TXF Global Commodity Finance Conference 2021 – Panel Discussion: The role of copper in the energy transition

Pablo Gonzalez, our Senior Portfolio Manager, was invited to speak at this years TXF Global Commodity Finance Conference in Geneva about the role of copper in the energy transition. You can watch the panel discussion in the video below. You can also access the slides by clicking the respective link.

Independent Capital Group – Slides for the TXF Global Commodity Finance Conference

ICG Commodity Update – September 2021

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

Energy

The latest gains for oil prices have come as part of a broader rally in energy markets, with depleted natural gas inventories and resurgent economic activity sparking fierce competition in Europe and Asia for natural gas to feed their power markets. A global natural-gas production deficit, depleted inventories, lower imports from Russia and a push from the Chinese government to slash emissions (switching out coal for gas) have all played a role in pushing gas prices higher. That comes as the Northern Hemisphere heads into the winter indoor heating months. Futures for US natural gas reached $5.8/MMBtu last week. They are up some 130% this year while European natural-gas prices have more than quadrupled this year. Coal and carbon-permit prices headed higher, too, adding to the strain on energy-hungry companies and industries in Europe and Asia. India’s power plants have only 4 days left of thermal coal stocks. A shortfall in global energy supplies is spilling into crude markets and could add momentum to this year’s rally in oil prices according to several analysts that increased oil price forecasts. Power plants are already starting to switch from using natural gas to using oil in Asia. China ordered its state-owned companies to secure energy supplies for winter at all costs. The order from Beijing is the latest sign that rising energy prices are becoming a political issue, after the White House recently said crude’s rally was a concern. Meanwhile, the OPEC+ alliance will meet today to review the next monthly increase. Paradoxically, high prices are partly the result of cuts to exploration budgets. Globally, producers have cut back capital spending by about half over the past decade. Therefore, not surprisingly, OPEC’s said consumers should brace for more energy shortages unless the world boosts investment in new oil-and-gas development. Despite its clear unpopularity the energy sector has been the best performing sector within the S&P 500 this year by a wide margin. Indeed, oil and gas companies are earning as much cash as never before. The positive price outlook and rising demand for oil has prompted renewed M&A activity, with ConocoPhillips agreeing to acquire Royal Dutch’s Permian Basin assets for $9.5bn in cash. This perhaps portends further consolidation among industry players as the O&G majors divest of assets for ESG reasons and smaller operators exit the market. Finally, we think, it’s becoming increasingly understood that the various ESG policies to reduce fossil fuel usage are having a counter-productive effect on energy prices, as renewable energy generation is not able to bridge the gap between continued demand and fossil fuel plants going offline as we transition to renewable energy sources. Interestingly, the OPEC secretary M. Barkindo said: the world can’t afford to underinvest in oil and the energy crisis in Europe and many parts of the world is a wake-up call. The ECF continues with an absolute and a relative strong performance.

Industrial Metals

The power crunch in the top base-metals consuming country has triggered production losses at smelters and fabricators in the past few months, hitting both supply and demand for everything from copper to tin. So far, the biggest impact has been felt at energy-intensive aluminum plants. According to Goldman Sachs, that has chocked off aluminum supply, just under 3 million tons of annual smelting capacity, fueling the metal’s rally to the highest level since 2008. While that’s already about 8% of China’s total capacity, the prospect of further power rationing as the country braces for higher winter demand will keep the sector under pressure. Policy makers in China are worried about higher commodity prices and are willing to intervene to drive costs down. While the nation’s position as the world’s top buyer gives some pricing power, ultimately, they’re hostage to the dynamics of supply and demand. According to analysts, Beijing announced the first of its metal sales in June, with more following in July and September. Since then, copper has remained near unchanged, while aluminum and zinc extended gains. Clearly, those sales were not enough to materially alter the market balance in the mid- to long-term. Looking at copper, prices for the bellwether commodity this year will probably average more than $4/pound – that would be a record annual average. The supply-demand equation for copper is very tight, even amid market-wide uncertainties fueled by Chinese property turmoil and global energy crunch. Copper plays a crucial role in in a global transition toward cleaner energy and transport. But not only copper, the world needs more mines to meet demand for battery metals required to shift to less polluting energy sources. The ability to build mines in a world where extractive resource industries has become more challenging as investors put greater weight on the environmental credentials of metals producers, while social issues including dealing with local communities have also been under the spotlight. That adds to industry challenges that include supply disruptions and rising cots of raw materials. The industry keeps its exploration budgets in check though. BHP, one of the world’s biggest miner, spent little more than it earned in an average 12-hour period last year exploring for new deposits. The company spent just $53 million looking for copper last year, when it posted record profit of $37.4 billion. The industry is universally bullish on copper, expecting a surge in demand while long-term supply looks constrained by the lack of new mine development. Yet part of the reason copper is so favored by miners and investors alike is because new deposits have been so hard to find. The company expects its total exploration spend to jump to $800 million this year.

