ICG Commodity Update – January 2023

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

Energy

Oil has been bumpy in recent months – supported by demand expectations from China but with pressure from contraction fears in western economies. Nevertheless, China’s rapid shift to reopen its economy following lengthy lockdowns should help oil demand rise to a record level this year, the IEA said, lifting its forecast for oil demand growth this year by 200kboe/d to 1.9mboe/d. Traders expect China to resume buying high quantities of oil through the spring. Indeed, preliminary announcements by various agencies suggest that the Chinese New Year celebrations boosted mobility – domestic travel jumped to 90% of 2019 levels. Analysts expect that China alone could add 1.5mboe/d in 2023. A similarly sudden turnaround for the fortunes of economies in Europe and the US is also boosting oil-demand expectations, according to the IEA. Europe’s economy this year is expected to fare better than previously forecast, as warmer temperatures have eased its energy supply crisis. The US had also a mild January that caused natural gas prices to fall to $3/mcf. The extra oil demand means that the IEA now expects total oil demand this year to average 101.7mboe/d, well above pre-Covid levels and a record amount. The EIA (US) expects 1.0mboe/d and OPEC 2.2mboe/d growth this year. Global oil supply is also expected to grow, led by the US and Iran. Markets could be in deficit until 3Q23 resulting in a decline in already low inventories, thereby tightening the oil market – while SPR releases were an effective tool to help control oil prices in the 2H22, President Biden’s ability to use them as effectively in 2023 is probably more limited. Over the next weeks oil and gas companies will report their 4Q22 results, highlighting the record-high profit generated last year. Oil and gas companies’ contribution to the S&P 500 Index’s earnings has nearly doubled compared to 2022. Energy now represents more than 10% of the S&P 500’s estimated net income, up from 6.5% a year ago. Still, energy makes up only 5.3% of the index’s market capitalization even after a big outperformance in stock prices last year. Disciplined reinvestment and capital return remain key drivers for the industry. Shell reported $40bn net profit last year, 70% higher than eight years ago in 2014, when prices were at similar levels and the ECF was launched. That says something about how the industry has changed over that years.

Industrial Metals

After strong commodity prices seen through the first half of 2022, the second half of the year was significantly less exciting, with generally lower commodity prices into Q4 and cost inflation concerns taking some of the free cash flow margins out of the sector. According to analysts and seen in some of the most recent Q4 reporting, mining companies continue to generate strong cash flows and given strong balance sheets, the potential to provide attractive returns to shareholders. Miners have rallied into the new year, buoyed by higher commodity prices, lower inventory levels and improving sentiment on China, with economic expectations now appearing higher than previously thought. According to BMO, relative to industrial metal peers, copper demand in China performed well in 2022, with 2.9% year over year growth to ~14.4Mt (refined copper basis). While below the average for the past ten years, this did mark acceleration from 2021’s negligible growth. Meanwhile, copper inventory also dropped for the second year in a row. A group of base metals led by tin, zinc and copper have surged more than 20% in three months, further supported by the US Federal Reserve signalling a slowdown in the pace of interest rate rises and a softening in the US dollar, which importers use to buy commodities. Another upside risk for already tight copper markets is the social unrest in number two miner Peru (10% of total world mined supply). Protests have rocked the country for almost two months following the impeachment and replacement of former President Pedro Castillo. About 30% of Peru’s copper production is at risk. One of the largest mines, the Las Bambas facility, is currently shut amid a shortage of critical supplies caused by road blockages in the area. There are also supply risks in neighboring Chile, the world’s largest copper producing country. Project delays prompted a Chilean government agency to tone down its projections for copper output in the top-producing nation, the latest sign of the challenges facing the industry as demand for the wiring metal increases. Developing new projects is getting trickier and pricier given increased scrutiny on environmental and social issues and the need to dig deeper. In the case of Chile, permitting difficulties combined with efforts to increase taxes and re-write the constitution have led companies such as BHP, Antofagasta and Freeport-McMoRan to put off decisions on major investments.

Precious Metals

According to the World Gold Council, 2022 was one of the strongest years for gold demand in over a decade. Annual gold demand (excluding OTC) jumped 18% to 4,741 tons, almost on a par with 2011 – a time of exceptional investment demand. Two years on from dropping to its lowest level in a decade, central bank demand has rebounded strongly. 2022 saw the second consecutive year-over-year increase in demand from this sector, with net purchases totaling 1,136 tons. This marked a banner year for central bank buying: 2022 was not only the 13th consecutive year of net purchases, but also the second highest level of annual demand on record back to 1950. Mine supply on the other hand increased by only 1% year-over-year to 3,612 tons. Chinese production rebounded, but this was mostly attributed to base effects after wide-ranging shutdowns in 2021. Recycling volumes were also subdued, which meant total gold supply rose only 2% year-over-year to 4,755 tons over 2022. Looking at Silver, Endeavour Silver said there was a supply shortfall of nearly 200 million ounces in 2022. In general, Primary silver reserves are declining as mining depletion exceeded additions. However, silver is a green metal which supports rising industrial demand, placing upwards pressure on the price of silver. While 80% of supply is sourced from mining, 20% comes from scrap – according to the company, silver scrap recycling is at a 25-year low and over the past 10 years, the silver industry has been in a 500m ounce physical deficit. Investors should be aware that an average solar panel uses about 20 grams of silver, meaning, every Gigawatt of solar power needs 2.8 million ounces of silver. Also, battery powered electric vehicles have twice as much silver as internal combustion. With silver being produced primarily as a by-product of base metals mines, grades falling for years, and new deposits are scarce, silver prices could rise in the future. On the company side, the worlds largest gold producer, Barrick Gold, announced that the company’s output in 2022 slid to its lowest level since 2000, missing analysts’ expectations and its own target as operational woes curbed production. Acquisitions could help lift Barrick’s metals output while awaiting longer-term projects to come to fruition. The CEO said in an interview that he’s focusing on deals in “the junior part of the market” this year.

