ICG Commodity Update – September 2020

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

Energy

Crude oil was plagued by both supply concerns (Libya restarting, OPEC+ restlessness) and demand worries (C-19 flare up in Europe and parts of the US). As the number of global Covid-19 infections continue to rise, the return of restrictions that could reduce the number of cars on the road and overall economic activity is leading to market pessimism that oil demand will take a long time to recover. While the easiest gains on the oil demand recovery are behind us, most analysts still expect demand to continue to rise at a slower pace over the coming months. However, falling oil inventories across the globe suggest that the oil market remains undersupplied. Indeed, crude production of OPEC+ was likely stable in September vs August. Instead the US is now generating fewer than 11mboe/d, down from 13mboe/d early this year, EIA data show. Two-thirds of oil-and-gas executives who responded to a recent survey said they think US oil production will never fully recover. According to Deloitte 107’000 jobs were slashed in the US oil, gas and petrochemicals sector between March and August and seven out of 10 jobs lost will not be reinstated. Energy equities continued to struggle during the last few weeks. Lousy oil-and-gas earnings this year have turned off many investors, who remain unenthusiastic about the sector despite a modest rebound in crude prices from the historic lows of this spring. Indeed, Exxon and Shell recently said that key parts of their business continued to struggle through the summer and early fall, which will weigh down the third quarter results they are set to report in coming weeks. That is combining with longer-term concerns about future competition from renewable energy and electric vehicles to drag down the value of many oil-and-gas companies to decade lows. Share prices of Royal Dutch Shell and BP hit fresh 25-year-lows. Last week NextEra Energy, the large utility/renewable energy owner, nearly reached market cap parity with ExxonMobil. Actually, smaller, independent players continue to face a struggle for survival. A total of 36 producers filed for bankruptcy in North America in the first eight months of the year, according to Haynes & Boone, with combined debt loads of about $51bn. Rystad expects ~150 additional North American oil and gas producers to file for bankruptcy by the end of 2022 if crude prices remain $40/bl. The industry has lost some investors over concerns about the energy transition, even though the world will need large amounts of oil and gas for decades to come. The recent near-death experience for some oil producers is a good reminder that investors should focus on companies with strong balance sheets, ample liquidity, robust cost structures, and low sustaining capital requirements like we focus for the ECF. Despite the current challenges ECF companies should generate attractive cash flows going forward and come back even stronger (Div yield at 4.4% and FCF yield at 9% growing to 17% by 2022E).

Industrial Metals

Commodities, as well as financial markets, have been hit by fears that parts of Europe may enter a broad lockdown. Heightened US political uncertainty and rising tensions between the US and China have also contributed to the risk-off move. Before this, sentiment was already starting to weaken due to less positive surprises on economic data releases versus market expectations in the US and Europe and signs that central banks have become hesitant about stepping up their already highly accommodative monetary policies. But as potential new restrictions will likely be more localized, analysts don’t expect Europe to enter into a broad lockdown again. Hence, it’s not believed the latest pullback in commodity prices marks the beginning of a trend reversal. Copper, this year’s best-performing industrial metal, tumbled by the end of the month as traders were forced to liquidate speculative long positions in the face of an oversupplied market. But the long-term case remains constructive, with the global shift away from fossil fuels and well-defined resources laying the groundwork for a multi-year advance.  The “green-wave” relies heavily on base metals, especially copper. An electric vehicle for example contains about 3.5 times more of the metal than a comparable gasoline-driven one. Wind and solar require 2 to 15 times as much copper per unit of output as fossil fuel generation. In fact, no one wants mining, but they want the product. Mining companies capex and growth is slowing significantly on strict capital return of most investors. On the supply side, new resources will be tough to find. The world has valued and hunted copper for hundreds of years, suggesting that many of the major ore bodies have already been discovered and exploited. Also, short-term supply disruption due to COVID has been an important offset to demand weakness during the outbreak – secondary outbreaks, as seen worldwide, or additional mobility restrictions in key producing countries remain a threat to supply, while demand is recovering, mainly due to China. Overall the sector looks relatively well positioned albeit vulnerable if the broader market sells off due to slowing global growth, new Covid-19 waves or geopolitical tensions. Meanwhile, members of Union No.2 representing supervisors at the Escondida, the world’s largest copper mine, have voted to strike, according to reports. The decision to strike followed unsuccessful labour negotiations with management, with the latest offer rejected by >98% of the union.