Precious Metals

Gold prices were set for a second quarterly drop in three quarters as the prospect of the U.S. Federal Reserve tapering its pandemic-era stimulus strengthened the greenback, making bullion more expensive for holders of other currencies. Expectations that the Fed could withdraw economic support kept the dollar index near a one-year high. Spiking U.S. bond yields added to the currency’s firmness. Deepening safe-haven bullion’s woes, benchmark U.S. 10-year Treasury yields held above 1.5%, a level not seen since late-June. Reduced central bank stimulus and interest rate hikes tend to push government bond yields higher, raising the opportunity cost of holding non-yielding gold. While gold’s price action has been lacklustre, the fact that investors have already offloaded a lot of their gold holdings suggests prices shouldn’t drop much further. According to analysts, the fears of stagflation are growing ever stronger, which could once again spur interest in precious metals. Also, there are multiple crises currently threatening the global economy. In China, a slowdown in growth looks likely due to the power crunch and there’s still a risk from Evergrande Group’s financial woes. And while President Joe Biden has signed a nine-week stopgap funding bill that averts a government shutdown, it fails to resolve the threat of a US default linked to the debt limit. Even though gold ETFs suffer persistent outflows, holdings are still historically high. Looking at gold equities, Agnico Eagle Mines and Kirkland Lake Gold, the largest and second-largest gold producers in Canada, announced an all-stock merger, valued at about $13.5 billion that creates a new mining giant with its centre of gravity in Canada. The merged entity will produce about 2.5 million of its 3.4 million ounces of gold per year form Canadian gold mines. According to the companies, the deal will create regional synergies and at least $2 billion in savings during the next decade as the two companies have a large geographic overlap in their asset base, with a string of exploration properties, mines and ore processing facilities located in close proximity to each other. The low premium ties into a gold mining sector trend that dates to at least 2018 when Barrick Gold announced a no-premium all-stock merger with Randgold Resources valued at $6 billion and when Newmont announced its acquisition of Goldcorp valued at roughly $10 billion.

ICG Commodity Update – August 2021

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

Energy

OPEC and its allies agreed to stick to their existing plan for gradual monthly oil-production increases after a brief video conference. Ministers ratified the 400kboe/d supply hike scheduled for October after less than an hour of talks, one of the quickest meetings in recent memory and a stark contrast to the drawn-out negotiations seen in July. In the US, a government report showed a further contraction in nationwide crude inventories to the lowest level in almost two years, while the nation’s oil infrastructure continues to grapple with Hurricane Ida’s impact. Nevertheless, most processors that were hit by Hurricane Ida escaped major damage and are expected to be back online within three weeks, according to IHS Markit. As mentioned already several times, we think the shift out of fossil fuels will take place more slowly than the consensus expects. During these transition years, the energy companies offer a very compelling investment opportunity. A recent study from BMO shows that the implied price of Brent-equivalent crude oil required to cover the costs of finding, developing, and producing a barrel of crude oil and/or natural gas worldwide slipped 17% in 2020 to average $57.0/boe vs. $68.7/boe in 2019. In perspective, global supply costs are now >50% below implied levels at the 2014 peak! With oil at +$70/bl the oil and gas industry has amazing cash margins. However, the controllable characteristic of companies with higher returns is a focus on costs. We believe the key to long-term investment success is in identifying companies that take the full-cycle cost management responsibility seriously, resulting in superior returns on capital. The same BMO study also expect the industry’s ROCE to recover to 8% in 2021 and reach 18% by 2023, on an unadjusted basis—nearly as high as 2005. Further to that, to protect shareholder value during periods of lower oil prices, many companies have reduced spending and focused on capital efficiency, harvesting of cash flow, and returning free cash to investors. This trend was obvious during the 2Q21 results and we think this will continue for years as the industry is developing in an absolute cash cow. Last but not least, the median forward EV/EBITDA multiples for the sector have hovered near historical lows since mid-2018, in sharp contrast to the broader market. To put all this in context, the ECF portfolio companies have low costs (cash costs $13/boe), low debt (net debt/equity 35%), a low valuation (P/CF 4.6x) and a very high free cash flow yield (18.5% for 2022E). We think, all this continues to sound very attractive. For us its no surprise that BMO expects a multi year upcycle on oil and gas.

Industrial Metals

In August, commodities slumped on speculation that economic growth will slow a rebound in demand for raw materials with metals, agriculture and oil falling. According to analysts, the Fed’s upcoming reduction of asset purchases will remove some of the liquidity, which led to profit taking of some investors. The fast-spreading coronavirus delta variant is adding to investor anxiety, with recent weaker-than-expected data in the US and China suggesting the global economic recovery is slowing. While iron ore fell from its May record, attention is now turning to an uncertain outlook for consumption, raising the prospect of more sharp, short-term moves. China’s demand is showing signs of faltering, though expectations are building that authorities may turn to infrastructure to help prop up the economy. Some analysts are still massively bullish from these levels given the anticipated steel demand recovery once China overcomes the current COVID-19 outbreak. The market is being buffeted by sometimes conflicting policies in China, the top commodity consumer. Officials had turned to stimulus to boost growth, fueling demand for commodities key to infrastructure. At the same time, they sought to cut steel output and expectations for a flurry of restrictions saw mills front-load production in the first half. On the other hand, there are also long-term supply constraints that are likely to underpin iron ore. Vale, the world’s largest producer, has been trying to recover output since a dam disaster more than two years ago, while Rio Tinto has said it’s struggling to keep up with demand. Producers say the market remains susceptible to supply disruptions and short-term spikes are likely. Aluminum, another commodity targeted by production cutting in China, reached a fresh decade high. Some investment banks forecasting even further gains as the industry braces for a potentially seismic shift into deepening deficits. Supply is increasingly challenged, particularly in top producer China. The energy-intensive aluminum industry has come into China’s crosshair during a crackdown on pollution, while a seasonal power crunch has also dented output – China is responsible for almost 60% of aluminum production worldwide. In the years to come, demand looks set to soar in EV and renewable energy, and efforts to rein in the aluminum industry’s heavy carbon footprint could spell the end of a decade-long era of oversupply. The rally is creating a huge windfall for producers who’ve been plagued by weak prices for years. But the gains over the past year are adding further fuel to concerns over inflation as manufacturers increasingly look to pass on costs to consumers. The portfolio of the industrial metals champions fund is invested in in two of the top producers, Alcoa and Norsk Hydro. The fund offers its investors an exposure of almost 10% to aluminum and alumina, one of the main ingredients for primary aluminum production.

