ICG Commodity Update – April 2020

The ICG Commodity Update is our monthly published comment on energy, industrial metals and precious metals market.

Energy

The drop in oil demand in April was likely the largest in history. However, the beginnings of a gradual reopen of European and US economies suggests that we are past the worst of the demand downturn. There has been a full recovery in road congestion for the work week days across major Chinese cities. Weekly preliminary oil demand estimates from the US confirm an improving demand trend. This trend in improving data is likely to continue going forward as more countries loosen their restrictions. At the same time, global oil supply is expected to contract significantly. First, as operating costs are not being covered for many oil fields, there are forced production shut-ins. At a Brent price of $25/bl, 10mbpd of oil production does not cover operating costs. Low prices have already triggered global production shut-ins worth 3.9mboe/d acc. to WoodMac. Also, OPEC+ have started to cut production. Nevertheless, the supply side has a time gap. Therefore inventories are increasing but going forward this increase may slow. Nevertheless, questions are being raised on how many more days of supply storage there are in the tanks if oversupply continues. Orbital estimates tanks can still accommodate >2 billion barrels worldwide. The global storage is 56% filled. Unlike energy equities, which price for anticipated fundamental changes, energy commodity prices reflect the state of the current market. Some regions are experiencing more oversupply than others. This was obvious in Cushing, Oklahoma, which is the NYMEX clearinghouse for the WTI oil contract. In a perfect storm, the May WTI futures contract fell to minus $37.6/bl on 20.04. Oil prices went negative for the first time on record and garnered substantial media attention. A lot of the storage got contracted during April. This doesn’t necessarily mean that the tanks got full at that time, but they were basically secured. The contango got steeper and steeper because you have to take delivery on the NYMEX exchange and there was no storage available to take the delivery. Some days before expiry of the May contract a lot of people were still long. Indeed, bullish investments in oil ETFs reached a historic high. It’s important to know, that Brent does not deliver into a landlocked, physical delivery point like WTI.

Nevertheless, oil prices at a multi-year low are pushing the rebalancing of the oil market into the most painful phase for producers. A wave of capex guidance updates indicates cuts of >30% for 2020. Capex cuts will reduce enhanced oil production recovery activity and will lead to a rise in decline rates in these fields. Underinvestment in the exploration and development of new oil supply could eventually lead to insufficient supply growth over the coming years. During 1Q reporting season companies are providing sobering forward outlooks. In an example of the strain facing energy companies, Shell cut its dividend for the first time since 1945. Despite this, energy equities outpaced the broad market over April.

Industrial Metals

Commodities ended the month with a mixed performance, even as April 2020 made history as the month that prices for WTI crude futures traded below zero for the first time ever. According to analysts, the bounce in copper prices reflect the earlier re-opening of the economy in China. This is not yet an all-clear, but China as well as Korea and Taiwan appear to be past the worst economic impacts from the COVID-19 pandemic. Looking closer at China, there are some strong recent data points in the metals sector. Analysts agree that China is on a recovery path even with the external shock from the global lockdown, but there is growing evidence that, on the back of old school fiscal measure, the metals intensity of this recovery is strong. While most are cautious that China alone can offset the drop in global demand we are seeing, in each of 2009, 2013, and 2016 Chinas pull on metals markets during a recovery cycle was much stronger than anticipated. Also, while in some cases inventory is still elevated, in steel and cement the market has seen aggressive draws over April, implying construction has recovered strongly as migrant workers returned. Indeed, latest data from Chinese consultancies shows rebar consumption over the last two April weeks the highest ever seen. Meanwhile, aluminum inventory is now back below levels seen in April last year and SHFE copper inventory back to levels into Chinese New Year. Prices remain well below the low end of the 2019 trading range though. Looking ahead, it’s reasonable to expect commodity prices to recoup some of their losses due to coronavirus-related demand destruction once the crisis is behind us. Both the global central bank accommodative policies and government fiscal stimulus may also work to spur economic growth and inflation, both of which can push commodity prices higher.