ICG Commodity Update – December 2022

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

Energy

Crude oil prices started the year 2023 at same levels as a year ago despite what happened during 2022. Indeed, according to UBS the energy problems of 2022 – redirected Russian supply, chronic underinvestment in upstream capacity – are here to stay. And with demand recovering in China as well as in emerging markets overall, energy prices should continue to climb in 2023. With China reopening, oil demand looks set to exceed 2019 levels and hit a record high of 103mboe/d in 2H23. Emerging Asia, including India, should return to driving oil demand growth in 2023. Meanwhile, Russian oil production should fall in 2023 due to the EU’s embargo on Russian crude and refined products (to come into force on 5 February). While production outside the OPEC+ group, which is primarily driven by the US, will likely grow again in 2023, the increase should only be modest following years of underinvestment in building new supply. With OECD oil inventories (commercial and strategic) standing at the lowest level since 2004 and spare capacity set to keep dwindling in 2023, UBS believes higher prices are needed to slow down oil demand growth and encourage investments in new production. 2022 has proven to be another strong year for the oil and gas players. According to Rystad, revenues of public E&P companies increased 55% in 2022, reaching $2.4tn in total. This is about 40% higher than the previous record from 2013. This is not, however, as impressive as the growth in profit, where profit is defined as revenue minus all operational costs, cash to governments and investments. Combined profit reached $800bn, 76% higher than in 2021, which was the previous record year in terms of profit. On the other side, total investments grew by 18%, or $45bn, over 2021. The global upstream investment ratio dropped to about 27% this is a new all-time low. This shows that oil and gas companies remain cautious and the shift in industry behaviour of return vs. growth may continue. Nevertheless, the E&P energy weighting in the S&P500 remains well below historical averages (even after this year’s outperformance), but it is attracting attention. What’s particularly interesting is the gap between earnings contribution and market cap weight is essentially as high as it was in 2007-2008. In fact, looking at P/E, there are few periods where energy has traded this cheap (mid -1980s post oil collapse, 2005-2009, 2011-2012, and today). The ECF has now a record low P/CF of 2.8x.

Industrial Metals

Despite growing economic headwinds, most metals prices remain at healthy levels by historical norms. While most analysts expect 2023 metals demand unlikely to be stellar, the reopening of China and therefore its demand will offset weakness in the developed world. Goldman Sachs recently published its 2023 commodity outlook, where the bank states that the setup for most commodities next year is more bullish than it has been at any point since they first highlighted the supercycle in October 2020. What most banks point out are the broadly depleted inventories – with geopolitical tensions high, and security of commodity supply into core value chains rising in terms of strategic importance, the world has fundamentally shifted from a “just-in-time” to a “just-in-case” model. For most raw materials, visible exchange inventory cover is much lower than seen at the start of 2022. This has not only left commodity prices more susceptible to financial positioning, and ultimately outsized price swings, but it also means that prices will likely broadly remain at a premium to cost curves until inventory levels replenish to more usual levels. Looking at China, the country is reopening rapidly and people have more cash in their bank account than ever before. Chinese households currently hold 50% more money than before the pandemic started 3 years ago – analysts expect the release of pent-up demand to be similar if not bigger than it was in the western world when governments relaxed strict covid-rules. In general, supply chain pressures have eased markedly from earlier in the year, but metals and mining output has been hampered by the surge in costs and underinvestment over recent years. Despite a near doubling year-on-year of many commodity prices by May 2022, capex across the entire commodity complex disappointed and continues to do so – even the extraordinarily high prices seen earlier this year cannot create sufficient capital inflows and hence supply response to solve long term shortages. Despite the recent price declines, commodities still finished the year as the best performing asset class – analysts highlight that commodity supercycles never move in a straight line, rather, they are a sequence of price spikes with each high and low higher than the last. Once high prices have rebalanced the market in the short term, the high prices are no longer needed, and prices come crashing back down as we witnessed late this year – but it takes years to resolve long-run supply issues.

Precious Metals

The precious metal complex, has struggled for much of the year amid one of the fastest rate hike cycles on record, combined with the surge in US-dollar to a record high, despite inflation spiking to a multi-decade high. Since the autumn extremes the dollar and 10y treasury yields are down, which has seen gold rally to bring the annual average in line with 2021 – the annual average record in terms of nominal price. The likelihood of recession in major markets threatens to extend the poor performance of equities and corporate bonds seen in 2022. Gold could provide protection as it typically fares well during recessions, delivering positive returns in 5 out of the last 7 recessions. While macro factors form the basis for much of the impact on gold, geo-political flare-ups could lend support to gold investment, as in Q1’22, where investors look to shield themselves from any further turbulence. Analysts attribute a large proportion of gold’s resilience in 2022 to a geopolitical risk premium, with gold’s return not fully explained by its historically important drivers. On the company side, the pressure to adopt the green revolution, there has been a declining interest from miners in deploying capital to gold projects – Barrick Gold for example, the world’s largest producer, is not the only precious metal miner that has voiced its interest in diversifying into copper and sees Indonesia as a possible site for exploration as it hunts for gold and copper deposits across South Asia. Global gold production has been falling since 2019 and is likely in the early stages of a new downtrend. Miners that have traditionally focused on precious metals have been redirecting their capital to battery metals and other mineral resources that comply with the green agenda. Many gold-focused miners have significantly shrunk their production. According to analysts, it is important to highlight that during prior periods of similar significant decline in total global gold production, like that which began in 2020, related mining stocks performed exceptionally well for the next decade. The aggregate number of ounces being added to global reserves has been peripheral compared to prior decades. It is becoming increasingly challenging to find precious metals. As a result, the reserves of the top 10 mining companies are down 33% over the last 15 years.

ICG Commodity Update – November 2022

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

Energy

Markets have experienced intense headline volatility the last few sessions in advance of the OPEC meeting this weekend. Signs of an oversupplied market in recent weeks briefly pushed oil prices to lows not seen since last year, leading to speculation that the production cartel could cut output further to tighten supplies. Many forecasters expected that cut would spur a period of sustained oil price strength given a significantly bullish backdrop. In particular, analysts have pointed to sanctions on Russian oil production, weakening US production growth, and persistent global demand growth, with Morgan Stanley and Goldman Sachs expecting oil prices of >$100/bl by 1Q 2023. However, last week, the G7 implemented a Russian oil price cap at $67-$70/bl (i.e. above the current Russian oil price). As such, that has eased the pressure on global market participants that were expecting a more aggressive price cap, and a related reduction in Russian oil flows. On the other side, there are growing expectations/rumours that China is seeking to shift away from “Zero Covid” measures, towards a more relaxed policy/re-opening (albeit gradually). This is important as a substantial proportion of Chinese oil demand is used in the transportation sector (i.e. over 55% of Chinese oil demand, particularly consumption of diesel in trains and delivery trucks). Interestingly, the US moved to grant Chevron a license to resume oil production in Venezuela after sanctions halted all drilling activities almost 3 years ago. The increase in oil supply in the short term is limited (~ 0.2mb/d over a 6-12 months according to Credit Suisse) but is a change in narrative around US sanctions on Venezuela. No new investments are expected by the company in the country until certain debts are repaid by PDVSA to Chevron. Oil and Gas equities have outperformed the commodity recently and this resulted in some multiples expanding. Nevertheless, they don’t screen poorly in our eyes. According to analysts they continue to price-in high $60/bl WTI and low $3/mcf. Another perspective is the following: We launched the Energy Champions Fund in March 2014 with a NAV of $100/share and oil prices were around $100/bl. At that time the EV/EBITDA was at 5.5x, dividend yield at 2.6%, ROE at 13.3% and cash costs at $22/boe. Today we have an oil price of around $85/bl and the NAV is still at $68/share with an EV/EBITDA of 3.1x, dividend yield of 5.7%, ROE 34.6% and cash costs of $13/boe.