Precious Metals

After hitting year-to-date highs, commodity indexes have dropped in September, while precious metals and energy have led the decline. With a fall of more than 17%, silver prices have plunged the most across the entire commodity complex. Precious metals, in particular gold, are waiting for the next leg in fiscal and monetary support or the next step down in negative real interest rate expectations. Analysts see a high likelihood that governments and central banks will step up their game to support growth again. This should add favourably to higher precious metal prices. Furthermore, the build-up of uncertainties ahead of the US election and the chance of a contested outcome boost the yellow metal’s attractiveness as a diversifier in a portfolio context. Silver prices should follow gold, but with considerably more volatility. Also, even as gold prices struggled in September, Investors are keeping their faith. Holdings in bullion-backed exchange-traded funds are wrapping up an 8^th quarter of expansion, the longest run in almost a decade. So far in 2020 they’ve surged about 860 tons, dwarfing any prior full-year inflow, and are near a record. Overall, the gold mining industry is still in a sweet spot. With gold prices near record highs combined with a relative low capex, gold mining companies producing record high free cash flows. Also, the industry is expected to be net debt negative by 2021, which should further spur pay-outs in form of dividends as well as share buy-backs. Gold-equivalent cash costs of gold producing companies fell already from $765/oz in FY2018 to $690/oz in FY2019 (PMC weighted average at $585/oz) – the gold industry is currently more profitable than at any point in recent history.

ICG Systematic Equity Fund CH Update – September 2020

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

• Nach ihrem kräftigen Rebound seit März verlieren die Aktienbörsen im September an Schwung – wieder anziehende Corona-Fälle sowie die vor der Tür stehenden US-Präsidentschaftswahlen führen zu tieferer Riskobereitschaft unter den Anlegern
• Angesichts einer anhaltenden Erholung der Realwirtschaft, welche die Erwartungen der Marktteilnehmer in der Summe übertrifft, setzen konjunktursensitive Sektoren ihre Outperformance gegenüber defensiven Branchen fort
• Aktien bleiben aus fundamentaler Sicht ein klarer Kauf – die Flutung mit billigem Geld sowie positivere Konjunktursignale geben Aktien Rückenwind
• Technisches Bild liefert Aktienanlagen breite Unterstützung – Überhitzungstendenzen bauen sich während der Konsolidierungsphase der Aktienbörsen ab
• Maximale Aktienquote von 100% per Ende September
• Stilmodelle werden defensiver – Präferenz für Aktien mit tiefer Volatilität und starkem Preismomentum
• Übergewicht in Aktien aus dem Industriegüterbereich auf Kosten von defensiven Branchen
• Der Systematic Equity Fund CH verliert im September leicht (-0.94%) – einer guten Titelselektion stehen Verluste aus Absicherungsgeschäften gegenüber

