ICG Commodity Update – September 2024

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

Energy

Oil prices dropped nearly 9% in September, despite a late-month rally in the broader commodity complex driven by China’s economic stimulus. This decline may indicate a shift in market focus from demand improvements to concerns over additional supply. Prices fell further after a FT report suggested Saudi Arabia might abandon its price-targeting strategy and increase output. Since November 2020, OPEC+, led by Saudi Arabia, has cut output to stabilize prices, but this strategy has been undermined by weak demand, especially from China. At the same time, Saudi Arabia’s market share and revenues have declined amid rising non-OPEC+ production and weakening demand. Though the FT report may be denied, Saudi Arabia’s frustration with non-compliant OPEC+ members like Iran, Russia, and the UAE is evident, raising the possibility of increased Saudi production unless quotas are enforced. However, oil prices rebounded by $5/bl in early October as Middle East tensions escalated. Israel-Iran conflicts, including the killing of Hezbollah’s chief and a missile strike on Israel, have heightened risks. The rise in crude prices reflects investors factoring in a renewed risk premium as potential military conflict between these key regional players threatens vital oil flows. Analysts note the market hasn’t fully factored in risks to Iranian oil facilities or the possibility of Iran blocking the Strait of Hormuz, a threat made but never carried out. A recent BMO study of 120+ oil and gas companies shows the “all-in” cost to cover expenses and generate a 10% return has risen to $70.84/boe in 2023, up 16% YoY. While costs are now slightly above pre-pandemic levels, they remain significantly below the peak observed during the 2014 cycle. Conversely, BMO estimates OPEC+’s all-in breakeven price to be $89/bl in 2024. While the oil and gas sector’s stock market performance has been lacklustre over the past decade, equities have outperformed significantly since 2021, reflecting improving financial returns and free cash flow profiles. Despite this, valuation multiples have only modestly recovered and remain near the low end of historical norms, in contrast to the broader market. The ECF, with its focus on low-cost producers with high returns and growing free cash flow, is well-positioned to benefit from the current energy environment.

Industrial Metals

Industrial metals have experienced a significant rally following China’s announcement of measures to boost economic growth and revive its property market. China’s initiatives, including increased consumer lending, cuts to short-term interest rates, and reductions in mortgage rates, have sparked optimism in global commodity markets. On a single day, iron ore prices surged 6.7%, marking the most substantial daily increase in over 16 months, while copper, aluminium, and zinc also saw impressive gains. This positive momentum comes despite a backdrop of earlier economic challenges, as China’s real estate sector has struggled, leading to concerns about demand. Analysts believe that while China’s policy measures aim to uplift market sentiment, the overall economic landscape is improving, potentially supported by future fiscal stimulus and increased infrastructure spending. Moreover, the anticipation of interest rate cuts in major economies, especially following the U.S. Federal Reserve’s recent half-point reduction, is creating a more favourable investment climate. This environment encourages mining companies to explore mergers and acquisitions as a strategy to enhance their portfolios and secure new projects. With copper and other industrial metals projected to see soaring demand due to the energy transition and technological advancements, miners are increasingly looking to expand operations through strategic acquisitions. Recent deals reflect a growing trend where companies invest in established assets rather than solely relying on exploration. As large players leverage their balance sheets to acquire companies with promising projects, this trend can lead to greater efficiencies and increased supply. Additionally, China’s economic strategies include a pivot towards emerging markets and increased use of the renminbi (RMB) in international trade. This trend, coupled with the expansion of the BRICS bloc and efforts to establish trade systems outside of the U.S. dollar, could reshape commodity markets. Notably, over 50% of China’s transactions involve the RMB, which may lead to higher pricing dynamics for industrial metals as the dollar weakens and dedollarization accelerates. Overall, recent measures from China and ongoing M&A activities provide a glimmer of hope for the industrial metals market. The interplay between recovery efforts, evolving trade practices, and geopolitical factors is set to create a positive trajectory for metals.

