ICG Commodity Update – May 2024

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

Energy

Over the past month, oil prices have reflected diminishing geopolitical risks as attention shifted to weakening fundamentals. Concerns about slow demand growth in China alongside rising oil inventories in developed countries, have pressured prices. Consequently, OPEC+ decided on Sunday to extend the 3.66mboe/d cuts by a year until the end of 2025 and to prolong the voluntary 2.2mboe/d cuts by three months until the end of September 2024. Starting in October 2024, OPEC+ will phase out the voluntary 2.2mboe/d cuts gradually over the following year, contingent on market conditions, with the possibility of halting or reversing the increases if market fundamentals deteriorate. Goldman Sachs viewed the decision as bearish due to a recent rise in inventories, while UBS and RBC remained confident that the alliance will continue to manage the market effectively. Morgan Stanley suggested that a seasonal demand upswing might push the market into a renewed deficit over the summer. Many analysts had predicted that OPEC+ would face challenges setting targets for 2025 due to unresolved individual capacity targets for each member, a previous source of tension. However, OPEC+ postponed the capacity discussions until November 2025. Instead, the group agreed to a new output target for the UAE, allowing it to gradually increase production by 0.3mboe/d, up from the current 2.9mboe/d. OPEC+ decided to use independently assessed capacity figures as a guideline for 2026 production, thus delaying a potentially contentious discussion by a year. M&A activity in 2024 is expected to remain high and could surpass the 2023 level of $258bn, according to Rystad Energy. Barron’s magazine noted that a series of M&A deals resemble the reassembly of Standard Oil, which was broken up by the Supreme Court in 1911. Standard Oil of New Jersey became Exxon, which merged with Mobil in 1999, and Exxon has recently merged with Pioneer Natural Resources. Chevron is attempting to merge with Hess, and last week, ConocoPhillips announced its merger with Marathon Oil for $23bn. Additionally, Saudi Aramco’s $12bn share sale sold out shortly after the deal opened on Sunday, with the government receiving demand for all shares within a few hours. These developments indicate a resurgence of investor interest in the energy sector.

Industrial Metals

The global copper market is gripped by fears of a shortage, propelling prices to record levels and sparking a $49 billion takeover battle between BHP and Rio Tinto. However, the battle is over for now, as BHP walked away, cheering investors eager for proof that the miner will not pursue deals at any cost. BHP was forced to abandon its audacious takeover plan to create a global copper giant after Anglo American rebuffed repeated approaches from the world’s biggest miner during a five-week saga. A successful conclusion to the $49 billion all-share attempt would have been the industry’s biggest deal in more than a decade. Nevertheless, BHP’s Australian shareholders saw good news in the failure. Meanwhile, copper smelters in China had pledged to reduce capacity after their fees collapsed due to a supply squeeze on the imports of ore they use as feedstock. The prospect of insufficient copper in China was one of the pillars supporting a rally that took the metal above $11,000 a ton for the first time in May. However, the cuts haven’t happened, and China’s faltering economy isn’t able to absorb the excess, with prices retreating to just above $10,000 a ton. Although that’s still an 18% gain for the year, it suggests that as long as China remains oversupplied, copper will struggle to make further headway. Despite the price pullback, copper mining equities have been resilient. A trend to watch for industrial metals investors is the power consumption growth in China, expected to grow 6% year-over-year in 2024 and with a CAGR of 5% from 2023-2030. Additionally, China’s grid capital expenditure is expected to grow 5-10% year-over-year in 2024. Industrial metals such as copper, zinc, and iron ore tend to move in tandem with electricity production. This trend could eventually replace the demand from the struggling Chinese real estate sector. Power demand worldwide is in general a critical factor for metals demand. AI is an overarching theme in the market today, and power is potentially the bottleneck. According to Goldman Sachs, driven by data centers, AI, and the electrification of everything, Europe’s power demand could grow by over 40% in the next ten years. Combining the increasing demand for additional electricity generation with the adoption of renewable energy technologies—both of which are highly metals-intensive—creates a strong long-term fundamental case for industrial metals.

Precious Metals

Gold had another positive month closing above $2’300 an ounce. Data last week showed a slowdown in the Fed’s preferred measure of underlying inflation. Traders are looking for more confirmation from US policymakers on the rate trajectory, with the focus turning to the next Fed meeting that starts June 11. Fed officials may keep borrowing costs elevated for longer until there is more clarity on whether price pressures are making a sustained move toward the central bank’s 2% target. UBS strategists in a note recently raised their forecasts for gold to $2,600 by year-end. The bank’s bullish outlook is owed to stronger Chinese demand, on top of a series of soft U.S. data in April, which has driven some repricing of expectations for U.S. Federal Reserve rate cuts. Goldman joins UBS in raising price forecasts and expects gold at $2’700 an ounce by year end, mainly driven by solid demand from emerging market central banks and Asian households. For equities, there is an improved optimism on operating cost inflation control which is supporting the interest in equities as investors are looking for leverage to gold – according to analysts, the market sees a bias towards the low risk, large, liquid companies. Looking at silver, the metal had a good run as of late and is currently trading over $30 an ounce. According to the Silver Institute, the market is headed for its 4th year of deficit, driven by record use of silver in industrial applications, which set a new high in 2023 at 654.4 million ounces. Ongoing structural gains from green economy applications underpinned these advances. Higher than expected photovoltaic capacity additions and faster adoption of new-generation solar cells raised global electrical and electronics demand by a substantial 20%. At the same time, other green-related applications, including power grid construction and automotive electrification, also contributed to the gains. This year is expected to be a solid year for total silver demand, which is forecast to grow by 2%. Industrial fabrication should post another all-time high, rising by 9%, propelled by an anticipated 20% gain in the PV market and healthy offtake from other industrial segments. Nevertheless, compared to the historical average gold to silver ratio of 61x, the metal has still some catch up to do, as the ratio is currently standing at almost 77x.