Industrial Metals

Commodities surged last month, with bullish investors emboldened by signs that China will take a softer line on Covid and the Federal Reserve will slow rate hikes. China’s top official in charge of its Covid response said the fight with the virus is entering a new stage, in remarks that hinted at more easing of stringent curbs. In Washington, the Fed signaled a slower pace of monetary tightening from December on. Both developments offer hope that two of this year’s major headwinds for industrial commodities may be at a pivot point. When it comes to copper, the warnings keep getting louder: the world is hurtling toward a desperate shortage of the metal. Humans are more dependent than ever on a metal we’ve used for 10,000 years. New discoveries in copper are increasingly unlikely, given the long history of mining – that means most of the world’s great deposits have already been found and exploited, more than half the world’s 20 biggest copper mines were discovered more than a century ago. Mines globally continue to grapple with logistical challenges exposed by the pandemic and exacerbated by Russia’s invasion and Chinese lockdowns. In the case of Chile, the top copper-producing nation, just registered its first year-on-year output increase since mid-2021, a sign the industry may be recovering from a string of operational disappointments – a rare sign of supply relief, although ore quality has been falling and some mines face water restrictions in a prolonged drought. On the company side, Rio Tinto announced it plans to spend up to $3 billion in each of the next three years to develop new capacity for commodities needed in the global economy’s energy transition. The investments will target commodities like copper and lithium, where demand is expected to grow rapidly in the coming decade, as well as iron ore, which is facing sweeping market changes as the steel industry tries to cut carbon emissions. The top global miners are all trying to embrace new sources of demand thrown up by decarbonization. Rio said it expects the energy transition to add as much as 25% in demand across the firm’s key products by 2035. On the ESG front, Rio is aiming to halve its emissions by 2030. It plans to invest around $7.5 billion globally to halve its total operations emissions by 2030, a clear commitment to achieve a more sustainable and environmental friendly business.

Precious Metals

Gold extended its advance after Federal Reserve Chair Jerome Powell signaled the pace of tightening would slow at the next meeting, ahead of economic data that could bear on the central bank’s future rate hikes. Powell was optimistic inflation could be contained without the US economy tipping into recession, but said borrowing costs would still need to keep rising and remain restrictive for some time. Monetary tightening has weighed on non-interest bearing gold throughout the year by pushing up bond yields and the dollar, though bets on a slowdown and China’s Covid loosening saw it rise 8% in November – but is still down 14% from a peak in March.

On the company side, Newmont, the largest gold producing company, hosted an analyst update where the company reiterated that it expects to reinvest around $2.5bn/year, comprised of $1-1.5bn sustaining capex, $0.8-1bn growth capex and the rest allocated to exploration. The company said they are reviewing the inputs to its dividend framework and will likely use a $1’700/oz gold price assumption. Also, the company is willing to use cash on the balance sheet to fund the dividend – since 2019, the company has paid-out around 60% of its free cash flow. Newmont is expected to achieve its 2022 guidance. In the PGM sector, Northam fires up South Africa platinum takeover battle with another bid for smaller Royal Bafokeng (RBPlat) – Northam already holds about 34.5% of RBPlat, with options to raise its stake to 37.8% after buying out the company’s largest shareholder a year ago. Rival Impala Platinum has acquired around 41% of RBPlat as it seeks control of low-cost mechanized assets that are essential to maintaining the profitability of its adjacent Rustenburg operations. For Northam CEO, purchasing RBPlat would help close the gap on the country’s top tier producers and notes that the offer is aligned with Northam’s growth strategy and presents a unique opportunity to acquire a controlling interest in a scarce, high quality ore body with established and well capitalized infrastructure. Before making its offer, Northam had tried to block Impala’s bid for RBPlat on antitrust grounds.

ICG Commodity Update – October 2022

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

Energy

Energy performance has remained strong following record 2Q results – most analysts expect 3Q earnings to show sustainable and competitive profitability and capital return while broader market struggles. Solid fundamentals have led Energy to regain lost ground with sector performance now in line with Materials, Industrials, Financials and Utilities since 2015. According to BMO, energy has further upside potential with companies still trading at a 2-5x P/E discount to other value sectors. Most recent OPEC+ cuts should support oil prices into year-end with underinvestment in the industry translating to higher long-term prices. Higher commodity prices, capital discipline, reduced costs and leverage has been a driver of share prices which is expected to continue by most market participants. With balance sheets repaired, a meaningfully higher percentage of FCF is expected to be returned to equity holders. Corporate returns (ROE) are increasingly competitive with the broader market at current commodity prices and given this outlook, analysts believe oil and gas companies can outperform in even a range-bound commodity market. The pullback in oil prices from peak levels has led to a flattening of the curve, although it remains steeply backwardated with the long-term price ~$60Bbl – there are some key upside risks to oil prices, supply could surprise to the downside given global underinvestment, U.S. producer discipline and peak shale productivity, Russia sanctions, the SPR having nearly run its course, and OPEC+ willingness to support price could all lead to higher prices in 2023 and going forward. Rystad scenario analysis show that under a most extreme (but unlikely) scenario, where geopolitical situation escalates to the point Russia restricts exports, and OPEC+ cut 1mbbld in Jan 2023 in addition to 1mmbbld in Dec, the supply shock could see prices hit US$230/bbl. On the negative side, for oil companies at least, President Biden says he is seeking to impose higher taxes on oil firms who do not boost their US production and refining capacity. This comes on the back of Exxon and Chevron reporting a combined 3Q net income of over $30bn and revenue of close to $180bn. The top 4, Exxon, Chevron, Shell and Total, are paying nearly $100bn to shareholders annually in the form of buybacks and dividends while reinvesting just $80bn in their core businesses this year.

