Tuesday 03 February 2015 by Lincoln Tragardh Week in review

From the Trading Desk

This week: RBA cuts official cash rate 25bps to 2.25%; inflation figures lead to heavy trading in inflation linked bonds; USD action continues; two new USD DirectBonds from Kinross Gold Corporation; Fortescue and Newcrest production reports; and updated SilverChef research.

Economic wrap

Last week markets digested the recently announced European Quantitative Easing (QE) program and the possibility of a Greek default. Australian inflation data (CPI) was also released, sparking speculation and a variety of opinions on the direction of the RBA’s February rate decision. All uncertainty was removed when the RBA announced it was cutting the official cash rate by 25bps to 2.25%. (For details on the statement and market reaction, see the “RBA cuts – Bonds rally hard” article in today’s WIRE).

In the Eurozone, developments in Greece have put a dampener on the QE program. With Syriza’s victory in the Greek election, heightened political uncertainty has investors concerned that the new government may default on its financial obligations. This has impacted Greek government bonds, with their 10 year bond breaking above a 10% yield. Markets will be paying close attention to Greece as the situation plays out in coming weeks.

Domestically, last week was dominated by the release of CPI data for the last quarter of 2014. Consumer prices rose by 1.7% year-on-year, which was just below expectations. However the trimmed mean, which excludes volatile items, met expectations at 2.2% year-on-year. The RBA, when setting the cash rate, looks at the trimmed mean figure and targets a range of 2-3%. Speculation around CPI and how the RBA would interpret it led to heavy trading in the inflation linked space, with the majority of trades being in Sydney Airport and MPC (Melbourne Convention Centre) inflation linked securities. (For more details on the inflation figure and the impact on investment portfolios see the Hedge against inflation now while it’s cheap article in today’s WIRE).

The Australian dollar fell against the US, starting the week at around 78.80 US cents and closing at around 77.60 US cents. However, it was volatile, in line with varying views on an imminent rate cut. Following the trimmed mean CPI figure, investors firmed in their view that the RBA would leave rates on hold, triggering a mid-week rally with our dollar briefly tipping over 80 US cents. However, by the end of the week, the market derived probability of a rate cut had increased, helped by speculation from News Limited columnist Terry McCrann, and the AUD fell with it. Following yesterday’s rate cut, the AUD plummeted to 76.50 US cents, a five and a half year low.

The bond rally picked up pace, with yields down across the board, first in anticipation of the RBA meeting and then confirmation of a rate cut. Government bond yields were down 10 basis points for both the five and ten year bonds last week. The market then reacted aggressively to the RBA decision. Following the rate cut, yields fell 15-20 basis points across the curve. Five and ten year Government bond yields were at all-time lows of 1.85% and 2.25% respectively. The bond market is clearly expecting more rate cuts and a period of low interest rates in Australia for many years ahead. Good news for fixed rate (and inflation linked) bonds but not so good for floating rate notes.


Once again USD bonds dominated weekly trading activity as investors continued to expect the USD would strengthen.

FMG Resources (Fortescue or FMG), Newcrest Mining (NCM) and Virgin were most active, particularly the former two on the back of positive production reports (see below for further detail).

Indicative offer prices/yield to maturity (YTM) for the most common USD bonds (all fixed rate) are detailed below:

  • FMG 17 – $99.50
  • FMG 19 – $91.75 (but this has been volatile with prices as high as $93.25 just before Australia Day)
  • NCM 21 – 4.21%
  • NCM 22 – 4.52% (in 20bps from a week ago and the most heavily traded of the Newcrest bonds)
  • NCM 41 – 6.01%
  • Virgin 19 – 104.25

Note: Foreign currency bonds are only available to wholesale investors

In the AUD space, Qantas remains active. With recent articles predicting a return to profit of circa $1bn, both the equities and bonds have continued to rally. Of the three Qantas bonds available, the 2022s have been the most heavily traded with the offer yield in 47bps since the start of the year (from 5.97% to 5.50%). In early/mid-January we saw a lot of sellers across the Qantas curve, switching into the Virgin USD bond. However, we have since turned net buyers despite the reduction in outright yields. The three Qantas bonds are currently offered at the following indicative YTM:

  • Qan 20 – 5.33% (retail and wholesale investors)
  • Qan 21 – 5.42% (wholesale investors only)
  • Qan 22 – 5.50% (wholesale investors only)

As reported above, there were also good volumes in Sydney Airport and MPC (Melbourne Convention Centre) inflation linked bonds following the CPI release last Wednesday.