ICG Commodity Update – April 2024

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

Energy

Despite heightened tensions in the Middle East, oil prices have seen only modest reactions. Brent crude reached a peak of $92/bl on April 12th but has since retreated to $84/bl, similar to levels seen at the beginning of the month. Historical patterns suggest that geopolitical risk premiums tend to dissipate without actual supply disruptions. Additionally, there is ample spare capacity held predominantly by a few key countries (like Saudi Arabia and the UAE) that could offset significant supply disruptions if they were to occur. On the demand side, the outlook has brightened with diminished recession concerns, though forecasts vary widely. Nonetheless, OPEC has not fully implemented its latest production cutbacks. According to a Bloomberg survey, Iraq and the UAE continue to exceed their agreed limits by several hundred thousand barrels per day. Although overall production, particularly in the U.S., is at record levels, the efficiency of oil recovery per foot drilled in the Permian Basin has declined by 15% from 2020 to 2023, matching levels seen a decade ago, as reported by Enverus. This drop is attributed to decreased fracking efficiency. However, recent innovations in oilfield technologies, increasingly adopted last year, promise faster, more cost-effective, and higher-yielding fracking operations. Analysts expect the adoption of new technologies, particularly simultaneous fracking, to accelerate. Despite declining productivity and a limited rig count, advancements in well length and fracking techniques are driving record oil production in the U.S. Notably, the ongoing earnings season underscores key trends, including capital return discipline, modest growth expectations for U.S. shale liquids, and cautious spending outlooks. Interestingly, TotalEnergies is considering a U.S. listing, potentially joining U.S. equity indexes. This move aligns with the fact that U.S. funds already constitute 47% of its shareholder base and are increasing their holdings compared to European investors, likely influenced by ESG and political considerations. Similar plans are rumored for Shell. However, the domicils are not up for debate. Overall, sector sentiment towards energy is improving, and this positive trend is expected to continue.

Industrial Metals

In April, the US announced new restrictions on trading in Russian aluminum, copper and nickel. The rules, which restrict the use of metals on global exchanges and in over-the counter derivatives trading, will apply to Russian metals produced on or after April 13. Metals produced before that date are exempt. The US is also banning Russian imports of all three metals. Analysts see this move as more symbolic, given its only for new material and expect the actual impact to be relatively limited. Nevertheless, it is also expected that this move might translate in premiums for aluminum and copper – given momentum in general prices currently, this might add more fuel to the rally. Looking at China, steel and iron ore futures have risen as the government vowed more action to tackle the real estate sector woes that have stifled construction activity and hampered commodities demand more recently. The central government said it would study steps to digest a huge glut of empty homes, while some major cities announced their own measures to support the steel-intensive property sector. One of the major developments in the commodity equity markets last month was BHP’s $39 billion bid for Anglo American. The proposed combination, which has been rejected by the smaller rival, would create the world’s largest copper producer, with about 10% of supply, and add heft to BHP’s already significant iron ore and coal operations. It would also require Anglo to divest South African subsidiaries. That’s more than enough to trigger intense oversight by regulators concerned about implications for market concentration and access to key minerals. According to analysts, Riot Tinto and Glencore are waiting on the sidelines to either make a bid or for opportunities to buy parts of Anglo American’s business. The biggest producers all want to increase copper output to take advantage of rising demand in electric vehicles, grid infrastructure and data centers. Production from existing mines is set to fall sharply in the coming years, and miners would need to spend more than $150 billion between 2025 and 2032 to fulfill the industry’s supply needs, according to CRU Group. Projects that are shovel-ready and in quality jurisdictions are at a record low as there was a dramatic under-investment in mining and development in the last decade – with rising costs and more complexity to get all the permits ready, analysts think that currently, its cheaper to buy projects that are almost completely built than to find and develop themselves.

Precious Metals

Gold has gained about 12% this year despite uncertainty over when the US central bank will reduce rates. The metal made a record-breaking rally that saw it hit a succession of all-time highs in April, with those gains linked to strong central-bank purchases, demand from Asian markets and haven buying. Central bank buying hit a Q1 record of 290t. China marked a 17th consecutive monthly increase while the Reserve Bank of India already exceeded last year’s annual net purchases. The World Gold Council was keen to highlight Industrial demand for gold which jumped 10% y/y to 79t. The AI boom is taking centre stage in discussion, for gold, this involves high-end communication chips. In past gold bull markets, gold equities typically showed 2-5x leverage. Currently, gold equities are rebounding from significant lows compared to gold and broader markets, still distant from their peaks. Analysts observe a phase of margin expansion, affirmed by recent annual and quarterly reports. While all-in sustaining costs rose by approximately 10% annually in 2021/2022, they remained steady in 2023 and are predicted to decrease in 2024. Early indications from Q1 2024 reports suggest controlled costs, with major players like Newmont surpassing expectations through effective cost management. Many miners are seeing expanding margins, maintaining a healthy AISC margin around USD 730/oz in 2023, expected to continue growing. This trend underscores miners’ capital allocation discipline, evident in robust dividend policies and selective M&A endeavors. Unlike the previous cycle, there’s scant evidence of overspending, with CAPEX forecasts suggesting restrained expenditure ahead. Limited availability of Tier 1 gold projects fuels the importance of M&A for maintaining or expanding production levels. Investing in precious metals equities offers the advantage of gaining beta exposure to increasing gold and silver prices. This operational leverage, realized as miners expand margins, leads to significant outperformance compared to physical gold during market rallies – a trend which has yet to materialized. Most analysts see the upside potential for precious metals equities, or mining equities in general, as substantial. The strong performance of Newmont is particularly significant to generate greater interest in the industry overall.