Industrial Metals

Macroeconomic headwinds have pushed copper futures down almost 30% from a peak in March, despite brisk demand and shrinking inventories that are nearing historical lows. According to Freeport-McMoRan, the world’s largest publicly-traded copper producer, the copper markets don’t reflect a strikingly tight physical market. The company says, customers are not scaling back orders and are really fighting to get products. The decline in copper prices this year reflects investor concerns about the global economy, weak economic data from top consumer China, the European energy crisis and a strong dollar. Such a pricing environment will defer new projects and mine expansions just when the world’s epic shift to electrification requires a massive amount of all sorts of metals, including copper. Indeed, WoodMacenzie recently published a study that states the mining industry would have to deliver new projects at a frequency and consistent level of financing never previously accomplished to meet zero-carbon targets. For copper, the additional volume needed means that 9.7 Mt of new mine supply will be required over the next decade from projects that have yet to be sanctioned – equivalent to nearly a third of current refined consumption. To date, a shortfall of this magnitude has never been overcome within a decade. The study is underlining that more than $23bn of investment a year in new projects or 64% higher than the average annual spend over the last 30 years has to be made by miners to meet demand. In theory, higher prices should encourage project sanctioning and more supply. However, the conditions for delivering projects are challenging, with political, social and environmental hurdles higher than ever. But copper is not the only metal which will be key in the future – the world needs lithium supplies to grow fivefold by the end of the decade to meet projected demand as the electric vehicle revolution gets into full swing. This looming shortage has seen miners engage in bidding wars for assets. Rio Tinto for example is asking for pitches from some of the biggest investment banks for lithium companies and projects it could buy as the mining giant looks to expand into the key battery metal. Rio already bought a lithium mine in Argentina for $825 million and is looking to bring it into production as soon as 2024.

Precious Metals

Gold headed for its seventh straight month of declines, the longest losing streak since at least the late 1960s. Attention is now firmly on the Fed, whose aggressive rate hikes have caused bullion to drop more than 20% from its March peak. Gold slipped as US economic data set the stage for another 75 basis point rate hike, pressuring the metal. A core gauge of US inflation accelerated in September, while consumer spending stayed resilient. On the positive side, evidently for both gold and silver, physical investment demand remains incredibly robust, and mints are struggling to keep pace. Investment silver product markets seem to be experiencing the most acute tightness. Expected record silver imports into India, logistical issues, lack of Chinese supply, and demand for prompt delivery, has seen silver uncharacteristically flown by air. On the PGM side, lower than expected mine production from South Africa and lower PGM recycling supply has tightened balances for both platinum and palladium. On the back of a stronger outlook for global light vehicle production and sharp cuts to both mine and scrap supply, palladium balance has tightened up significantly this year, moving to around a 740 k oz deficit – according to JP Morgan. Also, top PGM producers expect to see strong demand growth in platinum markets going forward, owing to its vital role across the hydrogen value chain. PGM markets are in a chronic deficit but are driven by the ICE vs. EV story – analysts expect that demand for fuel cells will more than replace the demand from ICE catalysts by 2040, although innovation is a wildcard in both directions. Ruthenium, also a platinum group metal, was flagged for its potential in the catalytic conversion of bio-based feedstocks, and applications in next generation semiconductor wiring. On the company side, Newmont reported profits that trailed estimates as the world’s biggest gold producer struggled amid lower prices. The company has been grappling with higher costs of labor, energy and supplies this year as inflationary pressures wash through the industry amid lingering supply-chain disruptions. In mid-September, Newmont delayed a decision on a major investment in Peru until the second half of 2024, citing war in Ukraine, rising prices for materials, supply-chain disruptions and competitive labor markets.

Recycling – a significat source of metals

Recycling is a significant source of metals that can reduce the need for new metal mines. The amount of each metal that comes from recycling varies, however. This is for two main reasons:

• Some metals are used in ways that make it hard to recycle them (e.g. Lithium in batteries)
• Recycling systems and technologies are less efficient for some metals

Independent Capital Group recently visited the Elrec Recycling Plant in Liechtenstein to get an insight into this business. Elrec is one of the leading recycling companies in the region and has a modern and the most powerful cable granulation plant nationwide. The plant is particularly interesting as it ensures almost 100% recovery of valuable copper granulate and by-products such as aluminium, other metals and plastics from cables. Due to the role of copper in the energy transition, efficient recovery through recycling is extremely important to soothe future supply deficits.

To extract the valuable copper granulate, cables of all kinds are first shredded. The copper is then separated from the by-products and stored in large 1-tonne bags for resale.

In addition to copper and general scrap recycling, Elrec also specialises in aluminium – also a key metal in the energy transition. The company has a facility that uses magnets to separate the aluminium from by-products such as paper and plastic. The aluminium cans are pulled into the rear area of the unit by means of a magnet, while the by-products are stored in another compartment for further processing.

Many thanks to the whole Elrec team for the interesting tour!

ICG Commodity Update – September 2022

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

Energy

Europe (and the world) is in the midst of an energy crisis that could materially worsen over the coming months. Europe has aggressively increased LNG imports to help offset the loss of Russian imports. To date, these have been accommodated by higher U.S. exports and lower LNG deliveries to China. North American natural gas prices could move higher through the winter heating season, enhancing the cash flow bonanza many companies are already experiencing. The intensifying global energy crisis has led politicians to consider incremental tax on oil & gas industry profits. The EU has proposed taxing the “windfall” earnings of oil & gas companies to the tune of €25bn. Analysts believe the policy is misguided out of convenience, as rising industry income is already a massive windfall to most producing jurisdictions via progressive royalties and taxes. As a cyclical business the industry relies on commodity upcycles to support full cycle returns on capital. Over the last 3 downturns the sector has written off $800 billion due to economic headwinds. Meanwhile, industry returns on capital have averaged <5% over the last decade, hardly “in excess” as many politicians suggest. Windfall tax also overlooks the root of the energy supply problem: underinvestment. While higher investment today may do little to ease near-term constraints, the fiscal uncertainty of a special tax is bad news for investment in future supply. There is mounting evidence that fossil fuel abhorrence and related policy is having a negative impact on global energy supply, and division over oil & gas investment is likely to extend if not worsen the crisis. Recently several high profile voices weighed in, reinforcing the position on the themes of global underinvestment and the sector’s necessary role in decarbonization/transition. Fossil fuel divestment may prove to be a problematic investment strategy as it not only leaves returns on the table, but also skirts opportunities to influence transition plans and ignores the vital role of oil & gas companies in leading/funding transition. The industry is already hesitant to invest, even though it generates record high cash flows. The weighted average free cash flow yield of the ECF portfolio companies increased to a record of over 24% this year. In other news, OPEC+ is preparing to meet this week to discuss the biggest production cut since the pandemic. The group is considering slashing production by more than 1 million barrels a day to revive plunging prices.