New USD DirectBonds – Kinross Gold Corporation 5.125% (1 September 2021 maturity) and 5.95% (15 March 2024 maturity) senior unsecured bonds

Yesterday we added the following two Kinross Gold Corporation senior unsecured USD bonds to the DirectBonds list:

  • Kinross Gold Corporation 5.125% senior unsecured bond (1 September 2021 maturity), indicatively offered at a yield to maturity of 4.35%
  • Kinross Gold Corporation 5.95% senior unsecured bond (15 March 2024 maturity), indicatively offered at a yield to maturity of 5.55%

Both bonds are available to wholesale investors only in minimum face value parcel sizes of USD10,000.

We note the 2024s are yielding just over 1.0% higher than the similarly rated Newcrest Mining 2022 USD bond.

Kinross is projecting a net debt to EBITDA ratio of 1.2x for FY15 which is at the lower end of its peer group. In comparison, Newcrest’s FY14 net debt to EBITDA ratio was more than double that at 2.6x.

Offsetting this are the higher geopolitical risks surrounding Kinross’s operations in Russia and West Africa, noting the Russian operations are in far Eastern Russia and well away from Ukraine. To date there seems to have been minimal impact from the geopolitical tensions in that region.

Further details on these bonds are available for wholesale clients only please see the factsheets by clicking here, 1 September 2021 maturity or 15 March 2024 maturity (login required).

Fortescue quarterly production update – by Alen Golubovic

Fortescue recently released its quarterly production report for the December 2014 quarter (2Q15). The 2Q15 results have been relatively positive for Fortescue in what is a challenging market for iron ore. Fortescue’s direct costs fell by 11% in the December quarter to US$28.48/wet metric tonne (wmt). After allowing for other costs (shipping, royalties, overheads), it achieved a total delivered cost of US$41/wmt against a realised iron ore price of US$63/dry metric tonne (dmt). While cost reductions have not kept pace with the sharp falls in iron ore prices, Fortescue was still able to generate positive margins and is targeting a further 15% reduction in total delivered costs to US$35/wmt. We expect that its margins will narrow further in 2H15 if the average iron ore index price remains at or around US$65/t.

While Fortescue’s ability to reduce costs has been impressive (albeit aided by the currency and oil price), its key risk remains a sustained fall in iron ore prices. The key mitigants to iron ore price risk are:

  1. The company has the option to sell assets to generate additional cash if required, with its mine, port and rail assets valued at approximately US$18bn.
  2. Fortescue has no further scheduled debt repayments until the 2017 bonds mature.

S&P has affirmed Fortescue’s credit rating based on its revised average iron ore index price assumption of US$65/t over 2015/16. However, S&P noted that there would be pressure to downgrade Fortescue’s rating if average prices fell below this level. The iron price index is currently at US$62.45/dmt.

Newcrest quarterly production update - by Alen Golubovic

Newcrest released its December 2014 (2Q15) quarterly production report last week, reporting a 2.7% rise in gold production in 2Q15 versus 1Q15. Full year production guidance was increased by 4%-5% (2.3-2.5m ounces versus 2.2-2.4m ounces previously). The Cadia and Telfer mines exceeded production expectations, with the Cadia East production ramp up occurring faster than expected. Total all-in sustaining costs (AISC) were 3.1% higher than the previous quarter in US dollar terms. However, AISC margins remained relatively healthy in the December quarter at US$377/ounce sold.

Overall, Newcrest’s quarterly performance reflects mixed performance across its mines. Cadia and Telfer, which represent about half of the company’s gold production, have achieved production levels which have exceeded expectations. However, ongoing issues at Lihir and the high production costs at Hidden Valley continue to be a drag on the company’s overall performance.

SilverChef Limited Research Update – by Will Arnold

We have updated the full research report on SiverChef Limited. Click here to view.

The SilverChef Limited 8.5% fixed rate bonds are indicatively offered at a yield of 3.48% to first call in September this year or 6.36% to maturity in September 2018.

All prices and yields are a guide only and subject to market availability. FIIG does not make a market in these securities. For more information, please call your FIIG representative.


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