Looking at Equities, Glencore cut its 2020 capex guidance by about $1-$1.5 billion compared to original forecast and joins in mining industry’s rush to cut spending. The cuts are as a result of some projects deferrals, lower production and falling input costs. Glencore also lowers output goals for metals including zinc and nickel after operations were disrupted. Several mines around the world have been forced to slow or temporarily close as countries wrestle to contain the spread of the virus. Other producers including BHP Group and Rio Tinto have also announced plans to review or lower capital spending, putting the brakes on development projects as they seek to maximize cash and protect balance sheets. There is growing concern that the spread could lead to disruption at key assets that drive profits.

Precious Metals

Gold prices hit fresh record highs twice in April. The expansion of the monetary base by the Fed combined with low interest rates and amplified inflation creates a very constructive environment for gold. The Federal Reserve is in the process of creating an unprecedented amount of new money to deal with the fallout from the epidemic. The Fed has announced several multi-trillion dollar monetary programs designed to provide massive liquidity to markets to prevent the economy from collapsing. The easing of the lockdowns in some parts of the world as well as hopes for treatments dented the rise a bit by the end of the month. Some of the world’s largest hedge funds are raising their bets on gold, forecasting that central banks’ responses to the coronavirus crisis will lead to devaluations of major currencies. They are wagering that moves to loosen monetary policy and even directly finance government spending, intended to limit the economic damage from the virus, will debase fiat currencies and provide a further boost to gold, according to the financial times. New York-based Elliott, which manages about $40bn in assets, even told its investors that gold was one of the most undervalued assets available and that its fair value was multiples of its current price. Looking at platinum, there is currently 73% of world supply disrupted due to the lockdown in South Africa – which is the world’s largest platinum supplier by country. Same goes for Palladium with 38% of supply out of markets.

Looking at gold equities, analysts expect gold miners to profit from the rebalance of the MSCI Standard Index in May as some gold equities will go into several indices which will spur buying. There was also M&A activity in the precious metals space with Silvercorp Metals acquiring Guyana Goldfields. Silvercorp said the acquisition will create a diversified precious metals producer with two profitable underground silver mining operations in China and a gold mining operation in Guyana. Also, a company jointly owned by Barrick Gold and China’s Zijin Mining Group got a reject on its application to extend the lease on the Porgera Gold mine in Papua New Guinea. The special mining lease expired last year and discussions are underway since 2017. The country wants to start negotiations about a transitional period, after which time the state will enter into owning and operating the mine. Barrick and its Chinese partner will pursue all legal avenues to challenge the Government’s decision. Operations are currently suspended.

Dienstleistungen für wohltätige Stiftungen

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ICG Commodity Update – March 2020

The ICG Commodity Update is our monthly published comment on energy, industrial metals and precious metals market.

Energy

This may be the most brutal environment for energy markets in decades. The combination of significant demand destruction and a meaningful increase in oil production is very unusual in the oil world. The former has been caused by the coronavirus pandemic, and later by the upcoming production increase following the collapse of the production deal between OPEC and its allies. Oil prices have tanked as a result and Brent crude oil reached $20/bl (-65% YTD) at the end of the month.

The demand impact is unprecedented in global post-war modern history. In general, this is probably the largest economic shock of our lifetimes, but carbon-based industries like oil sit in the cross-hairs as they have historically served as the cornerstone of social interactions and globalization, the prevention of which are the main defence against the virus. Accordingly, oil has been disproportionately hit, likely more than 2x economic activity according to Goldman Sachs.

Meanwhile, with the collapse of the production cut deal, most OPEC+ nations that have the potential to increase production have signalled they will from April onwards. This will flood an already oversupplied market, pushing the incremental supply into inventories. This resulted in oil prices plunging into the cash cost curve to force production shut-ins at existing oil fields. Data from Wood Mackenzie indicates that with Brent at $25/bl, around 10mboe/d of global oil production does not cover operation costs; this rises to around 22mboe/d if Brent trades at $15/bl.

Nevertheless, there is still hope that low oil prices might force Saudi Arabia, Russia and other producers to the negotiating table including the US. Indeed on Thursday Trump tweeted that 10 to 15 million barrels cuts were possible by Russia and Saudi Arabia pushing the oil prices up 25%. Interestingly, the prospect of the US joining in on any output cut was raised by the Texas Railroad Commission. President Trump is set to meet this Friday with the heads of some of the largest US oil companies to discuss measures to help the industry as it fights for survival. While at the end coming to an agreement remains difficult, signs of policy discussions are surely positive and may result in an urgent meeting of OPEC+ and probably other producers.