Precious Metals

Gold has dropped this year as progress in battling the pandemic eroded demand for haven assets and prompted central banks including the Fed to prepare to taper stimulus programs. Chair Jerome Powell said last week the US central bank could begin reducing monthly bond purchases this year, with the labour market making clear progress. In a speech to the Jackson Hole economic conference, Powell signalled the US central bank will remain patient and repeated that he wants to avoid chasing transitory inflation and potentially discouraging job growth in the process – a defence in effect of the current approach to Fed policy. According to analysts, an underperformance in job gains may support the stance for lower-for-longer rates, potentially translating to strength for gold. On the company side, South Africa’s Impala Platinum lifts pay-out on record profit. The company announced a fourfold increase in its dividend after surging platinum-group metals prices yielded a record profit. Impala follows Anglo American Platinum and Sibanye Stillwater in boosting pay-outs to investors. The final dividend of $680 million brings the total pay-out for the year to an equivalent of about 50% of free cash flow. This completes a turnaround for Impala, which just two years ago was on the verge of cutting jobs and closing operations. Supply shortfalls for the platinum-group metals are continuing to buoy prices, even as automakers, the largest consumers of the metals, slow down on some operations due to shortages of semi-conductors. According to the company, the medium-term automotive demand outlook for PGMs remains robust, with tightening emissions standards and rising production volumes from a COVID-19-depressed base, likely to support firm demand through the middle of the decade. The CEO of Impala also said that the company is studying plans to refurbish an old base metals refinery in Zimbabwe to ease bottlenecks at its main plant in South Africa. The additional processing capacity could also help lift the company’s nickel and copper output and make it easier to participate in new projects. The precious metals champions fund offers its investors exposure to the attractive PGM-market and holds 5 top-producer in the space. The 5 positions have an average FCF-yield in 2022E of almost 20%, EBITDA Margin 2022E of 54% combined with low P/CF of only 5.2x and an average net debt to equity of 19%.

ICG Commodity Update – July 2021

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

Energy

Brent averaged $74.3/bl in July, marginally higher +1.2% MoM, although this masks significant intra-month volatility. Oil prices have increased by 50% since the beginning of the year but circumstances changed in mid-July when OPEC+, after two weeks of haggling, reached a deal to boost production by 400kboe/d every month starting in August, with the baseline being increased for some countries. Indeed, some days ago, a Reuters survey reported that OPEC oil output rose in July to its highest level since April 2020 at about 26.7mboe/d, up 610kboe/d from June’s revised estimate. Therefore, output has risen every month since June 2020, apart from February. Interestingly, fundamental data continues to be robust with high frequency inventory falling 16.7mboe or 1.3% WoW and down to the lowest level this year. This suggests that despite increasing production levels, the market continues to be in deficit. It’s worth noting that 2H21 looks likely to remain in supply deficit, according to several analysts. Nevertheless, at the same time, the accelerated spread of virus mutations in recent months has stoked fears that the global economic recovery and with it the oil demand growth could be slowed. This, coupled with signs of increasing inflation risks, caused stock markets and oil prices to contract during the month (Brent falling 7% or ~$5/bl on 19. July). Oil and gas equities have seen a sharp pullback with all this (US shale XOP Index fell 20% in 2 weeks). On the other side, all 3 major gas hubs rallied further in July. This is the fourth consecutive month of price increases in natural gas. The gas market appears to be sending a clear warning signal to energy markets of the dangers of curtailed investment but recovering demand. A further focus on the micro side has been on oil and gas companies 2Q21 reporting season for signs of an increase in forward production guidance, but Exxon and Chevron reporting suggest that discipline will remain for now. The same with the listed small-to-mid-cap space where capital discipline paired with strong energy pricing is leading independents to enjoy a period of super-normal FCF generation, driving accelerated balance sheet repair and potential for increased shareholder return. All this was also visible in Europe where the Oil Majors reported strong earnings and strong increases in dividends and shares buybacks. ESG remains high on everyone’s agenda, but there is an increasing focus on tangible measurements of ESG metrics and greater emphasis on ‘direction of travel’ allowing for more rational differentiation we think. Nevertheless, global oil and gas companies have cut capital spending since mid-2020 as calls for them to cut carbon emissions and adopt sustainability policies grow while producer margins over the coming couple of years are among the highest at any point in history.