Summary: Gold Forum Europe 2024

We participated in Denver Gold Group’s “Gold Forum Europe” held during April in Zurich, Switzerland. We’re delighted to share with you the key insights gathered from the conference.

The Conference Summary offers an in-depth analysis of the prevailing factors influencing the global gold markets. Furthermore, we took advantage of the opportunity to engage with several companies and have spotlighted significant developments.

Highlights

• Compared to last year, this year’s Gold Forum Europe saw a significant increase in attendance, giving us the opportunity to connect with numerous portfolio companies. This surge isn’t surprising given the continual rise in gold prices, reaching new all-time highs.
• The cost pressure stemming from tight supply chains has eased and is no longer a significant concern. Companies are now in a phase where cost are largely flat and coming down in the near term leading to companies’ margins expanding – a sweet spot.
• Many companies have expressed frustration over the perceived undervaluation of their reserves and resources, as well as their growth profiles by analysts. This suggests that they believe there is a considerable amount of hidden value in their stocks.
• Smaller companies face survival challenges, highlighting the importance of size and diversification. To thrive, companies should focus on achieving economies of scale, enhancing productivity, and improving visibility and liquidity to attract new shareholders.
• Analysts highlight that equities could catch up due to improved quarterly results in the future. This could prompt analysts to revise their estimates and lead to inflows from ETFs.

Find out more in the PDF

ICG Commodity Update – March 2024

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

Energy

WTI crude oil futures stand at $85/bl, with Brent nearing $90/bl, marking their highest levels since October 2023. This surge in prices is driven by various factors, including OPEC+ production cuts, robust demand, and increased geopolitical tensions. The ongoing conflict in the Middle East has prompted significant rerouting of global shipping routes around Africa to ensure the safety of crews and cargo. Hedge funds have displayed growing bullishness towards crude oil in recent weeks, with net-long positions in Brent reaching their highest point in nearly 13 months. Near-term prices are commanding strong premiums over future contracts, indicating a willingness among traders to pay a premium for immediate delivery of barrels. This recent rally in crude prices follows an upward revision in consumption forecasts by the IEA. That was before Chinese manufacturing data lately showed signs of an economic recovery. Despite these positive indicators, the IEA still anticipates a peak in oil demand by 2030. Interestingly, the long-term outlooks provided by the IEA and OPEC diverge significantly. OPEC’s World Oil Outlook forecasts record-high global oil demand of 116mboe/d in 2045. Despite these projections, OPEC+ is expected to maintain its current output policy at an upcoming review meeting this week. Additionally, Mexico’s state-controlled oil company, Pemex, plans to reduce crude exports in the coming months. In the US, crude production has contracted by 760kboe/d due to the effects of the Winter freeze, surpassing initial estimates. Americas oil production development is important as it covers most of the growth in global demand in 2024. In summary, the oil market appears tighter than initially forecast at the beginning of the year, with analysts predicting a deficit through the end of the year. The oil and gas industry has witnessed a surge in dealmaking activity with $84bn in M&A transactions, driven by economies of scale and valuation premiums for large-cap companies. Despite challenges, the industry is actively seeking to attract “general” investors and regain its prominence in the broader market. While the energy sector’s weight in the S&P has declined in recent years to 3.7%, projections suggest a potential rebound. At least on earnings power it is expected that it will comprise over 6% of S&P earnings in 2024 and 2025, according to Jefferies.

Industrial Metals

Weakness in the Chinese economy has been a pressure point for commodities this year, but the turning of China’s PMI from showing contraction to showing growth in March is seen as a signal for stronger commodity demand – Copper rallied back above $9’000/t as investors weighed the upbeat factory data from China and the potential for output cuts by the country’s leading smelters. Investors are becoming more optimistic about the world’s second-largest economy after the official manufacturing purchasing managers index in March registered the highest reading in a year. While there is a relatively long list of reasons to be long miners, one of the keys is global industrial production. The recovery in global manufacturing PMIs that started in January is critical according to analysts. Further improvement would strongly indicate that there is a real trend higher, which should ultimately be followed by an acceleration in global demand growth for metals. The US economy continues to defy prior bearish expectations, and a soft landing or ‘no landing’ scenario is now the consensus view. Analysts had been concerned about the impact of weakening demand in the US – a stronger than expected US economy is therefore a clear positive. There are several topics which act as a demand pull for industrial metals, most notably the energy transition and more recently the demand in data centers. Copper is an important metal in power-intensive data centers as the electrification of data centers will require a significant increase in grid capacity. Add to this the need for more electric power capacity for EVs and the shift to more renewable power (which requires more copper per MW than fossil fuel power), and we have new end markets for copper. According to most analysts, the copper market is entering an extended period of deficits sooner than previously anticipated – the consensus on the incentive price for new supply is around $11’000/t, representing an increase of over 20% from current levels. Mining stocks ride the wave of rising commodity prices thanks to their built-in leverage. This leverage becomes especially apparent during cyclical upturns, making equities a more attractive option than futures. Yet, it’s important to recognize that mining companies can face various challenges, like operational issues, geopolitical risks, and rising costs. Given these risks, we recommend a diversified portfolio strategy, encompassing both commodity and geographic diversification, as the most prudent approach.