Nevertheless, the price collapse is reshaping the oil and gas sector, with the focus having shifted to survival mode. We have reviewed the financial gearing ratios of the industry. If the markets averages $40/bl oil in 2020 operating cash flows would fall by 20% this year according to UBS. Integrated Majors gearing would end about 300bps higher at YE2020 at about an average of 29% net debt/cap. However, smaller players have significant higher leverage ratios. At the end Oil Majors will probably consolidate the best assets in the industry and will shed the worst assets. There will be local consolidation amongst E&Ps, and when the industry emerges from this downturn, there will be fewer companies of higher asset quality. With robust balance sheets, a manageable dividend burden, and leading FCF outlooks we see Oil Majors as best positioned to weather the storm, with less ‘need’ to right size the dividend. Most of our portfolio is invested into those companies and such companies are masters in crisis like this. However, the bruised and battered US shale industry is also poised to emerge from the oil crash as a winner, according to Goldman Sachs. Shale’s high-pressured wells and short drilling time mean the industry is well positioned to benefit if the current plunge in oil causes long-term damage to production capacity, resulting in a price jump when demand returns. Paradoxically, all this will ultimately create an inflationary oil supply shock of historic proportions because so much oil production will be forced to be shut-in. The global economy is a complex physical system with physical frictions, and energy sits near the top of that complexity. It is impossible to shut down that much demand without large and persistent ramifications to supply. The one thing that separates energy from other commodities is that it must be contained within its production infrastructure, which for oil includes pipelines, ships, terminals, storage facilities, refineries, and distribution networks. Therefore as Goldman Sachs is saying, this will likely be a game-changer for the industry. Once you damage the capital stock in oil it is an expensive and time-consuming process to rebuild, assuming it can be rebuilt at all. Therefore in spite of everything, we think that this may become a big opportunity going forward.

Industrial Metals

Broadly diversified commodity indices are down heavily this year with energy, particularly crude oil and oil products, the most, followed distantly by base metals. The negative impact of COVID-19 on economic growth via government policy measures is severely weighing on commodity demand – economic activity is suffering greatly. Analysts expect GDP growth in major economies to contract sharply in 2Q, by up to mid-single digits. A beacon of hope for commodities is China. China’s GDP growth is primed to expand modestly in 2Q, after slumping sharply in 1Q. The slide in demand from developed economies is a headwind. But with China accounting for around 50% of global base metal demand, Chinas expected growth trajectory should provide critical support to the commodity sector. By the end of March, PMIs in China are already back from their lows in February and also back to growth with values over 50. After the lockdown, activity in manufacturing is slowing building up. Already 90% of Chinese manufacturing and construction activities had resumed by end-March. When it comes to base metal inventories, visible inventories have been on the rise across the sector. The good news is that the increase has been in line with seasonal norms during 1Q, with industrial production and fixed-asset investment sliding by double digits in the first two months of the year, the inventory uptrend has been surprisingly benign, except for nickel. According to analysts, overall inventory levels at exchanges remain 10-50% below the 3-year average when adjusted for seasonal swings. Looking at iron ore, Marine Traffic shows that Australia’s Big 4 surprisingly shipped 76Mt in March 2020, which is on an annualized basis a 27% month-over-month and a 36% year-over-year rise. The Pilbara iron ore operations and shipments are largely tracking to the guidance that was provided prior to the COVID-19 outbreak. Some analysts see iron ore as their most preferred commodity exposure, however, other markets could tighten up more quickly than expected, with such a large share of supply out because of the strict corona measures. A number of major commodity producing countries including Peru and South Africa have announced restrictions that will result in temporary closures of mines and smelters to prevent the spread of the virus, more curtailments may yet be imposed. The majority of announced closures are for 2-3 weeks, but it is possible that restrictions are extended and that some marginal operations may stay closed until commodity prices improve. The duration and therefore the total amount of lost supply in 2020 is unclear at this stage. The most impacted base metals are zinc and copper. Supply disruptions for iron ore and nickel are limited at this stage. It is worth noting the iron ore market in particular is highly concentrated leaving it vulnerable if supply is disrupted in Australia or Brazil.