Industrial Metals

According to Goldman Sachs, commodities are set to rebound sharply after their recent sell-off unless there are widespread lockdowns to tackle the delta variant. If delta risk does not materialize, commodities are set for the next leg higher. The risk of material lockdowns is still relatively low, and the bank said, even if that happened, it would only delay their outlook by six to eight weeks, given past experience. Broad commodity demand has yet to be impacted and nearly every raw material market is still in deficit, while the structural drivers remain intact. The metals and mining companies have been holding back on capex, M&A and opting to return more cash to shareholders rather than push organic growth. Variable dividend policies tied to free cash flow have enabled higher payouts, subsidized by lower capital spending rather than an increase in debt. Debt across the industry remain at historically low levels. Despite ample financial capability for M&A, activity is the slowest in years. In general, the mining sector has been one of the biggest beneficiaries from the world’s efforts to emerge from the pandemic. The trillions of dollars poured into recovery packages have ignited demand for commodities, driving prices sharply higher and sending inflation pressures rippling through the global economy. While previous rallies lured the industry into ambitious investment plans to build and expand mines, many producers this time appear to content to return their profit windfalls to investors. Indeed, all the five Mining Majors reported their biggest-ever earnings for the six month through June and this resulted in announcing record returns to shareholders via strong dividend increases and more shares buybacks. Mainly iron ore has been a big driver of profit for the largest producers. The world’s biggest commodity after oil hit a record in the first half and has spent the last three months hovering around $200/t, a level not seen in a decade. Steel and copper prices both set fresh records this year, thermal coal has also soared, and even diamonds have had a resurgence. Even after a recent set-back, commodity prices across the board remain historically high for now and bless the mining industry with bumper profits. One of the largest copper producers, Freeport-McMoRan, gave a hint of what to expect – the company has wiped out $5bn of debt in the last 12 months, hitting its target months ahead of schedule, and setting the stage for an increase in shareholder returns. Of course, the mining companies are not immune to inflation themselves and are grappling with a rise in input costs such as oil or rising labor costs due to worker shortages. Also, governments in resource-rich countries, especially in Latin America, are looking at the industry as a source of extra revenue – for now though, the miners are cashing in like never before.

Precious Metals

Gold has just gone through a very healthy year of consolidation after hitting a high of $2’089 on Aug 7th, 2020. But don’t count gold out yet. According to analysts, it could be only a matter of time before gold prices turn back towards $1’900/oz and its all-time highs from last year. Gold prices have struggled to hold support around $1’800/oz as bullion is seeing little benefit from new lows in real interest rates. Commodity analysts at Credit Suisse noted that real yields are lower than levels observed last year when gold prices were trading at $2’000/oz. The lower real rate is being driven by increased demand for inflation-linked Treasury bonds amid concerns on the delta variant’s impact on US economic growth. It appears that gold prices have decoupled somewhat from yields in recent weeks, but Credit Suisse doesn’t expect this to last, suggesting near-term upside for gold. Peaking inflation, strong job growth, and the announcement of QE tapering could still bring some downside risk to the gold market, weighing on investment demand – including ETF outflows. Goldman Sachs expects the recent move in real rates to create a perfect setup for defensive investment demand into gold. The lack of gold performance so far this year is likely due to negative wealth shock to emerging markets from a stronger dollar and COVID-related income shocks, particularly as many emerging markets lack the social safety nets, according to the bank. Looking at equities, analysts say that price-to-earnings as well as price-to-book relatives have bounced from levels that ordinarily are associated with lows and are abnormally cheap on these measures – the companies of our PMC fund have a P/CF of only 7.1x and a P/E 2022E of 9x compared to the benchmark GDX which has a P/CF of 12.1x and a P/E 2022E of 18x. Historically speaking, gold shares trade at the same index level as 25 years ago, but with a 4-5 times higher gold price. Also, gold and gold equities can be a good diversifier against extreme global leverage. Both the commodity and the companies have lagged against other asset classes this year, indicating potential upside, especially when looking at profitability measures with ultra-low net debt – the companies of our PMC fund have an implied free-cash-flow yield of 15% in 2022E with nearly no debt (net-debt-to-equity of only 2%), while the benchmark GDX implies a 7% free-cash-flow yield in 2022E or just half as much. While the industry overall is valued cheaply, making enormous high free cash with low-to-no debt, our portfolio companies showing above average financial and operational metrics relative to its peers.

ICG Commodity Update – June 2021

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

Energy

Oil recently rallied to above $76/bl, its highest level since October 2018. Unlike then, when the market was supported by excessive fear of a potential stop in Iran oil exports, the current rally is driven by a steadily tightening physical market, with strengthening time spreads across WTI, Brent and Dubai. The tight WTI-Brent differential implies that North America is driving the current deficit, as local demand rebounds in the face of inelastic local supply. This tightening is in fact running slightly ahead of most analyst expectations, with high-frequency mobility and flying data pointing to global demand currently near 97.5mboe/d and with shipping data pointing to a still moderate ramp-up in OPEC+ exports. Goldman Sachs estimates that the global market is in a 2.3mboe/d deficit currently, with the remaining excess inventories down to 330mboe. At the current rate of draws, this excess will be gone within 3 months. However, oil prices are down this week as the market awaits the next OPEC+ decision, scheduled for July 1. While the need for higher OPEC+ output in August is clear, there remains uncertainty on the magnitude of this next output hike. Ultimately, much more OPEC+ supply will be needed to balance the oil market by 2022. Analysts forecast demand to rise by an additional +2mboe/d by year-end, leaving for a 5mboe/d supply shortfall, well in excess of what Iran (1mboe/d max) and US shale producers can bring online (expected up 0.3mboe/d through year-end). Therefore, it’s not so surprising to see some commodity traders like Trafigura or bank analysts like Bank of America saying oil may surge to $100/bl next year.
After the hard times of 2019/20, the higher oil prices came initially as a relief and now as an opportunity for the oil and gas producers. Firstly, a wider array of organic developments should provide good returns with budgeting at $60/bl; and secondly, the large-scale continuing divestment by the major oil companies – driven by a push towards greener energy – is providing scope for inorganic growth. Oil and gas companies are generating record free cash flows currently and valuation continue to be depressed. Further to that, futures prices for crude oil and natural gas remain well ahead of sell-side consensus expectations based on data compiled by Bloomberg. This suggests material CF / EPS revisions are anticipated in the coming months. We continue to see the current environment as a very attractive investment opportunity for the natural resource sector.