Precious Metals

Gold set a fresh record after geopolitical risks bolstered its appeal as a haven asset – despite these new nominal highs, gold remains approximately 50% below its inflation-adjusted price peak in 1980. Interestingly, analysts point out that US investors have largely stayed out of this rally as you can see with the outstanding shares for the GLD, the largest physical gold ETF in the world, as the ETF has seen consistent outflows. A Bank of America survey revealed that a majority of advisors hold less than 1% of their portfolios in gold. The gold market finds itself grappling with a perplexing trend. Despite the price of gold reaching unprecedented highs, holdings in ETFs backed by physical metal have steadily declined for nearly two years. Bloomberg suggests that this decline may not necessarily indicate mass selling, but rather a shift from ETFs to more cost-effective, off-exchange vaults. Data from Bloomberg indicates that total known ETF gold holdings have decreased by 25 million troy ounces since early 2022, equivalent to approximately $54 billion in today’s market value. This trend raises a double mystery. Firstly, it defies the typical correlation between ETF flows and gold prices. Secondly, such significant outflows would normally exert substantial downward pressure on prices, implying that entities beyond the ETFs themselves are purchasing even more gold. A cursory examination of official vault holdings supports this notion. According to the London Bullion Market Association, only around 13.8 million ounces of gold have departed London storage since the beginning of 2022, a significant portion of which represents storage for ETF gold. While this data provides only a partial perspective, as not all vaults disclose their holdings, it suggests a scenario where gold exiting ETFs, which levy management fees, is being reallocated to private custodians. Moreover, the expenses associated with private gold storage in a regulated facility likely undercut those of ETFs, making it an attractive alternative. On the company side, Alamos Gold is buying Argonaut Gold in a deal valued at $325 million – a move that is expected to create one of Canada’s largest and most cost-effective gold mines. Alamos has garnered recognition for its adept timing of acquisitions within the market. The company is quantifying long-term synergies of over $500 million.

Summary: Swiss Mining Institute’s “Mining Investment Conference”

We participated in Swiss Mining Institute’s “Mining Investment Conference” held during March in Zurich, Switzerland. We’re delighted to share with you the key insights gathered from the conference.

The Conference Summary offers an in-depth analysis of the prevailing factors influencing the global metals and mining markets. Furthermore, we took advantage of the opportunity to engage with several companies and have spotlighted significant developments.

Highlights

• At the conference, there was an evident sense of optimism as gold finally broke out of the range it had been confined since the early part of the decade, soaring to a record $2’200/oz this month
• Strategic moves by foreign central banks, particularly China, to diversify reserves into gold highlight a broader trend
• Gold equities have decoupled from historically high gold prices and are trading at a record discount
• Industrial metals, notably copper, anticipate significant price surges driven by demand dynamics and limited new discoveries, underscoring the critical role of mining in meeting evolving global infrastructure needs
• Participants expect the mining industry to consolidate

Find out more in the PDF

Summary: Scotiabank’s 52nd Annual Energy & Power Conference

We participated in Scotiabank’s 52nd annual Energy & Power Conference held at the end of February in Miami, Florida. We’re delighted to share with you the key insights gathered from the conference.

The Conference Summary offers an in-depth analysis of the prevailing factors influencing the global energy and power markets. Furthermore, we took advantage of the opportunity to engage with several companies and have spotlighted significant developments.

Highlights

• M&A activity was one of the prominent themes of the conference
• The industry is actively seeking to regain the interest of general investors
• Participants view natural gas as crucial to the energy transition. Especially LNG demand is forecasted to grow at ~4% CAGR during 2023-2030. During the same time, North America’s LNG capacity is projected to grow from 91mtpa to 280mtpa by 2030
• Electricity demand driven by data centers, AI, EVs and electrification of industrial processes is expected to surge significantly

Find out more in the PDF

ICG Commodity Update – February 2024

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

Energy

Crude oil has seen a gradual but steady upward trend this year. The widening time spreads indicate a tightening of physical conditions influenced by various disruptions, such as attacks on ships in the Red Sea. Hedge funds have also reduced their short positions. Nevertheless, delayed expectations of a Federal Reserve rate cut, robust production from non-OPEC+ sources and an uncertain Chinese demand outlook have limited gains. OPEC+ extended its oil production cuts until the middle of the year, totalling around 2mboe/d. This extension had been widely expected by traders and analysts. Surprisingly, Russia pledged to strengthen its role by focusing more on production cuts than exports. Russia announced an additional 471 kboe/d cut for Q2/24. If these cuts are implemented in full, the oil market is likely to tighten further, according to UBS analysis. The earnings season for international oil companies (IOCs) has come to a close in Q4, with EPS results beating expectations by an average of 7% after missing by 6% in Q3. De-risked balance sheets enabled the sector to beat forecasts, with distributions now averaging 45% of operating cash flow, according to Jefferies. Consolidation in the US shale industry pushed the value of global mergers and acquisitions in the oil and gas exploration sector to its highest level in seven years in the first quarter. Deals worth over $55bn were announced in the first two months of 2024. In particular, the acquisition of Endeavor Energy Resources by Diamondback Energy, both of which focus on the Permian Basin, attracted a lot of attention. Woodmac reports that the ten largest producers in the Permian Basin will now account for 53% of production in the basin. M&A’s have the potential to lower the break-even point through cost synergies and encourage a move away from short-term thinking in terms of investment and growth, making companies less vulnerable to price volatility. It is worth noting that such acquisitions are often preceded by a slowdown in oil and natural gas production growth. Therefore, this series of follow-on deals could also support global crude oil and natural gas prices.