ICG Commodity Update – August 2020

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

Energy

Crude oil capped a 4th monthly gain in August but has struggled to hold >$43 as increasing coronavirus infections raise concerns about the sustainability of the demand recovery. Following a year of unprecedented shocks, uncertainties over oil fundamentals has never been higher. Even at the latest OPEC+ meeting, the group announced a very high compliance rate of 97% but the statement, while positive in tone, offered also cautious guidance for the coming months. Indeed, the oil market flipped into undersupplied territory in July. However, the fragility of the oil market was also highlighted, along with the significant uncertainties associated with oil demand, and all members were called on to be vigilant in the coming months. Only China, that had a stronger-than-expected PMI with its early recovery and robust fiscal/monetary support resulted in an oil demand level above last year’s. On the equity side, the 2nd quarter of 2020 will go down in history as one of the worst for the energy industry. A collapse in demand, a collapse in drilling activity, and a collapse in oil prices took their toll without exception. Company results were a sea of red. However, investor expectations were low, so generally speaking energy stock prices were unfazed by dismal results. Rather, investors scrutinized how management teams are planning to position their companies to ensure greater resilience to future oil price cycles. Many companies also used the opportunity to reset their stated long-term energy price expectations, resulting in big asset write-downs. Finally, a couple of companies adjusted their dividends lower and made them more flexible. Therefore, we think the exceptional situation was used by many to lower the bar and this should accelerate the earnings recovery from here. Dedicated energy investors are increasingly comfortable with the positive rate of change thesis on oil, especially the supply side. The thesis is grounded in the upstream commitment to focus on debt reduction, return of incremental dollars to shareholders, and staying disciplined on re-investment. Finally, the announcement of Exxon Mobil’s exit from the DJI Index has been widely seen as emblematic of the decline in importance of Big Oil as the wider sector’s importance dwindles (now <2.5% of the S&P). The current disparity is probably generated by a combination of the cyclical/structural and thematic/sentiment. Nevertheless, investor legend Warren Buffett increased his investments in commodity related companies (Dominion Energy, Barrick Gold, Japan’s 5 biggest trading companies) this year showing increasing interest in the commodity sector that was out-of-favour for too long and may become a big opportunity going forward, he probably thinks. ICG is looking also for the companies with the strongest moat on different variables and offer an attractive well diversified portfolio of best-in-class companies that will strongly recover with the increasing focus of general investors in commodities.

Industrial Metals

In August, copper climbed to the highest since mid-2018 after data showed China’s recovery is on track. Chinese economic activity continued to rebound in August. Signs of tight supply and a stronger-than-expected rebound in metals usage in China have driven prices higher since mid-March. Also, there are concerns about a shortfall in global copper output, with inventories on the LME dropping to their lowest since 2005 by the end of August. Treatment fees for copper concentrate extended declines this year, dropping below $50 a ton, according to data from SMM, another signal for a tight market. According to analysts, industrial metals continue to strengthen in general amid continued USD weakness, as supply disruptions dominate the narrative along with a persistent decline in LME inventories. COVID-19-related disruptions and risks to output continue to impact major mining operations globally. Bolivia’s largest mine for example has suspended operations indefinitely for the second time this year due to an uptick in infections across the country. Bolivia is a major producer of zinc and silver. Further to that, investors have also started to buy raw materials that they think will fare well if the Federal Reserve’s efforts to revive the economy stoke inflation. Market measures of inflation expectations, such as inflation breakevens, have risen during the summer. A 2015 paper for the Yale International Center for Finance found commodities were positively correlated with inflation between 1959 and 2014. In contrast, stock and bond prices tended to post small declines when inflation accelerated. On the company side, Zambia said Glencore and First Quantum Minerals are willing to sell their combined 90% stake in Mopani Copper Mines to state-owned investment group. Zambia has had an uneasy relationship with mining investors, clashing with Glencore earlier this year over the company’s plan to mothball Mopani’s operations after the pandemic hit copper prices. Also, Warren Buffett’s Berkshire Hathaway lifted the veil on stakes in five major Japanese commodity traders that dominate the nation’s energy and raw materials industries. That move will intensify a focus on the outlook for raw materials just as prices hit the highest since 2018. Berkshire’s stakes amount to a little more than 5%, but Buffett made clear that they could be increased. While the quintet operate in different areas, they derive much of their revenue from energy, metals and other commodities, supplying resource-poor Japan with essentials.

Precious Metals

Precious metal prices pulled back recently as long-dated interest rates rebounded, hitting silver and gold in particular. By the end of the month, gold stood at close to USD 1970 per ounce, while silver closed august at USD 28.1 per ounce. However, analysts expect prices to recover to their previous highs as real US rates can go more negative, USD weakness should continue, and growth and policy uncertainties linger. On the company side, gold miners continue to find themselves in a perfect storm scenario of rising revenues and falling costs due to low oil prices and efficiency gains. Barrick and Newmont for example, two of the largest gold miners, use $65/barrel and $60/barrel respectively for budgeting and guidance purposes. This implies significant free cash flow generation and downside to future costs vs. guidance. Analysts expect the theme will persist through 2021 as low real interest rates drive investor support for the metal and mining managements continue to focus on cost discipline. Also, gold miners are widening their investment appeal as dividends are boosted. According to Gold Fields CEO, more generalist investors search for yield amid low bond-market returns. The sector, which once largely drew attention of specialist funds, is no attracting a broader base of investors who previously considered gold miners too leveraged and high-risk. A sign for that is Warren Buffett’s recent move with adding Barrick Gold to Berkshire Hathaway’s investment portfolio after shunning gold producers for years. The buy comes as a bit of a surprise, Buffett has been critical of gold, saying it isn’t as good of an investment as businesses, farms, and real estate because the metal is not productive. While the stake in Barrick Gold is small for Berkshire Hathaway, Buffett’s company is now one of the miner’s top shareholders with a stake of close to 21 million shares. In general, Berkshire’s investment in Barrick is considered good for the whole mining industry.