Industrial Metals

The global economic recovery continues and remains metals intensive, with demand expectations still being pushed higher. With this, analysts expecting widespread supply bottlenecks in terms of both raw materials and logistics. However, China’s anti-inflation rhetoric has been stepping up, dampening both physical demand aggression and financial market positioning. Analysts remain positive on current commodity prices and especially pointing out industry free cash flow which looks extremely robust. While demand tailwinds may be easing, with extended lead times and raw material markets susceptible to disruption, a supply risk premium to the cost curve can be justified over the coming quarters. Additionally, and adding another layer of complexity to commodity markets is the unusual situation where the developed world is leading industrial growth instead of China, mainly owing to the different timing of 2020 lockdowns. As excess economic support is slowly drained from the Chinese economy, the US and Europe currently lead the way in physical end-demand indicators. As the IEA recently noted, the shift towards clean energy naturally involves burning less fuel but building more equipment. Indeed, on the IEA estimates, since 2010 the average amount of minerals needed for a new unit of power generation capacity has increased by 50%, with an onshore wind facility requiring nine times more mineral resources than a gas-fired plant of the same capacity. According to some analysts, the energy transition is much more important for future demand than for the current market, and while the thematic trend has undoubtedly driven asset allocation towards the sector, in their view it is merely a supporting act in the current demand upcycle. The metals and mining industry on the other hand isn’t immune to inflation. Oil prices are a significant input cost – analysts expecting to see cost inflation creep into earnings over the coming quarter. However, unlike previous cycles we are not seeing the same surge in capex-related costs, with lower growth spending meaning less exuberance in pushing projects. Furthermore, management is expected to remain disciplined and as a result, cost gains are unlikely to provide shocks. Most commodity prices remain trading well out of cost curves and with the relative lack of supply response, there is less need to spend time pushing supply off the market through the inevitable cycles over the coming years. This should lead to a period of sustained free cash flow and strong margins over the coming years well above longer-term cyclical norms for incumbent producers.

Precious Metals

Although precious metals already have one eye on a potential Federal Reserve tapering cycle, analysts expect relatively sticky demand support for gold and silver from both central banks and ETFs over the next few months, particularly if wider market volatility increases. Unsurprisingly, given rising inflationary pressures and positive economic growth surprises, central banks around the world are increasingly setting the stage for less accommodative actions over the coming months and quarters. As Federal Reserve Chair Powell recently noted, it is time to start talking about tapering. As BMO Economics notes, Fed policy (and the same is true for many other central banks) appears destined to become less accommodative but remain meaningfully net accommodative overall through 2023 at least. Compared to other commodities, 2021 hasn’t been a great year for gold so far, with current prices slightly down over those at end-2020 and ETFs seeing outflows. And yet, things are well on course for yet another annual average record in terms of nominal price. For gold producers, even with cost inflation starting to show some signs of a comeback, operating margins are extremely robust, and with the industry now showing impressive capital discipline relative to past cycles, analysts anticipate strong free cash flow over the coming years. This is seen as the important story for gold equities, rather than potential for further aggressive underlying commodity price gains. Regardless of this, investors continue to be generally sceptical of the discipline of company management teams and potential for erosion of free cash flows including the increasingly heated M&A market, which has seen a recent influx of transactions at higher premiums (versus the zero-premium “mergers of equals” which were seen last year). With a relatively flat, but very robust precious metals pricing environment, analysts believe that the entire group is trading at a discounted level. This can be seen for the Precious Metals Champions Fund portfolio companies. While trading at a P/CF of 6.9x and a P/B of only 2.9x, the expected free cash flow yields for 2021E, 2022E and 2023E are at 10.8%, 14.5% and 14.2%.