Industrial Metals

As reporting season kicked-off, the recent declines in profits reported by major mining companies, including Rio Tinto, BHP, and Glencore, reflect a retreat from the extraordinary gains witnessed in the aftermath of Russia’s invasion of Ukraine. It is essential to consider the context of the preceding period marked by price spikes and wild swings, which led to blockbuster earnings. Rio Tinto, despite a 12% fall in profits attributed to weaker commodity prices and rising costs, maintained resilience by paying a higher dividend, reflecting its overall financial strength. BHP, undergoing significant restructuring to enhance efficiency, faced a hit in profits primarily due to a write-down in its nickel business. However, the company’s half-year underlying profit exceeded expectations, and cautious optimism was expressed about a demand recovery in 2024. Glencore, despite a steep drop in annual profit, still achieved impressive earnings of $17.1 billion. As the mining industry anticipates a more balanced global economy in 2024, these profit declines should be viewed in the context of a return to normalized conditions following a period of exceptional highs. Looking at lithium, Albemarle, the leading lithium supplier, has voiced concerns about the sustainability of current prices, deeming them insufficient to spur the necessary supply investments for long-term demand growth. Global lithium companies scaling back expenditures and curtailing production as demand slowed precisely when new mines ramped-up. This sudden shift has resulted in a market oscillating from shortages to oversupply. Contrasting this trend, SQM, the world’s second-largest lithium producer, has adopted a distinctive strategy. Despite operating in an oversupplied market, SQM is forging ahead with expansions and stockpiling of the battery metal, positioning itself for a potential resurgence in demand. This approach carries a dual impact on the market dynamics. On one hand, the continued increase in output during a period when buyers are depleting inventories may extend the glut. On the other hand, it reflects a calculated wager on the return of buyers, aligning with the sustained growth in EV demand. According to SQM, the next decade is poised to witness a fourfold surge in lithium demand. This strategic perspective underscores SQM’s readiness to navigate the evolving market dynamics, balancing the present challenges with a forward-looking optimism anchored in the transformative trajectory of electric-vehicle adoption.

Precious Metals

While gold is breaking out, it is frustrating to see how gold equities continue to underperform. Over the past year, while the metal itself has experienced a 12% increase, the gold equity index has declined by 8%. BMO attributes this underperformance to factors such as inflation, leading to elevated total costs, diminished margins, and constrained free cash flow. Additionally, the mining industry grapples with short mine lives, requiring constant reinvestment to replace depleted ore. A looming labor shortage compounds these challenges, driving up costs and hindering productivity. Although certain issues may persist, there is optimism regarding the impact of inflation diminishing. During the annual reporting of our portfolio companies, notable improvements in costs and margins have already been observed. Analysts anticipate a reduction in inflationary pressures as the economy slows down, labor constraints ease, and energy prices normalize in the industrial supply chain. Projections point towards a 5% annual unit cost deflation in 2025 and beyond. Traditionally, the gold sector’s cost curve aligns with fluctuations in gold prices, resulting in increased marginal supply. However, the current cycle demonstrates a sustained level of discipline among companies. There is a focus on adhering to cutoff grades and reserve price assumptions, with an emphasis on generating free cash flow over prioritizing revenue. Despite rising industry costs, these do not seem to stem from self-inflicted actions. Gold equities are currently undervalued, with historically low valuations, while expected increases in free cash flow yields and dividends lie ahead. Management teams have exhibited greater discipline in capital management, avoiding overpaying for mergers and acquisitions. This prudent approach has contributed to a still fragmented industry with numerous small companies. Examining key financial metrics, the precious metals champions fund’s portfolio boasts a weighted average P/B multiple of only 1.2x, a price-to-cash flow ratio of 5.4x, and a dividend yield exceeding 2.5%. The anticipated rise in free cash flow yield from 6% in 2024 to over 15% in 2025 aligns with the continued maintenance of healthy balance sheets among our portfolio companies, characterized by minimal to no debt.

ICG Commodity Update – January 2024

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

Energy

Oil prices have recently risen, with the Red Sea turmoil having the least impact. The surge is attributed to winter storms affecting U.S. oil production, particularly in North Dakota and Texas, causing a temporary 1mboe/d or 7.5% reduction in daily domestic output. However, this output is expected to fully recover soon. A week later, Saudi Aramco unexpectedly paused a 1mboe/d capacity expansion planned for 2027, without explanation. OPEC+ output cuts have left Saudi Aramco below its maximum output potential, pumping around 9mboe/d currently. The decision to abandon the capacity expansion reflects a longstanding trend in Saudi Arabia’s history of announcing substantial production expansions, only to backtrack on those plans later. The enduring reality is that the global shift away from Saudi crude is ongoing, with a growing preference for American oil. This transition extends beyond the United States, encompassing countries like Canada, Brazil, and Guyana as key players in the evolving landscape of the oil market. This will result in important geopolitical changes going forward. Therefore, not so surprisingly, Brent crude oil futures remained in the $70s for six weeks, disregarding geopolitical events like Houthi attacks in the Red Sea, oil tanker diversions, and tensions in Iran, and off the coast of Oman. Even oil options prices indicate market calm, with option-implied volatility decreasing from over 50% after the Hamas attack on Israel to around 36%. JP Morgan analysts concluded there was no geopolitical risk premium in petroleum prices currently. Big Oil’s prominence has diminished, comprising just 3.6% of the S&P 500, down from 5% a year ago. Microsoft’s market value now surpasses Exxon’s by 7 times and Shell’s by 14 times. Microsoft’s Free Cash Flow is on the other hand only 2 times bigger than Exxon’s and 2.3 times bigger than Shell’s in 2023. Nevertheless, Big Oil’s post-pandemic strategy involved taking cash from rising oil prices and returning it to shareholders. With a 20% crude decline in Q4 2023 and shrinking refining margins, analysts anticipate limited cash for stock buybacks this quarter, emphasizing the importance of operational performance. After $260bn of M&A in 2023, this trend is expected to continue, with notable deals in January, such as APA purchasing Callon Petroleum and Chesapeake, and Southwestern merging together.