Industrial Metals

Commodity prices came under more pressure last month, as a deteriorating economic outlook and a surging US dollar weigh on the value of the world’s raw materials. The price of copper has fallen by nearly a third since March. Some of the largest miners are warning that in just a couple of years’ time, a massive shortfall will emerge for the world’s most critical metal. The recent downturn and the under-investment that ensues only threatens to make it worse, not only for copper but for base metals in general. Analysts say, the market is just reflecting the immediate concerns. But if people thought about the future, the world is changing. It’s going to be electrified, and it’s going to need a lot of metals. The latest price volatility means that new mine output, already projected to start petering out in 2024, could become even tighter in the near future. Last month, mining giant Newmont shelved plans for a $2 billion gold and copper project in Peru. Freeport, the world’s biggest publicly traded copper supplier, has warned that prices are now “insufficient” to support new investments. Commodities experts have been warning of a potential crunch for months, if not years. And the latest market downturn stands to exacerbate future supply problems by offering a false sense of security, choking off cash flow and chilling investments. It takes at least 10 years to develop a new mine and get it running, which means that the decisions producers are making today will help determine supplies for at least a decade. While much of the attention has been focused on lithium, the energy transition will be powered by a variety of raw materials, including nickel, cobalt and steel among others. When it comes to copper, millions of feet of copper wiring will be crucial to strengthening the world’s power grids, and tons upon tons will be needed to build wind and solar farms. EVs use more than twice as much copper as ICE cars, according to the Copper Alliance. Bloomberg estimates that demand for copper will increase by more than 50% from 2022 to 2040. To put it in context, in human history, we have mined 700mt of copper. To meet renewable energy demands, we need to do it all over again — but in the next 22 years. That’s setting up a scenario where the world could see a historic deficit of as much as 10mt in 2035, according to the S&P Global research.

Precious Metals

Gold equities continue to be impacted by competing macro themes that represent both headwinds and tailwinds. On one hand, heightened uncertainty, both geopolitical and economic, is generating investor interest. On the other hand, gold equities have not escaped the recent market volatility with decade high inflation and rate hikes. Some investors are turning to precious metals as a store of value. While on the operational side of the mines, the threat of margin compression due to cost inflation is growing, and investors have been concerned about capital cost inflation for companies building new mines or expanding existing operations. Analysts expect to see a continued trend of investors preferring capital returns over growth, a sentiment that is not aided by inflation, which is perceived to increase the risk associated with capital-heavy growth projects. However, the gold price remains conducive to strong free cash flow generation, as it is still above its historical average. The world’s top gold mining executives see cost pressures sticking around into next year – those gathering at the Denver Gold Forum recently shared a collective view that the current economic environment is unprecedented. Gold prices are under pressure and equities tied to the yellow metal have slumped. Rising costs are plaguing mining companies and their operations around the world. While there has been a cooling of fuel prices, other components key to mining, including explosives and reagents, haven’t come down yet thanks to persistent inflation. According to analysts, such an environment leaves room for mergers and consolidation, especially for miners with cash and a need to grow. The best risk mitigator for any mining company is liquidity – The portfolio of the precious metals champions fund is on one hand defensive thanks to its by-mix of physical gold but also because of the selection of low cost and low indebted companies which are still generating a lot of cash even in an inflationary environment. Currently, the weighted average cash margin of the portfolio is standing at close to 50%, with an AISC of only $ 726/oz and a negative net debt to equity (companies are debt free). Even with gold prices at $1’660/oz, these companies are generating a free cash flow yield of over 11% next year – as much as never before.

ICG Commodity Update – August 2022

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

Energy

Oil declined by more than 20% in the three months through August, overturning all of the gains since Russia’s invasion of Ukraine at the end of February. Investors are focusing on tighter monetary policy around the world, which could crimp economic growth and eventually hit oil demand. Notwithstanding that we are in the midst of a global energy crisis. There are regional differences and levels of exposure to the energy crunch. However, few expected that in 2022 Europe would be burning more coal, importing more liquified natural gas, shifting from gas to oil for industry, and spending more money to subsidize fossil fuel consumption. Mainly, European and Asian natural gas prices trade at record high levels. Russia cut exports to Europe to multiyear lows this summer supplying less than a third of normal volumes and there’s no clarity on further moves. Europe is filling its gas reserves for the winter through alternative supplies (LNG imports YTD up 70% from 2021 levels) but also demand destruction and substitution. Nevertheless, European gas storage facilities are about 75% full. Despite the cuts, the pace of refilling is at average levels thanks to alternative supplies. There is a high probability that Europe reaches its goal of filling storage to 80% by the end of October, traditionally the start of the heating season. Yet, electricity prices jumped in Germany to >€600/MWh for the first time ever. The current price is >1’000% higher than the €41.1/MWh 2010-2020 average. High prices are likely to persist because in a case of a cold winter creating high gas demand, Europe has limited ability to increase its current flows from non-Russian sources and there is still the threat that Russia could shut off its remaining flows at any moment. Numerous industry executives, including the chief executives of Chevron and Shell have said recently that they expect the market to remain tight also for crude oil. Last week Saudi Prince Abdulaziz bin Salman said the oil futures market has become increasingly disconnected from supply and demand for energy. Saudi Arabia is considering cuts to OPEC+ production to try to balance this, a move that other members of the oil cartel said they may also support. The total free cash flow generated by all public oil and gas companies is expected to increase from $340bn in 2021 to >$550bn this year! This will be the highest value on record. Interestingly, all publicly-listed energy companies (excl. Saudi Aramco) have a combined market cap of $3tn, which is about Apple’s market cap even though these companies collectively generate 5x higher free cash flow. Further to that, given meaningful cost reductions, a robust commodity outlook and growing focus on cash harvesting, BMO believes that the industry ROCE could reach its highest level in 15 years, potentially exceeding 25% by 2023.