ICG Commodity Update – May 2021

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

Energy

The Brent crude oil price closed >$70/bl for the first time in two years on investors’ optimism that improving demand and a dwindling supply glut may mean the market can absorb additional production from OPEC+. Indeed, OPEC+ agreed to continue relaxing curbs on oil production. Vaccination programs are enabling governments across North America and Europe to reduce coronavirus restrictions and resume more normal economic activity. In the US, oil and oil-product inventories have fallen more than expected in recent weeks, thanks in part to a pickup in demand for transportation fuels. However, this month the supermajors’ transition strategies were in the spotlight. Indeed, demands on big oil to adopt policies supporting the energy transition are escalating. The Hague court in the Netherlands ordered Shell to cut its emissions by 45% by 2030, an order that includes scope 3 emissions. Shell is appealing this ruling. In the US, the activist fund Engine No.1 won two board seats on Exxon’s board. This follows a debate with the company’s management over its energy transition strategy, which the hedge fund claims to be ‘value destructive’, as it keeps focusing on fossil fuels. On Chevron’s side, shareholders backed a proposal calling for the company to ‘substantially’ reduce scope 3 emissions in the medium to long term with 61% approval. These events will likely have long-term reverberations for the energy industry regarding capital allocation, oil supply/demand balances and legal and governmental issues. Further to that, the IEA created waves across the industry through the launch of its report “net zero missions’ by 2050”. One of the recommendations is that there is no new investment in oil and gas beyond 2021. Underlying this recommendation is its assumption that global oil demand declines steadily as consumers change behaviours and new technologies are rapidly (and aggressively) adopted. While we recognize the IEA is merely providing a scenario and highlighting policy options to achieve a net zero world by 2050, we believe that some recommendations are still illusory. In our view, the effect of a sudden complet stop of investments in the fossil energy industry could harm the world more than it helps, at least in the short-term. We think it’s nearly impossible to change the whole supply chain and infrastructure in such a short period of time. The renewable “alternatives” are definitely not ready to absorb this increasing energy demand yet. We need a change but unfortunately its not as fast as some people (govt) would like to have it. Some analysts even think that all these efforts create a very real possibility of crude oil prices spiking to unprecedented levels within the next few years. Ironically, such a spike may be just what environmental-leaning governments would like to see. Nevertheless, ECF companies are in their best shape in history and have a FCF yield of 12% this year, EBITDA margins of >60% and with a valuation of 5x EV/EBITDA continue to be in a sweet spot.

Industrial Metals

In May, many metals hit new cyclical highs as buyers fear further inflation scramble for supply, particularly as freight bottlenecks inhibit prompt deliveries. As supply risk remains prevalent, analysts expect prices at elevated levels over the coming months and thus, mining industry margins to remain extremely strong across both base and precious metals. Especially in the steel space, analysts expect industry margins to remain well above through-cycle norms for the next quarters. Steel is the cornerstone of global industrial growth, but it is also an industry where, over much of the past decade, low effective capacity utilization has kept margins subdued. And one key element driving that has been ongoing Chinese capacity additions and resultant deflation shipped to global markets via elevated exports. However, China’s decarbonization push has the potential to alter this trend dramatically, at least in the near term. With export rebates removed and China’s government reportedly gearing up for further capacity curbs to lower emissions into H2 this year, analysts are confident that Chinese net steel exports will be significantly lower for the rest of the year. Meanwhile, the situation is most acute in North America. US spot HRC prices reached another all-time high last month on extended supply tightness and strong demand. Most of the supportive drivers remain intact, with exceptionally low inventories, continued demand resilience, extended lead times and rising scrap prices. Also, copper is still standing at prices close to record levels with available on-exchange inventory cover thin, particularly in the robust ex-China market. The raw material end of the market remains extremely tight and fraught with near-term supply risk. Especially elections in both Chile and Peru due over the coming months, potential for enhanced supply disruption via industrial action is rising, while the shipping issues afflicting many markets are also hindering copper concentrate trade, most notably from Africa. Underpinning higher metals prices is a decision made by the world’s big miners half a decade ago to stop pumping ever-expanding supply onto the global market and focus on profitability. Now opening new mines will take time, even as Trafigura estimates an additional 10 million tons of annual copper production will be needed by 2030. IMC portfolio companies are reaping in the benefits of cost savings and capex cuts made years ago und generating record margins – FCF yield for 2020E is standing at a record of 10.2%, while the EBITDA margin is forecasted to grow to almost 50% in 2021E. Also, with a dividend yield of close to 3.5%, the industry is starting to payback to its investors.

Precious Metals

Analysts see an opportunity for precious metals outperformance over the coming quarter, with gold back in favour with asset allocators and traditional bar, coin, and jewellery demand seeing a continued recovery. BMO states that investors should keep a close eye later in the year for signs that the FED and other central banks are giving greater clarity on timelines for paring asset purchases. Gold headed for the biggest monthly advance since July, with inflation risks in focus ahead of key US jobs data due later that will offer clues on the economic recovery. Some Federal Reserve officials have said that recent price pressures are to be expected as the economy reopens amid pent-up demand and should prove temporary as supply glitches abate. The PCE price index, which the FED uses for its inflation target, rose 3.6% from a year earlier, the biggest jump since 2008. Many market participants see the question about inflation quite different than the FED. Gold erased its 2021 losses in May amid signs of accelerating inflation and a potentially uneven economic recovery due to the resurgence of COVID in some countries. Investor interest has also returned, with hedge funds and other large speculators boosting their net-long position in gold to the highest since early January. Looking at PGMs, UBS expects platinum markets to remain undersupplied in the near term. The market was slightly undersupplied in 1Q21, which marked the fourth quarter in a row. Although total supply will be higher this year compared to 2020, the bank expects demand to rebound due to rising vehicle production, where platinum is used in catalytic converters for diesel cars and trucks, stronger jewellery demand, and healthy investment demand. Also, investment demand will benefit from expectations of palladium-to-platinum substitution in catalytic converters for gasoline cars. Johnson Matthey, a producer of catalysts, is expecting platinum demand in gasoline cars to climb steeply this year, albeit from a low base as car producers aim to reduce costs. This assumption was also underlined by the management of Sibanye-Stillwater, one of the largest PGM producers of the world and a PMC portfolio company. The company said that they already see substitution of palladium and rhodium by OEMs due to high prices and expects platinum to outperform. The company, with an estimated 35% FCF yield this year and a valuation of around 3x EV/EBITDA announced just yesterday a 5% buyback starting from June 2nd. With a weighted average dividend yield of 3.2%, the PMC portfolio companies offer a yield which is more than double the industry average. Also, free cash flow yields are expected to grow from 7.2% in 2020E to more than 11.4% in 2022E with extremely low net debt to equity of 4%.