Precious Metals

Even though gold is in high demand, the metal closed the month with a modest performance of only +1%. New rounds of rate cuts and quantitative easing measures by central banks around the world speak for higher precious metal prices in the months ahead. But with investors scrambling for liquidity to cover losses in leveraged equity and bond positions, the gold price was under pressure until recently. Thanks to the Fed’s aggressive monetary stimulus, gold has already rebounded faster than back during the global financial crisis. Back in late 2008, gold weakened as well on liquidity needs over two months, followed by a firm recovery thereafter. With central banks rolling out all their tools to cushion the economic fallout, real interest rate expectations should move back into negative territory as inflation expectations, which have dived sharply of late, begin to normalize which is bullish development for gold. Holdings in gold-backed exchange-traded funds jumped to a new record as investors seek haven assets during the global coronavirus pandemic. Concerns about the physical supply of bullion roiled markets by the end of the month as logistical disruptions led to speculation there wouldn’t be enough metal in New York to deliver against contracts traded on Comex. Those fears have abated as investors rolled forward their positions, with inventory now more than able to cover the volume of gold eligible for delivery. Still, investors are piling into ETFs as supply of physical gold in the form of coins and bars become tighter going forward. Investors already have to pay up to lay their hands on small gold bars and coins – well above the per ounce prices being quoted on financial markets. As demand exploded, there has been pressure on supply, as global travel shuts down and some refineries and mints have stopped operating or capped production because of local lockdowns – South Africa for instance closed all its mines for at least 21 days from mid-March. On the company side, it is no surprise that a wave of government-enforced lockdowns, and heavy social distancing measures shutting down operations. So far there have been very few cases of infection on mine sites but measures have gone far beyond than just limiting non-essential people on site and travel. Some corporates have reduced people and production rates, or taken pre-emptive measures to suspend operations to protect local communities. The latest round of mine outages is a result of harder government and corporate prevention measures. Impacts range from complete cessation of activities like Argentina, South Africa and New Zealand to virtually no impact in the Pilbara iron ore operations other than precautionary measures.

ICG Systematic Equity Fund CH Update – März 2020

Das ICG Systematic Equity Fund CH Update ist ein monatlich erscheinender Kommentar über den Schweizer Markt und zum Fonds

• Ausverkauf an den weltweiten Aktienmärkten geht auch im März weiter – in historisch einmaliger Geschwindigkeit wird aus einem Bullenmarkt ein Bärenmarkt. Rekordhohe Konjunkturprogramme bremsen Abstutz gegen Monatsende
• Extremer Gleichlauf unter den Investoren zeigt sich auch auf Sektoren- und Stilebene: Zyklische Small- und Mid-Caps leiden unter dem schwindenden Risikoappetit am meisten, grosskapitalisierte Qualitätsaktien mit hoher Outperformance
• Oversold-Konstellationen an den Aktienbörsen bleiben angesichts eines anhaltend grossen Negativismus unter den Marktteilnehmern bestehen – unterstützt von einem förderlichen geld- und fiskalpolitischen Umfeld bleibt die Aktienquote bei 100%
• Auf Stilebene zeigen ICG’s Modelle  eine Präferenz für günstig bewertete Aktien mit tiefer Volatilität und starkem Preistrend von Firmen mit stetiger Cash-Flow-Entwicklung
• Zukauf von defensiven Sektoren “Gesundheit” und “Nahrungsmittel” während des Rebounds Ende März – Industriegüteraktien bleiben wegen ihres Bewertungsdiskonts übergewichtet
• Hoher Anteil von Small- und Mid-Caps (gegen 50%) sowie Gleichgewichtung der Einzelpositionen führt im März zu Underperformance gegenüber dem SPI – SMIM und SPIEX büssen im Berichtsmonat mit -12.43% resp. -11.53% rund 8% auf den SMI ein

Letter to our Investors

Friday 13. March 2020

Dear Investor

We are writing to give you an update on our investment solutions and on commodities more generally. Many of us may asked themselves how to behave in stressful times like these and how they should set up their portfolio for crisis mode – we sure did the same.