Industrial Metals

Recession fears continue to grip commodity markets, with oil, petroleum products, aluminium, wheat or sugar well below YTD highs and forward curves weaker. Goldman Sachs says commodities are pricing a recession more so than any other asset class. Nevertheless, they believe that commodities are the best asset class to own during a late-cycle phase where demand remains above supply. Mainly because physical fundamentals signal some of the tightest markets in decades. Inventories are in almost all markets significantly below the 5 year average and some stand at risk of depletion. Interestingly, Goldman Sachs analyzed the largest 50 copper projects, which are likely to bring 4mt of additional copper supply by 2026. Most of this incremental supply is likely to come online in the next 2 years, after which supply growth decelerates significantly. The majority of supply additions in 2027/28 come from unapproved projects, implying risks of delayed project starts and supply additions shifting to after 2030 given project complexity and scrutiny on ESG: 50% of projects were delayed by an avg. of 3 years vs 2018. By the way, US mining companies, automakers and a bipartisan group of congressional members are recommending that the US federal government cut the time needed to permit a new mine in order to boost domestic production of EV minerals. Further to that, Chile’s state-owned copper company Codelco cut its production outlook for 2022 to 1.49-1.51mt, down from a previous forecast of 1.61mt. Codelco’s production outlook for 2023 is also lower at 1.45mt and at risk according to local newspapers. The long-term supply gap remains unsolved, with widening mid-term deficits. Goldman estimates miners need to spend $150bn of capex over the next decade to solve the expected deficit of 8mt. On the other side, copper demand is likely to accelerate given the push towards a low-carbon economy and growing green copper demand. Indeed, REPowerEU plans using over $200bn of grants and other incentives aims to triple its wind and solar by 2030. In the US, the climate bill called the Inflation Reduction Act unlocks $370bn for clean energy but will likely trigger some $1.2tn in private investments by 2035 acc. to WoodMac. As we have highlighted several times, we still live in a material world. An energy system powered by clean energy technologies differs profoundly form one fueled by traditional hydrocarbon resources as they require significantly more industrial metals. Considering the difficulties to bring new mines online we are not surprised to see increasing M&A activity in the sector. Rio Tinto is buying Turquoise Hill Resources in a deal valued at $3.3bn, securing more control of a giant copper mine in Mongolia. BHP announced an $5.9bn offer to buy Oz Minerals that was declined. Nevertheless, it’s the first M&A transaction for BHP since 2011.

Precious Metals

Gold, silver and PGMs came under renewed pressure as the dollar resumed strengthening. Silver has now fallen below $18/oz for the first time since July 2020. Chair Powell’s Jackson Hole address struck a more hawkish tone, reiterating records caution “strongly against loosening policy prematurely” and acting as a cudgel against those looking for rate cuts in 2023. The market was too quick to price in a dovish shift by the Fed and with Fed member comments signaling continued focus on inflation. On the positive side, we saw some support from dip buying gold demand by EMs and central banks. The recent spike in Chinese gold imports is driven by a recovery in retail demand as lockdowns moderated occasionally. Looking at PGMs, stronger than expected shipments of platinum to China in the first half of the year spurred shortages elsewhere as supply declined from mines and recycling, the World Platinum Investment Council (WPIC) said. It was difficult to track what happened to some of the Chinese imports, so the platinum market was in surplus on paper but on the ground tightness sent lease rates surging to the highest levels in a decade, the WPIC said in its latest quarterly report. Metals Focus has released its Gold ESG Focus 2022, a report which looks at a number of ESG metrics across 16 of the largest gold miners. This shows that in 2021 combined Scope 1 & 2 greenhouse gas emissions dropped 1% YoY to 27’617kt CO2e, while water withdrawals dropped 5% YoY and water consumption 24% YoY. With this, the average emissions intensity of gold production fell 3% YoY to 0.81t CO2e/oz. Meanwhile, tax and royalty payments rose 39% YoY (with a higher average gold price and increased extraction) while community development spend rose 7% YoY. On the company side, Barrick Gold said it agreed to sell a portfolio of royalties to Maverix Metals for up to $60mn – the portfolio consist of 22 royalties on the production of minerals from mines located in North America, South America, Australia and Africa. Consideration consists of $50mn in cash and up to an additional $10m from three contingent payments. In general and despite the bearish sentiment for gold we see the precious metals companies at its best shape in history. The sector is going to be debt free this year. Our PMC portfolio companies have already net cash on their balance sheets. Miners cash costs increased recently amid the global inflation shock. However, margins are still above the average of the last few years. The free cash flow is as high as never before with an industry FCF yield of >8% – this will certainly result in higher dividends and shares buybacks.

Energy Crisis & Opportunities

Einleitung

Der Welt mangelt es derzeit an allen Formen von Energie. Während die erneuerbare Energieerzeugung und die Energiewende die Diskussion beherrschen, ist die Welt nach wie vor in hohem Maße von fossilen Brennstoffen – vor allem Öl und Gas – abhängig, und das wird voraussichtlich auch kurz- bis mittelfristig so bleiben.

Der Öl- und Gassektor war in den letzten zehn Jahren wahrscheinlich einer der unbeliebtesten Sektoren, was vor allem auf schlechte Aktionärsrenditen und ESG-Überlegungen der Anleger zurückzuführen war. In dieser Zeit haben die Unternehmen ihre Geschäftsstrategie bereinigt und sind gesünder als je zuvor – sie produzieren Cashflows in Rekordhöhe und halten ihre Kapitaldisziplin aufrecht, während sie sich auch im Hinblick auf ESG verbessern.

Obwohl die Öl- und Gasindustrie im vergangenen Jahr zu den Sektoren mit der besten Performance gehörte, sind die Anleger immer noch stark untergewichtet. Die Unternehmen erzielen derzeit Rekordmargen und belohnen ihre Aktionäre mit Dividenden und Aktienrückkäufen wie nie zuvor.

Die aktuelle Situation auf dem Energiemarkt sollte nicht nur als Krise, sondern auch als Chance gesehen werden.

Q&A über die aktuelle globale Energiesituation

Behandelte Themen

• Wie sich eine Rezession, ein inflationäres Umfeld und steigende Zinssätze auf die Energiemärkte auswirken

• Rentabilität und Aktionärsrenditen von Öl- und Gasunternehmen

• Das zukünftige Geschäftsmodell eines Energieunternehmens

• Überlegungen zur Kombination von fossilen Brennstoffen und ESG-Integration

Bitte klicken Sie auf den untenstehenden Button, um Zugriff auf den vollständigen Bericht zu erhalten.