ICG Commodity Update – April 2021

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

Energy

After collapsing a year-ago, crude oil has roared back amid a recovery in Asia, positive vaccine news and the lifting of lockdowns in some countries. Brent crude has gained 30% in 2021 as investors bet the re-openings will stoke consumption and keep draining inventories. Indeed, activity levels as measured by mobility have resumed their upward trajectory, particularly in countries of advanced vaccination (US, Israel, UK), e.g. US gasoline demand is near 2019 levels and domestic jet demand is +20% since March. Alongside this is the seasonal upswing in transportation, manufacturing and construction activity that begins now and accelerates into June. During this phase Goldman Sachs expects the biggest jump in oil demand ever – a 5.2mboe/d rise over the next 6m, 50% larger than the next largest increase over that time frame since 2000. Further to that, falling global oil inventories support the general view that the oil market has been significantly undersupplied this year. Also the head of Vitol Group, the world’s biggest independent oil trader, expects crude oil demand to increase by 7 to 8mboe/d by the end of 2022 and points out that producers will be stretched to meet that surge. All this is happening during a phase where, the push for clean energy also has some unintended consequences. Chief among these is that capital is fleeing the oil and gas sector and investment is plunging. The industry has slashed capital spending over the last 5 years due to lower oil prices and growing pressure from shareholders to focus on returning capital. In addition, some companies have begun to pivot investment away from oil in response to societal concerns about climate change. Some analysts expect the lack of capital spending could have serious repercussions as new supply fails to offset natural decline and keep pace with rising demand. JP Morgan showed that corporate crude oil reserves are depleting at record rates with the largest public oils globally had a negative 45% replacement ratio in 2020! It’s not surprising to us, that some people expect this could lead to a significant increase in crude oil prices in order to encourage companies to re-invest. Nevertheless, shareholders of oil and gas companies increasingly demand that companies harvest cash flow and increase shareholder returns through dividends and share buybacks. The underlying narrative that oil demand will eventually decline serves to reinforce this view. That’s not something bad per se. In our opinion, and despite all the known risks, we think that some oil and gas companies are uniquely positioned to provide investors with a relatively steady income stream over the next several years. We do not believe that this feature is adequately reflected in current market valuations given that some companies could essentially take themselves private in as little as 5 years, in theory. In fact, our ECF equities are generating > 12% FCF yield pa over the next 3 years and the valuation is still at EV/EBITDA 2022E of 4x.

Industrial Metals

In April, Goldman Sachs released an updated study stating, “Copper is the new oil”. According to the bank, copper as the most cost-effective conductive material, sits at the heart of capturing, storing, and transporting the new sources of energy to decarbonize the world. At the core of copper’s “carbonomics” is the need for the world to shift away from a production system based on hydrocarbons, to one based on a range of sustainable sources such as solar, wind and geothermal. Copper has the necessary physical properties to transform and transmit these sources of energy to their useful final state, such as moving a vehicle or heating a home. Goldman estimates that by 2030, copper demand from the transition will grow nearly 600% to 5.4Mt in its base case and 900% to 8.7Mt in the case of hyper adoption of green technologies. They estimate that by mid-decade, this growth in green demand alone will match, and quickly surpass, the incremental demand China generated during the 2000s. Ripple effects into non-green channels mean the 2020s are expected to be the strongest phase of volume growth in global copper demand in history – Goldman also updated its price forecast for the metal and expects the price to reach $15’000/t in 2025. The copper market as it currently stands is not prepared for this demand environment. On the company side, the mining windfall is the latest sign of a boom in iron ore, copper and other metals that’s sending an inflationary wave through the global economy, increasing the cost of everything from electrical wires to construction beams. The top five iron ore mining companies are on track to deliver bottom-line profits of $65bn combined this year, according to estimates compiled by Bloomberg. That’s about 13% more than the five biggest international oil producers, flipping a decades-old hierarchy. This fiscal year will be just the second time this century that the big 5 out-earn their oil peers. During previous commodity boom, which peaked between 2008 and 2011, big oil easily made larger profits than big mining. Underpinning the tightness in metals is a strategic decision made by the miners half a decade ago. After spending years pumping ever-expanding supply on the global market, they ripped up growth plans and focused instead on shareholder returns. The result was that supply largely stopped rising and prices start to pick up. This means for investors, that during this wave of high prices, they’re likely to see more of the profits. Unlike in the last commodity “supercycle”, the miners are reluctant to pour their extra earnings into acquisitions or new mines and instead choosing to distribute record dividends. The portfolio companies of the Industrial Metals Champions Fund have on average a dividend yield of 3.3% and a expected free cash flow yield of 9.7% in 2021.