On a week like this, where panic selling overrides rational considerations like fundamentals or profitability, the best strategy is often to remain calm and ride out the swings until markets stabilize. If history is any indication, severe dislocations actually offer rare opportunities. Even “Champion” companies with a long outstanding track record are sharply down and such companies are masters in crisis like this.

We have reviewed the financial gearing ratios of our universe. In general terms, natural resource companies appear to have learnt from the 2008/09 Great Financial Crisis (GFC). During that time emergency asset sales, restructures and equity raisings had to be undertaken, which exacerbated the downside for many share prices. This time financial leverage is a lot more modest. Nevertheless, we have run a bearish commodity price scenario based on the 2008/09 and 2015/16 cycles.

For energy markets there is little historic precedent to oil markets experiencing both a demand and supply shock simultaneously. However, the impact of the GFC in 2008/09 and impact from breakdown of OPEC agreement during 2014-16 may be suitable extremes to consider. These would suggest a scenario of oil prices visiting $30/bl or lower and averaging 2020 in the mid-$40s. Most oil companies calculated 2020 budgets on $50-55/bl oil at the beginning of the year. However, if the markets averages $40/bl oil in 2020 operating cash flows would fall by 18-20% this year according to UBS. Integrated Majors gearing would end about 300bps higher at YE2020 at about an average of 29% net debt/cap. However, smaller players have significant higher leverage ratios. The oil universe has an avg. net debt/cap of +70%. Therefore some players will disappear, but some will consolidate and become much stronger.

The Energy Champions Fund has currently a net debt/equity of 33%, P/B of 0.7x, P/CF of 2.4x, FCF yield 2020E of 12.7% and a dividend yield of 7.6%

For miners balance sheets are stronger vs 2015 and they are generally better positioned for a period of low prices. Total net debt of the industrial miners declined by 50% between YE2015 and YE19. The UBS spot commodity price scenario still implies a FCF yield of 10%, dividend yield of +10% and an EV/EBITDA 4x. A worst case scenario (commodity prices fall again 25%) would still result in a 5% FCF yield, dividend yield of 3% and an EV/EBITDA of 8x. This is because prices of copper, aluminium, iron ore and other resources have sold off recently, but have fared better than oil and equities, incl. the share prices of the miners who dig them up. Some analysts say the more muted response from metals should ultimately be seen as positive for other markets, given their price moves are often closely aligned with economic fundamentals.

The Industrial Metals Champions Fund has currently a net debt/equity of 23%, P/B of 1.4x, P/CF of 3.6x, FCF yield 2020E of 12.2% and a dividend yield of 8.1%

The Precious Metals Champions Fund has currently a net debt/equity of 11%, P/B of 1.8x, P/CF of 6.3x, FCF yield 2020E of 8.5% and a dividend yield of 2.1%

What is important to remember, is that the natural resource industry has dealt with sharp price declines several times in recent decades. Big oil and big mining companies have invested through those cycles. And we are convinced that most of them can and will defend its dividend through this period of cyclical weakness.

Macro data and commodity demand is likely to get worse before it gets better and it is too early to tell if we will see a ‘V’, ‘U’, ‘W’ or ‘L’ shaped recovery, but we believe monetary and fiscal stimulus will drive a recovery in commodity demand/ prices in the next 6 to 12 months and see significant value in natural resource companies.

For those of you that have been following us over the years, you may remember that our main commodity fund the Gateway Natural Resources Fund lost 60% on the 2008/09 GFC, but did +90% in 2009, and +150% by 2011.

Finally, this crash is frustrating for us because we had high hopes for commodities this year. Commodities were emerging from the slowdown of the previous few years and beginning to adjust to real fundamentals.

Last but not least, remember that commodities may be unloved, but they are needed.

We are open to further discussions and may send you further information on request.

We wish you all the best and good health!

Dietrich Joos                                                                            Pablo Gonzalez                                                                     Cyrill Joos