Industrial Metals

Heightened macroeconomic concerns from elevated interest rates, high energy prices, a strong U.S. dollar, and a sputtering China, continue to stoke global recession fears. Although some analysts remain concerned with near-term consumption risks, several commodity markets appear surprisingly tight in 2024, driven by ongoing supplyside underperformance and remarkably resilient demand. Moreover, with visible inventories for some metals already at critically low levels, analysts anticipate a relatively attractive pricing environment this year, despite economic uncertainty. In the case of copper, several hedge funds are betting that copper stocks are significantly undervalued, as they position themselves for gains this year. Those bullish bets follow a supply setback, with key mines running into trouble at the end of last year. The upshot is that what had looked like a clear case of excess supply has now morphed into a likely deficit according to analysts. The development underscores the fragility of supply in markets where there has been very little capex for new projects, or where even sustaining and maintaining existing operations has been a challenge over the past decade. Overall, copper gained only 2% last year, following a 14% decline in 2022. So far this year, the base metal’s price is little changed, bullish bets for 2024, however, are continuing to mount. Robert Friedland, the billionaire founder of Ivanhoe Mines, said recently he wouldn’t be surprised if the price climbed to $9,500 a metric ton this year, as interest rates come down and demand from China heats up. For miners with existing operations, copper’s tight supply dynamics are good news. But given the long-term demand projections, there’s a conspicuous lack of investment in new supply. That gap is so big that some manufacturers even warn it may put the energy transition at risk. Battery metals such as lithium and cobalt on the other hand are having a tough time. Core Lithium said it would close one of its mines, cutting 150 jobs. The battery minerals sector could be on track for more mine closures as its quarterly reporting season gets under way – with several producers on track to report annual losses. It’s not surprising that lithium prices have sharply retreated, considering the substantial influx of new companies focusing on this metal in recent years. Therefore, it is crucial to consider only those companies that can remain profitable even during downturns, thanks to their leading cost profiles and streamlined balance sheets.

Precious Metals

According to analysts, the resilience of gold can be attributed to geopolitical anxieties linked to escalating tensions in the Middle East, along with sustained robust demand for physical gold from central banks and China’s middle class striving to safeguard their diminishing wealth amid the property market crisis. Interestingly, with gold prices holding over $2,000/oz, it appears that the stage is set perfectly for a wave of M&A to sweep through the gold equities in 2024. While analysts note potential producer-buys-producer possibilities, valuation disparity and insights from management teams would indicate that there is also room for producer-buys-developer transactions, especially if the developer is fully permitted. More recently, exploration budgets have shown an uptick, but global reserves are still depleted, and senior gold company production is expected to decline – still, the number of transactions is lower than pre-COVID levels. According to BMO, tier one jurisdictions have, and are expected continue to, garner most of M&A interest in the space, with 41% of the mines acquired in the past 10 years being in Canada and the United States, and 25% in Australia in the same time frame. When examining transaction sizes, there is lower variability in value generation for the larger deals, and higher variability in ROI for the smaller deals. Logically, this can be attributed to the fact that smaller companies or assets generally have more opportunity for growth, especially on a relative basis. As demonstrated by the top 4 value generating deals, the most notable returns came from medium-large caps making smaller acquisitions. The precious metals champions fund’s portfolio prefers small to mid-cap companies, representing 84% of the equity exposure. The fund emphasizes the reserve valuation, calculated as the enterprise value divided by 2P reserves, and considers the cash costs of a company, among other factors. In essence, the focus is on evaluating how inexpensively a company or asset can be acquired and its ability to produce profitable ounces. Our analysis indicates that these factors are crucial in determining the attractiveness of a potential target. Currently, the weighted average EV/2P of the portfolio is at $280/oz (vs. universe at $346/oz) while the cash costs are at $1’100/oz (vs. universe at $1256/oz).

