the economy but the RSPT meant miners cut capex plans from a 33% increase to a flat result, total capex would only rise by about 5%. This compares to current expectations of an increase of 17%.

Macquarie suggests such an outcome would allow the Reserve Bank of Australia （RBA） to stay on hold with respect to rates in 2011. It wouldn't be enough to see the RBA cut rates, Macquarie arguing there would need be a decline in investment plans in the coming year for that to occur.

On the other side of the coin, Macquarie suggests if investment plans are maintained at current levels the RBA will likely be forced to recommence monetary policy tightening. This would impact negatively on household spending and increase the importance of business investment as a driver of economic growth.

With respect to the coal sector, Macquarie notes last week Chinese policymakers cancelled some VAT export rebates on steel products. This move is expected to put Chinese steel exports under further pressure.

Traditionally, Macquarie notes when China changes export rebates or taxes to deter imports, steel prices adjust to again make exports viable. Any adjustment requires either a fall in Chinese prices or a rise in ex-China prices, with the former the more likely in the broker's view given expectations of a weak third quarter in the Chinese steel market.

With the Chinese also set to resume allowing the renminbi to appreciate against the US dollar, Macquarie sees one impact as being a move up the cost curve for Chinese producers in US dollar terms. The impact if this will be greatest in markets where Chinese producers are the marginal cost suppliers, which includes the iron ore, coal, aluminium, lead and zinc markets.

A stronger renminbi should increase marginal cost price support in these markets according to Macquarie, thus potentially setting new cyclical floors for prices. The point made by Barclays Capital is for the base metals generally, fundamentals remain supportive of higher prices going forward. A reduction in macroeconomic concerns are the likely catalyst for such improvement.

According to Barclays, the best placed base metals to benefit in such an environment are copper and lead as supply performance of the former remains weak and is likely to slow in the second half of the year for the latter.

The weakness in copper supply leads Barclays to suggest there will be a substantial global deficit in the market this year, so the group recommends buying copper on dips towards US$6,000 per tonne. For lead Barclays takes the view China will become a net importer over the second half of this year, to the extent the market shifts to a deficit in the coming six months.

This implies lead inventories will reverse their recent upward trend, setting the stage in Barclays's view for lead to outperform relative to the other base metals.

While commodities have been the worst performing asset class over the first six months of 2010, Deutsche Bank generally agrees with the Barclays view commodity markets are being weighed down by the outlook for the European and Chinese economies and fears of a double-dip recession have weighed on prices.

The recent price weakness is likely to extend into the third quarter in Deutsche's view, especially for the base metals suite, given some overcapacity issues and current high levels of LME stocks. Deutsche notes the crude oil and stainless steel markets are also dealing with overcapacity at present, which should limit shorter-term price performance.

On a more positive note, Deutsche points out physical raw commodity supply remains tight for thermal and metallurgical coal, iron ore, copper and platinum. This reflects a combination of infrastructure constraints, labour and equipment shortages and long project development schedules.

Deutsche Bank expects global economic growth of around 4% in 2011, which should be enough in its view to generate tight commodity market conditions through both 2011 and 2012. this has seen the broker upgrade its commodity price forecasts in both years, which has generated resource sector earnings upgrades of 9% and 30% respectively.

In detail, Deutsche has lifted its aluminium, copper, nickel and zinc forecasts by 9-44% in 2012, having left its FY11 estimates largely unchanged. The broker's gold, silver, oil and uranium price forecasts are largely unchanged in both 2011 and 2012, while coal price forecasts with the exception of thermal coal have been increased by 14-38% for the two years.

In such an environment the broker's top sector picks are coal, gold, copper and the diversifieds. Coal is preferred among the bulks as Deutsche suggests there are stronger supply growth prospects for iron ore when compared to coking coal. This means coal prices could still gain into mid-2011 and even 2012, while iron ore prices are more likely to remain around the US$130 per tonne level in the broker's view.

With respect to stock selection BHP Billiton is Deutsche's top pick, its diversification and better medium to long-term growth profile giving it an advantage over Rio Tinto

In nickel Deutsche prefers Independence Group and Mirabela Nickel, while PanAust is its preferred copper exposure. In gold Deutsche likes Avoca Resources and Newcrest, while Aquarius Platinum is its top pick in the platinum sector.

Taking a contrarian view on aluminium means Alumina is rated as a Buy, while the changes to commodity price and earnings expectations means Deutsche has upgraded Western Areas, Panoramic Resources, Macarthur Coal and Extract Resources to Buys as well.

Mincor and Minara Resources have been upgraded to Hold ratings on valuation grounds, while the only Sells in Deutsche's coverage universe are Paladin and Equinox Minerals.