ICG Systematic Equity Fund CH Update – August 2020

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

• Konjunkturzahlen, welche die tiefen Erwartungen der Marktteilnehmer zuweilen deutlich übertreffen, sowie die  Ankündigung von Nationalbanken, die geldpolitischen Zügel auf längere Sicht hin locker zu lassen, geben den Aktienbörsen auch im August Rückenwind
• Angesichts der positiveren Signale aus der Realwirtschaft setzen Zykliker zur Aufholjagd an – Krisengewinner “Gesundheit” und “Nahrungsmittel” mit klarer Underperformance
• Die anhaltende Flutung der Wirtschaft mit billigem Geld zementiert die Alternativlosigkeit von Aktienanlagen – klares Buy-Signal für Aktien aus fundamentaler Sicht
• Technisches Bild liefert Aktienanlagen breite Unterstützung – Einziger Wertmutstropfen ist die zunehmende Zahl an Overbought-Indikatoren, die vor zu hohem Optimismus warnen
• Maximale Aktienquote von 100% seit Anfang August
• Stilmodelle präferieren Aktien mit hoher relative Stärke und nachhaltigen Wachstumsaussichten aus zyklischen Branchen
• Übergewicht in Aktien aus dem Industriegüterbereich auf Kosten von defensiven Branchen
• Mit einer Performance von 4.93% konnte der SPI im August dank einer guten Sektorenallokation und Titelselektion um 2.90% geschlagen werden

ICG Commodity Update – July 2020

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

Energy

Analysts see global oil supply falling by 1mbpd from 2Q into 3Q, driven by a drop of 0.5mbpd for both non-OPEC and OPEC production. The massive cut in capital expenditures by oil companies could lead to structural oil production declines in non-OPEC countries, such as the US, in 3Q 2020. Supply should start to increase again, albeit modestly, in 4Q versus 3Q, when production from OPEC and its allies is set to rise due to the tapering of the oil production cuts and as curtailed oil production in North America should be restored by then. Looking at demand, analysts continue to envision a gradual rebound through the year-end and into 2021. However, end-2020 demand could fall well short of end-2019 levels given that people will take some time to return to their old habits after covid related restrictions are lifted. The market sees oil demand down 3–4mbpd year over year in 4Q 2020, weighed down by less economic growth and changes in behavioural patterns (home working, fewer flights). Oil demand in the aviation sector will likely only recover more strongly when a vaccine has been developed. The increase in people driving to work or parks, instead of using public transport, should somewhat offset the demand crunch. The subdued supply, combined with the returning demand results in an expected undersupply of the oil market in 2H 2020 and 2021. Looking at companies, Exxon is pulling multiple levers to preserve its dividend. After posting a 2Q loss of $1.1 billion, marking the oil giant’s first back-to-back money-losing quarter in at least 36 years, the oil major said it has identified significant potential for additional reductions and is preparing deep spending as well as job cuts as it fights to preserve a 8% shareholder dividend, also, the company noted that capital spending in 2021 will be lower than this year’s. Exxon already slashed this year’s budget by 30% in April. European oil majors like France’s Total or Anglo-Dutch Shell scraped out small profits against expectations of losses in 2Q with the help of the trading units which can exploit market gyrations even when prices fall. Shell for example avoided its first quarterly loss in recent history after bumper earnings in its trading business. Adjusted earnings fell to $600 million from $3.5 billion a year ago, beating analysts’ forecasts of a $674 million loss. There was also M&A activity in the oil market last month, with Chevron to buy Noble for $5 billion in stock which marks the biggest oil deal since prices crashed. The oil price crash has decimated shares of many energy companies, making them attractive targets for those that have weathered the downturn and have the resources to buy. Chevron ended the first quarter with a cash pile of $8.5 billion after withdrawing a $33 billion bid for Anadarko last year and then being among the first big oil companies to slash spending during the downturn.