ICG Commodity Update – July 2022

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

Energy

Oil markets remain tight. At present, the global crude market faces a deficit of 2mboe/d and stockpiles are near record low levels. However, a key discussion with investors is related to potential demand destruction in a recessionary scenario. History shows that demand growth was negative in only 10 years since 1965. Equally, the demand decline was limited even during recessions. While recent US data has suggested that economic weakness is starting to impact oil demand, some analysts think that the pullback along with continued cost inflation will put additional pressure on supply, ultimately prolonging the duration of the current commodity super cycle. Indeed, low spare capacity continues to weigh on OPEC’s ability to deliver on its quotas. Further to that, with Saudi saying that its long-term max production capacity being only 13mboe/d, the world is increasingly looking for incremental barrels. However, public operators are not moving to accelerate activity levels in a hyper-inflationary environment, and service providers, are not investing in additional capacity, as supply chain and a lack of access to capital are increasingly barriers to entry. Gas markets are also tight, mainly in Europe. Russia cut exports to Europe to multiyear lows this summer supplying less than a third of normal volumes and there’s no clarity on further moves. Related to that, electricity prices jumped in Germany to >€400/MWh for the first time ever. The current price is ~1’000% higher than the €41.1/MWh 2010-2020 average. However, European gas storage facilities are about 69% full, with the pace of refilling at average levels despite the cuts. Nevertheless, EU nations are quickly lining up alternative supplies and import infrastructure. According to most analysts energy stocks offer the most attractive risk/reward opportunity within equities, especially after the recent sharp correction. Energy is a deep value sector that is simultaneously improving on quality, growth and income factors, a rare combination. The sector should deliver strong relative and rising capital return (dividend yield +4%, growing buybacks $16bn announced YTD, +100% vs FY21) funded by +20% FCF yields. Indeed, analysts keep lifting earnings forecasts for energy companies at a fast pace, and the stock market is struggling to keep up. As a result, the Stoxx 600 Energy index is now the cheapest sector in Europe, with a record low fwd P/E of 5x and trading at a historic discount relative to the Index of 56%. As a revenge of “old world economy” Exxon generated in 2Q22 more free cash than Alphabet and is #3 in the S&P 500 behind Apple & Microsoft. Chevron jumped up in the ranks with cash inflow to #5. Nevertheless, energy stocks remain broadly under owned. However, there is growing concern about ESG underperformance, resulting in many institutions starting to revisit their existing ESG frameworks and looking at different ways of softening ESG objectives all of which should translate to incremental equity flows into energy.

Industrial Metals

According to a new S&P Global study, unprecedented and untenable copper shortfalls in the coming decade put the global shift away from fossil fuels at risk. The bullish findings are a long way from the slowdown of recent months, when copper lost a thirds of its value from a March peak. Analysts from Goldman Sachs to Bank of America have slashed their near-term forecasts in anticipation of a drop in consumer spending and industrial activity. Longer term though, the equation changes. Demand is set to reach around 50 million tons by 2035 from 25 million today. With new deposits trickier and pricier to find and develop, the main sources of new supply would come from recycling and gains at existing mines. Based on current trends, an annual supply shortfall of almost 10 million tons would open up in 2035, the study of S&P found. That’s equivalent to 20% of demand projected to be required for a 2050 net-zero world. Even assuming aggressive growth in capacity utilization and all-time high recycling rates, the market would still face persistent deficits, including nearly 1.6 million tons in 2035, it said. According to McKinsey, big deficits like the study found are hypothetical, with higher prices potentially boosting supply or curbing demand. Copper is not the only important base metal to the green energy story though – Teck Resources recently published an estimate of the resources needed to build a 13MW offshore wind turbine: 125t of copper, 7t of zinc and 700t of steelmaking coal among other key commodities, showing clearly the importance of commodities in a green, electrified world. On the equity side, quarterly results of the top mining companies came in with most miners flagging higher costs due to inflationary pressure and lighter revenues due to the commodity price slump in recent months. Although companies are facing rising costs, profitability is still strong – while Rio Tinto for example reported a decline in first-half profit, resulting in a dividend cut, the absolute figure of its dividend, $4.3 billion, is still an enormous cash windfall for its investors. For now, profitability remains strong by historical standards, and the biggest miners continue to pay out large amounts of cash to shareholders. However, producers including Rio and larger rival BHP Group have been warning about the threat of slowing global growth and surging energy prices. It is also important to underline the financial health of balance sheets in the industry during uncertain times. Rio Tinto ended the first half with $291 million of net cash, while the portfolio companies of the Industrial Metals Champions Fund are currently having a net debt/equity of less than 13%. Analysts wouldn’t be surprise to see an uptick in deal-making as valuations are still low and companies are having full coffers of cash.

Precious Metals

Gold rose to the highest level since early July as investors braced for a stormy period in US-China relations with House Speaker Nancy Pelosi heading for Taiwan. The precious metal often benefits from bouts of geopolitical turbulence, and the Pelosi trip only adds to tailwinds that have helped gold rebound from a 15-month low. Growing fears about the global economy have also aided bullion’s rise to a four-week high. Helping bullion’s recovery could also be an end to outflows from gold-backed ETFs after 21 days of uninterrupted withdrawals, according to Commerzbank AG analyst. On the equity side, Gold Fields investors may be softening their opposition to the company’s planned acquisition of Yamana Gold, CEO Chris Griffith said at a mining conference. Gold Fields in May agreed to buy Yamana Gold for ~$7b in an all-share deal that would make the South African miner the world’s No. 4 gold producer. Griffith has previously acknowledged investors’ concern, particularly over the 34% premium being offered. Gold Fields is trying to show investors that acquiring single assets would be much less value-accretive and much more expensive. Also, Gold Fields announced a more generous dividend policy and plans to list in Toronto as the miner seeks to convince investors to support its bid. Looking at the incoming quarterly reports, there was no surprise that gold miners are grappling with higher costs of labor, energy and supplies in the 2nd quarter. According to Newmont, the world’s largest gold producer, the company has observed cost pressures, including the impact from Russia’s invasion of Ukraine and increasingly competitive labor markets over the past eight months. In general, earnings season has just started for gold miners and with precious metals equities selling off alongside the broader market, Q2 financial results will provide another data point for investors to gauge the health of the sector. While mining companies in Q1 battled to various degrees with inflation, supply chain issues, and labor force challenges, analysts have seen a mixed narrative in Q2’s production results, with some companies largely conquering these issues while others remain impacted. With both gold and silver prices down, analysts still expect strong realized metals prices as most of the decline occurred after the quarter ended. Most investors will continue to be focused on costs as the main variable impacting earnings. Thanks to our dynamic investment approach and our focus on low-cost producers, ICG calculates that the average weighted cash costs of the precious metals champions fund, adjusted to inflation and currency, is standing currently at around $785/oz which results in a cash-margin above 50% at current gold prices and should leave room for shareholder returns.