ICG Commodity Update – December 2023

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

Energy

Crude oil experienced its first annual decline since 2020, witnessing a drop of over 10% last year. Throughout December, the Brent futures curve displayed a bearish contango structure, with near-term barrel contracts trading at discounts compared to later ones. In 2023, speculators displayed the most bearish sentiment towards the commodity in over a decade. Non-commercial players’ net-long positions across major oil contracts reached the lowest levels on record, dating back to 2011. The diminishing confidence in OPEC’s ability to balance the market was exacerbated by the surge in algorithmic trading, accounting for nearly 80% of daily oil trades and causing price fluctuations independent of fundamentals. Despite this, supply remains a significant factor, with record production in the US reaching 13.3mboe/d last month. Increasing output from non-OPEC+ nations, such as Brazil and Guyana, has contributed to a global glut, despite OPEC’s efforts to curb supplies. OPEC recently released a statement affirming its commitment to “unity, full cohesion, and market stability”. On the demand side, there are varying expectations for 2024. According to the IEA, global consumption growth is expected to slow as economic activity weakens, with a forecasted demand increase of 1.1mboe/d for the year. While this is less than half of the 2023 growth rate, it remains high by historical standards. In contrast, OPEC maintained its demand growth forecast at 2.2mboe/d in its December report, which some analysts consider optimistic. Analysts continue to be cautious of geopolitical risks. Especially the recent attacks in the Red Sea by Yemen-based Houthi militants and the ongoing conflicts between Russia and Ukraine and the Middle East. The energy industry witnessed notable takeovers in 2023, with Exxon Mobil, Chevron, and Occidental Petroleum completing blockbuster deals, pushing the total value of announced M&A to $346.2bn. This marked an 80% increase from the previous year and ranked only below the values recorded in 2014 and 2018. Despite this, the S&P 500 Energy Index fell 4.8%, ranking as the second-worst performer among the 11 S&P 500 industry groups. In contrast, the Energy Champions Fund closed the year in positive territory, outperforming most of its peers once again.

Industrial Metals

In 2023, the commodities market experienced significant challenges, marked by a nearly 10% decline in the Bloomberg Commodities Index. Various commodities, including oil, gas, base metals, and grains, recorded declines, contributing to the overall downturn. However, copper prices saw a marginal increase during this period, driven by expectations of another deficit year. The market witnessed a deficit in 2023 due to robust demand and weaker-than-anticipated supply, contrary to initial projections of a surplus at the year’s outset. Forecasts indicate that these deficits are likely to expand in 2024 and 2025, primarily due to downgrades in several producer-related aspects. Fitch Ratings predicts a 2.7% increase in global copper consumption in 2024, attributing it to the metal’s role in the ongoing energy transition. Looking ahead to 2050, S&P anticipates annual copper demand surpassing the cumulative consumption from 1900 to 2022. Surprisingly, uranium emerged as the top-performing commodity in 2023, reaching a 16-year high of over $90/lb. Unlike previous spikes in 2007 and 2010 driven by specific market shocks, the current momentum is fueled by diverse factors, including climate change considerations, increasing acceptance of nuclear energy, advancements in reactor technologies, and geopolitical uncertainties affecting both demand and supply. A notable development is China’s decision to halt the export of certain rare-earth technologies, potentially complicating efforts by the US and other Western nations to secure strategic raw materials. Meanwhile, lithium faced a significant price decline, with spodumene prices plummeting by 80% over the past year, leading to the suspension of mining activities by an Australian producer. The lithium market struggled with a global supply glut in 2023, coupled with lackluster growth in battery demand and the impact of higher interest rates on global electric vehicle sales. In the realm of M&A, Nippon Steel announced its acquisition of United States Steel for $14.1bn. The acquisition price, at approximately 8 times US Steel’s 2024 EBITDA, exceeded the typical 4–6x valuations for major global blast furnaces. Additionally, it is said that Barrick Gold initiated discussions with First Quantum Minerals shareholders regarding a potential M&A transaction. According to S&P, the positive outlook for the mining industry is supported by the expected entry into production of at least 38 mines in 2024 all over the world.

Precious Metals

Geopolitical risks have consistently fueled safe-haven demand for gold, resulting in the metal reaching a record high in early December and closing 2023 with a 13% gain. Despite facing four interest rate hikes, in addition to seven the previous year, gold demonstrated unexpected resilience. Recently, gold experienced a pullback following a late-month rally, driven by expectations of rapid monetary loosening in response to a cooling economy. Attention is now focused on U.S. data, which will guide the pace of the Federal Reserve’s rate cuts. As we venture into 2024, the outlook for gold seems increasingly favorable, primarily shaped by the anticipated shift in interest rates. On the flip side, platinum group metals (PGM) faced a challenging year. Platinum recorded an 8% loss, while palladium plummeted over 38% in 2023. Several factors contributed to the decline, triggering negative speculative investor sentiment. After years of existing in a structural deficit, the palladium market is now experiencing structural oversupply. This shift is primarily attributed to palladium’s heavy reliance on catalytic converters in gasoline-powered vehicles, constituting about 90% of total demand. While gold miners celebrated the precious metal’s historic high, they are redirecting much of their windfall into copper. Interestingly, copper, previously downplayed by gold-mining executives, is gaining importance as investors recognize the growing competition for copper supply amid the global shift towards electrification and away from fossil fuels. The traditional premium of gold stocks over companies mining various metals is evolving. Barrick Gold, for instance, aims to transform into a “major-league copper producer” as revealed by CEO Mark Bristow in November. There are now rumors that Barrick has initiated discussions with First Quantum shareholders for a potential M&A transaction. Another major gold producer, Newmont, anticipates an increase in its copper revenue from 10% to 20% or more, following the takeover of Newcrest and the development of planned projects. About 30% of Newmont’s reserves are now in copper. Analysts observe positive signs in the macro backdrop for miners. S&P supports this positive outlook, highlighting the expected commencement of production in at least 38 mines worldwide.