Industrial Metals

Copper prices have rallied 39% from their March lows, as the combination of contracting supply, and demand from China bouncing back strongly has provided the market with an attractive story to chase prices higher. Analysts expect the market balance at 0.4% of annual demand. While this points to a marginal surplus on a full-year basis, the market should be undersupplied in 2H 2020. The copper market should flip into a modest deficit in 2021 of 0.5%, from an initially expected surplus of 0.7% –  the structurally low inventory backdrop in copper and bullish investor sentiment require little to lift prices sharply. Copper stockpiles tracked by the London Metal Exchange saw the biggest monthly drop in July since 2009. Iron ore futures surged above $110 a ton amid expectations that strong demand in China and lower supplies will leave the market in a deficit this year. According to a survey by Shanghai Metals Market, blast-furnace utilization rates rose to over 90. In Brazil, supply is set to take a little longer to return with delayed court approvals and safety tests for Vale’s recovery from its dam collapse last year. The strong iron ore demand is also reflected in Australian mining giants Rio Tinto, Fortescue Metals and BHP Group’s reporting of record shipments to China. The companies have reported record earnings on the back of the iron ore shipments. Australia’s record iron ore exports to China, and a surge in shipments of coking and thermal coal, indicate trade in the key industrial ingredients has not suffered because of a diplomatic row between the two countries. The reporting season is in full swing. Analysts have been monitoring how miners adapt to the virus outbreak. In general, 2Q operational results have been better than expected with miners managing to maintain production, but they have reduced “non-essential” activities including waste stripping and underground development as well as extended maintenance schedules. According to analysts, most mines will be able to adapt, but the risk of disruption from Covid outbreaks or unplanned outages due to extended maintenance has increased. Start-up and ramp-up of projects are likely to be delayed and no new projects will be approved in 2020. It is believed that this will materially reduce what was expected to be healthy copper mine production growth of over 3% in 2021/22. Also, authorities in Chile are cracking down on water use by mines threatening future supply in the top copper-producing nation. By the end of July, Chile’s environmental agency charged BHP Group’s Escondida mine, the world’s largest, for allegedly drawing more water than allowed for almost 15 years in a move that could result in the loss of its permit, closure or a fine.

Precious Metals

Gold surged 11% in July, the biggest monthly gain since 2012, as investors weighed a weaker dollar and record low US real yields. The health crisis has prompted unprecedented amounts of stimulus being unleashed to shore up economies including lower rates, which are a boon for non-interest-yielding gold. Simmering geopolitical tensions are also boosting demand. According to analysts, gold positioning indicates that investors’ attitudes toward the metal have changed amid the public health crisis, economic turbulence, and extremely easy monetary policy actions which made gold a star asset in 2020, arguably appearing more popular than ever. Looking at silver, conditions remain favourable after its 33% surge in July. First, the Federal Reserve signalled that it will stay accommodative until economic activity is back to reasonable levels and the unemployment rate has dropped sufficiently. This monetary backdrop, coupled with a weaker USD, is driving higher ETF holdings in silver. Second, industrial application demand should improve in the coming months as economic activity resumes. Third, silver mine supply has been disrupted by the pandemic, mainly in Latin America which accounts for around 50% of global silver mine supply. Golds record run has burnished cash flows and driven a surge in shares of gold producers. The rally provides a renewed test of discipline for the miners after a similar climb a decade ago prompted a spate of inflated deals and overly optimistic investments. With costs contained even after pandemic-related closures, virtually all are churning out impressive cash. According to analysts, Barrick alone generated $438 million in free cash flow in the first three months of the year. If prices stay high, miners can capitalize on the current excitement by encouraging a little more risk to tackle the problem of stagnant production. Companies will need to invest $37 billion by 2025 to keep output at 2019, as Wood Mackenzie estimates.