Precious Metals

Historically speaking, when gold prices go up, costs follow in lockstep. Now, however, Analysts see a disconnect. As prices rose last year, costs stayed relatively stagnant. Moreover, with limited growth capex being spent, balance sheets are naturally in much better position. Certainly, costs are set to rise this year owing to higher input prices, but margins are set to remain strong. According to BMO, the net effect of this phenomena, will give the industry a lot more optionality than seen in the past. High margins for miners have led to strong free cash flows. The challenge and the opportunity for gold miners is how to allocate these record free cash flows which are being generated. Balance sheet repair is largely complete across the sector, and return of capital through dividends, which was a key topic through most of 2020 and, while still important, should not be the only component of a capital allocation framework. Analysts often state that the global gold industry is still behind peer commodities in terms of consolidation and are expecting a new M&A wave. Currently, the world has double the number of producers over 500koz in size than at the low point, and while consolidation and partnerships have been to the fore among major producers, the spill over to the next level has been lacking. Gold is still lagging peers in consolidation. Speaking of M&A, Independent Capital Group recently participated at the Denver Gold Group Gold Forum and asked many companies about this topic. Although often cited in analyst papers, most participants favouring organic growth through asset development and/or exploration over acquisitions as valuations of development stage companies with attractive assets are currently high – preserving cash for shareholder returns and create value internally. Some participants are still looking for acquisitions though, while the focus will be more asset based than on a company level. Companies must balance among the priorities of maintaining a strong balance sheet, providing capital returns, and completing thoughtful growth as grade decline is an ongoing issue for quite some time now. Following some relative stability in recent years, grades are forecast to resume their inexorable decline, meaning ore processed by the end of this decade could be 3x that seen in the late 1990s. Gold has been out of favour as questions around a commodity “supercycle” have come up recently and the industrial side has outperformed. And yet, gold is in a pricing cycle with annual average prices above long-run inflation-adjusted norms for more than eight years. The Precious Metals Champions Fund portfolio companies are generating a free cash flow yield of over 10% in 2021 at current gold prices and are delivering record dividend yields of 3.4% and this at an EV/EBITDA of just 5.6x.

Partner der Independent Capital Group AG beteiligen sich an der Zurfluh Treuhand AG

Partner, der in Zürich ansässigen Independent Capital Group AG, beteiligen sich im Rahmen einer Nachfolgeregelung, zusammen mit der BERET-Gruppe, an der Zurfluh Treuhand AG (Arth/Zug). Die Transaktion erfolgt rückwirkend per 1. Januar 2021 und betrifft 100 Prozent der Aktien. Die auf Treuhanddienstleistungen spezialisierte Zurfluh Treuhand AG bleibt weiterhin als eigenständiges Unternehmen am Markt. Sämtliche Mitarbeitenden werden auch in Zukunft für das Unternehmen tätig sein. Die Geschäftsleitung besteht neu aus dem Gründer Erwin Zurfluh sowie der langjährigen Mitarbeiterin Pia Zürcher und Patrick Huwyler aus der BERET-Gruppe, welcher ab sofort das Team der Zurfluh Treuhand AG ergänzt. Mit der Beteiligung wird ein wichtiger Grundstein für die strategische Ausrichtung der Family Office Services der Independent Capital Group AG gelegt. Dadurch können nebst den Standorten Zürich und Basel neu auch Dienstleistungen aus den Kantonen Schwyz und Zug angeboten werden.

Independent Capital Group AG

Die Independent Capital Group ist eine unabhängige Schweizer Finanzboutique mit Niederlassungen in Zürich und Basel. Sie untersteht der Aufsicht der Eidgenössischen Finanzmarktaufsicht FINMA. Gegründet 2005, bietet die Firma mit ihren rund 10 Mitarbeitenden diverse Dienstleistungen in den Bereichen Vermögensverwaltung und -administration an.

Kontakt

Reto Michel, CFA                                                                              Mirko Kräuchi
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NZZ: Der Wettlauf um seltene Erden und Metalle hat begonnen – die Staaten mischen kräftig mit

«Von der Exploration bis zur kommerziellen Nutzung einer Mine vergehen in der Regel sieben bis zehn Jahre»

– Kommentare zum Thema seltene Erden von Pablo Gonzalez, CFA, Senior Portfolio Manager der Independent Capital Group, in der NZZ vom 27. April 2021.

Conference Distillate – The Denver Gold Group Gold Forum – April 2021

Independent Capital Group attended this years Denver Gold Group Gold Forum – Virtual Event from 13th to 15th of April. You can find the key takeaways in our Conference Distillate. We had the pleasure to talk to many exciting gold companies and would like to highlight 4 of our Precious Metals Champions Fund portfolio companies we met during the last 3 days.

– Sibanye-Stillwater with the Team of Investor Relations around Henrika Ninham, Chris Law and James Wellsted

– Torex Gold Resources Inc with CEO Jody Kuzenko, VR IR Dan Rollins and CFO Andrew Snowden

– SSR Mining Inc. with CEO Rod Antal, EVP & Chief Corporate Development Officer F. Edward Farid and Corporate Development & Investor Relations Brian Martin

– Kirkland Lake Gold (KL) with Executive Vice President Jason Neal, Vice-President Investors Relations Mark Utting and Senior Vice President Exploration Eric Kallio