ICG Commodity Update – November 2023

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

Energy

Brent oil is at $78/bl amid sustained scepticism that the latest supply cuts by OPEC+ will turn the market’s tide. The retreat came even after a difficult OPEC+ meeting last week that saw internal wrangling as well as a delay. OPEC+ oil producers agreed to voluntary output cuts totalling about 2.2 million barrels per day (mboe/d) for early next year led by Saudi Arabia rolling over its current voluntary cut. The market wasn’t enthusiastic in part because the reductions were voluntary, and this implies that any additional cuts become increasingly difficult to implement. Indeed, there is confirmed disunity in the group, with Angola publicly rejecting their quota and stating that they would produce at 1.18mboe/d from 2024. Some investors also expected the additional cuts to be deeper because of the recent large upside surprises to inventories and supply. According to Goldman Sachs, the additional cut’s now lowers 1H24 supply be around 0.7mboe/d and ends in 3Q24, which in theory means we will get a 1.2mboe/d 1H24 deficit. However, Q4 expected deficit was also around 850kboe/d and we’re currently in surplus. While it is hard to measure demand in real time, frequency / mobility indicators have generally met expectations and generally demand has looked “ok” according to Jefferies, but supply was strong. Especially this year we saw strong oil production increases by the OPEC members Iran +430kboe/d, Venezuela +150kboe/d, Nigeria +110kboe/d, Angola +60kboe/d and Gabon +60kboe/d. Meanwhile, Brazil said it would join the OPEC+ alliance next year but won’t take part in any production cuts for now. Ultimately, it is hard to be too bearish on oil prices in the short and medium term given OPEC+’s willingness to actively manage oil markets. On the producer side, M&A activity in the shale patch somewhat slowed in November as operators reported their 3Q23 earnings amid the backdrop of the megadeal frenzy in the prior month. Companies seem intent to stick to their “capital discipline” mantra in 2024, with few producers showing willingness to increase volumes beyond the maintenance to single-digit percentage growth range. Companies instead plan on inorganic growth and gaining the scale necessary to be competitive in the longer-term, signalling that more large deals may be on the horizon.

Industrial Metals

There are signs of the macro backdrop turning more positive for the miners as markets could be heading into an environment of a weaker dollar, lower bond yields, Fed rate hold/cuts, demand strength in several emerging markets, stability in China, booming demand in India, ongoing energy transition demand for metals, and mine supply constraints. M&A is likely to be a factor in 2024 as well. A key indicator of supply in the global copper market sank to the lowest level since August last year, as the shutdown of a large mine in Panama cuts the availability of ore for next year. The closure of the $10 billion Cobre Panama mine leaves world copper smelters with less raw material than expected to support their rapid expansion in capacity. That’s reflected in the so-called treatment charges for converting concentrated ore into metal, which rise when supply of mined copper is plentiful and drop when it’s getting tighter. Spot fees paid by Chinese smelters have fallen below $70 a ton for the first time since August 2022, Fastmarkets data show. Some analysts have lowered their forecasts for copper demand related to the energy transition as renewable energy projects are being delayed and EV penetration may be slowing, in part due to high costs. A plan to close First Quantum’s major mine in Panama is threatening to upend the global copper market by whipsawing the industry back into a period of tighter supply though. Until recently, the broad consensus among forecasters was that copper would enjoy a comfortable surplus for the next few years, before tightening sharply later in the decade as supply struggles to keep up with surging demand for the energy transition. Now, the news that Panama intends to shut down one of the world’s biggest and newest copper mines threatens to disrupt that trajectory. Copper prices have risen about 6% since the protests erupted in Panama. In general, for the past five years in a row, the mine disruption rate has been above the average of this century – this shows how quickly a balanced market can swing into deficit and how important it is to be diversified – geographically as well as on a commodity basis. On the company side, Glencore will buy a majority stake in Teck Resources coal business, ending a months-long saga that transfixed the mining industry and setting the stage for the commodity giant to exit the coal business itself. Glencore will pay $6.93 billion for a 77% stake in Teck’s business, while Nippon Steel and Posco will hold the rest.

Precious Metals

Gold touched an intraday record $2,135.39 an ounce thanks in part to its haven status as the more volatile the world gets, the better gold tends to do. Bullion has rallied almost 16% since early October, a surge that was initially sparked at the start of the Israel-Hamas conflict but has since been driven by bets on the Federal Reserve will shift to monetary loosening early next year. The Fed last week said the central bank’s policy rate is “well into restrictive territory” in comments that are being interpreted as largely dovish by markets. But the precious metal’s strength has been underpinned by a wider array of factors, from a wave of purchases by governments and central banks to geopolitical uncertainty, with 41% of the world’s population due to go to the polls next year. Gold has risen more than 600% since the turn of the millennium, though adjusted for inflation it remains below the high of $850 touched in January 1980, which would be equivalent to more than $3,000 in today’s dollars. Still, many investors have remained on the sidelines as gold has surged higher. Investors in gold via exchange-traded funds, a key driver of previous bull markets in the metal, have been sellers for much of this year, with holdings down by more than a fifth from a high in 2020. Looking at silver, industrial demand is well on track for a new record level, with the Silver Institute numbers showing 632 million ounces this year. Currently ~160Moz of silver is used in photovoltaics on an annual basis, equivalent to ~15% of global demand. BNEF has highlighted that in an effort to increase solar module capacity and efficiency, many Chinese solar companies are looking at new designs including heterojunction and TOPcon cells that are reported to use significantly more silver than incumbent designs. Analysts suggest that these new technologies could be 3 times more silver intensive. On the company side, Sibanye Stillwater, one of the largest PGM producers, said it plans to lay off 575 employees in South Africa following a review of its gold operations in the country. According to Northam Platinum CEO, large swathes of the South African PGM production base are currently loss-making. This is very concerning for the country. The typical miner in South Africa has around eight to 10 dependents, so layoffs will have a profound social and economic ripple effect.