ICG Commodity Update – June 2022

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

Energy

Oil headed for a third weekly drop, its longest losing run this year, on concern that a potential recession will cut into energy demand. Oil fell about 8% in June as investors fretted over a potential global slowdown, eroding a rally spurred by the war in Ukraine, interruptions to supplies and rising demand. The jump in prices alarmed President Joe Biden, who’s spearheading efforts to get producers in the Middle East to boost crude output. Even though oil fell in June, the world economy is short all forms of energy, with global natural gas and coal prices also soaring, as a result of improved fundamental conditions, poor policy choices and repercussions from Russia’s invasion of the Ukraine. Moreover, global refining capacity is also constrained, meaning that shortages of refined petroleum products are leading product prices to outperform crude oil prices. Relentless demand for energy has resumed following the COVID interlude, much as it has after any of the temporary downturns over the last 40 years. The world economy began to experience energy shortages in 2021 as demand recovered more quickly than many anticipated and supply growth continued to lag, in part due to the OPEC+ group managing the oil market. Then, seven years of underinvestment in productive capacity and infrastructure collided with the Western World’s pivot away from Russian oil and gas, creating an even bigger problem. Given the immovable force of climate policy and shunning of Russia supply, the only solution appears to be commodity prices that are high enough to weaken future demand growth. According to Analysts, oil is clearly driven by macro-economic developments at the moment, fundamentally, the market is still tight so downside is expected to be more or less limited. North American oil and gas equities have materially outperformed the broader market over the last 18 months. However, investors generally remain underexposed to oil and gas equities, with sector weightings not far off the lows in 1998/99. Somewhat incongruently, the sector’s earnings and free cash flow contribution to the market are more than double its weight in the S&P and TSX, and the sector is in the best financial position in more than 30 years. According to BMO, low investor exposure to oil and gas equities reflects misperceptions about the future of the industry as well as the causes of the sharp increase in crude oil and natural gas prices. Most generalist investors are convinced that oil is the new tobacco and should be avoided. Not surprisingly, oil companies are not taking their cash windfalls and re-investing them in new supply that would ultimately lead to lower oil prices and rather allocate their profits to shareholder returns via dividends and share buybacks.

Industrial Metals

Base metals booked the worst quarterly slump since the 2008 global financial crisis as China’s economy recovered only gradually and fears of a world recession intensified. Markets have been buffeted by both growth and inflation worries for some time now and are not getting any relief from G-7 central bankers, most of whom are intent on raising interest rates further. Early indicators for China’s economic activity tracked by Bloomberg suggest an improvement during June as Covid-19 restrictions were gradually eased. An overall gauge of the outlook returned to neutral after deteriorating for two straight months, though the recovery remains muted. It’s a dramatic reversal from the past two years, when metals surged on a wave of post-lockdown optimism, inflationary predictions and supply snarls. Inventories remain at critically low levels in several metals markets, setting the stage for potential price spikes. . Both exchange and estimated total stocks on average across the complex are at the lowest levels since at least 2000, leaving supply chains and prices more susceptible to supply and demand shocks, as well as financial market squeezes. Longer term, demand growth will have to be aggressively adjusted to cope with constrained supply across a number of energy transition metals, notably copper & nickel. According to analysts, the commodity bull market is not over, it has hardly just begun. Natural resource related equities experienced three distinct periods of outperformance over the past century. One period was associated with intense inflation (1970s), one period was associated with crippling deflation (1930s), and one period was associated with the China boom in the early 2000s. All of these three periods had one thing in common: commodity prices were extremely cheap relative to the broad market. Comparing the Goldman Sachs Commodity Index today with the Dow Jones Industrial Index, commodities remain still in undervalued territory. Investors have to keep in mind that despite the recent sell-off, almost all of the key commodities are trading well outside of the cost curves and as a results, margins and free cash flow yields of natural resource companies are still robust. Looking at the diversified miners alone, EBITDA expectations for 2022 are US 160bn, up 5% on 2021, with nearly half of the year’s EBITDA already banked. Even with analysts’ expectations of lower commodity prices going forward, they still support strong cash flow, with 2023 EBITDA of US$123 billion still the third highest year in a decade. Further, despite some inflationary pressure to capex and costs, analysts still expect free cash flow yields to be strong for the foreseeable future with solid balance sheets and potential for significant shareholder returns via dividends and share buybacks.

Precious Metals

Gold headed for a third straight monthly decline as investors weighed rising interest rates against recession fears, with central bankers warning of a longer-lasting inflation shock. Federal Reserve Chair Jerome Powell and his European counterparts may be forced to tear up their playbook of the last 20 years as they debate how to tackle persistent price pressures and slower growth. Speaking at the European Central Bank’s annual forum, President Christine Lagarde said it’s unlikely that the world will soon go back to a low-inflation environment as a result of the pandemic and geopolitics. According to analysts, the lingering uncertainty on the extent of policy-tightening to curb inflation may still be having a hold on the yellow metal’s prices, with central bankers’ comments continuing to reiterate their resolve in keeping prices down as a priority. Also, although for most market participants symbolic, the European Union is working on new sanctions to target Russian gold, matching a move by the Group of Seven nations aimed at further choking off Moscow’s revenue sources, according to people familiar with the matter. The impact from a ban on Russian gold imports by G-7 nations is likely to be fairly limited, given that the industry already took steps to restrict Russian gold. Looking at gold mining companies, the most important theme for most is inflation. While cost inflation is very real, and was a dominant theme in Q1/22 conference calls, analysts expect that higher-grade deposits, larger deposits, prudent management teams, and robust gold pricing should all act to maintain free cash flow margins. Assuming that the gold price remains robust, and inflation impacts other segments of the market, analysts expect that there is a good chance that investors could come back to the sector. This will be especially true if the companies maintain cost discipline and keeping their focus on dividends or shareholder returns in general. Most companies use a gold price assumption to calculate reserves that is roughly $1,400/oz on average, implying that the companies are retaining a relatively conservative stance in their mine plans. As with base metals miners, despite some inflationary pressure to capex and costs, analysts still expect free cash flow yields to be strong for the foreseeable future with companies being in their best financial health they have ever been – the net debt to equity of the precious metals champions funds portfolio companies is currently negative, meaning companies have more cash on their balance sheets than debt leaving still enough room for more dividend hikes and share buybacks to come, as we have already seen in the last couple of quarters.