Precious Metals

The gold industry is experiencing a resurgence, buoyed by a increase in gold prices, which have reached all-time highs. At the recent Denver Gold Forum, executives discussed growth prospects and potential M&A – this marks a stark contrast to previous years when the industry faced high operating costs and a lack of investor interest. The current optimism stems from an almost 28% rise in gold prices since January, supported by aggressive central bank buying, geopolitical tensions, and a shift towards de-dollarization. These factors are creating a strong demand for gold, not only as a safe-haven asset but also as a strategic component in portfolios. The recent surge in gold prices has attracted significant attention from institutional investors, indicating a growing confidence in the long-term prospects of the sector. However, the industry is exercising caution, with leaders emphasizing discipline in spending and a focus on shareholder returns. Notably, companies like Newmont and Barrick Gold are now prioritizing responsible acquisitions and cash flow management to avoid the pitfalls of the past. Despite the positive market conditions, junior miners continue to face challenges, struggling with capital flows and discounted valuations. Nonetheless, there are signs of an emerging bull market with increased exploration spending and new discoveries, reflecting a healthy level of optimism across the sector. Central banks have continued their purchasing spree, with record demand expected to drive prices higher, while geopolitical conflicts in the Middle East and Eastern Europe maintain gold’s status as a safe haven. Additionally, the potential for further Federal Reserve rate cuts could lead to more favorable conditions for gold investments in the near future. While gold stocks have lagged the metal’s performance, analysts believe that the current environment may present a compelling buying opportunity as profit margins improve. The focus is now on operational efficiency and prudent capital management, which could enhance overall profitability across the sector. Companies are poised to capitalize on this favorable backdrop, making the gold sector an attractive space for investors seeking growth. The ongoing consolidation in the industry, marked by high-profile acquisitions, highlights the strategic shift toward acquiring quality assets. Overall, the gold mining sector is on an upward trajectory, and with disciplined strategies in place, it is well-positioned for a prosperous future.

ICG Commodity Update – August 2024

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

Energy

Oil prices have erased nearly all of this year’s gains over the past couple of months due to economic concerns in major consuming nations, coupled with ample supply, which has weighed heavily on market sentiment. Meanwhile, in Libya, the state oil firm has declared force majeure at the El-Feel field, with an escalating power struggle already halving the nation’s output. These disruptions may provide OPEC+ with the opportunity to restore some production next quarter, as initially planned. However, the market remains divided on whether OPEC+ will proceed with the planned production increase. Looking at the longer-term outlook, Exxon recently published its energy forecast with several notable points. According to the report, a consumption level of 50mmbtu per person is necessary to significantly improve human development indicators. However, today, more than 4 billion people live in countries that fall below this “modern energy minimum.” This level is far below the standard of living in modern societies, where reliable energy is essential for housing, infrastructure, jobs, and mobility. Bringing these nations up to the modern energy minimum is expected to drive a 15% increase in global energy use between now and 2050. While renewables will undoubtedly play a critical role in this energy transition, oil and natural gas will continue to constitute more than 50% of the world’s energy mix in 2050. Even if every new car sold in 2035 were electric, oil demand in 2050 would still be around 85mboe/d – similar to levels seen in 2010. Exxon projects that oil demand will plateau after 2030, but remaining above 100mboe/d through 2050. On the supply side, Exxon estimates a natural decline rate of 15% per year, nearly double the IEA’s estimate of around 8%. At this rate, oil supplies could drop from 100mboe/d today to less than 30 million by 2030. Meanwhile, wind and solar contributions to the global energy mix are expected to increase more than fourfold, while coal will continue to be displaced by lower-emission sources such as natural gas. This shift is significant, as electricity usage is projected to grow by 80% by 2050 as part of the global energy mix. In summary, as Exxon emphasizes, energy is essential for improving quality of life, and the world will require more of it in the future – something that appears to be underestimated by the current market.

Industrial Metals

August began turbulently for global markets, with a broad sell-off driven by concerns ranging from a tepid employment report to the unwinding of the yen carry trade. This led to nearly 90% of the MSCI World Index closing in the red on the first Monday of the month. However, by the second week, market fears had subsided, and the recession scare proved to be temporary. Despite the broader market’s recovery, industrial metals struggled to regain lost ground, ending the month in negative territory. China played a significant role in this underperformance, as the country’s last engines of growth showed signs of faltering amid an ongoing property crisis that continues to weigh on the broader economy. Given that China historically accounted for over 50% of global commodity demand growth pre-pandemic, it is challenging to build significant deficits in these markets without robust Chinese demand. Currently, most analysts expect China’s economic growth to fall short of the government’s target of “around 5%”. Adding to these demand-side challenges, the supply side was stronger than anticipated. This combination has led to rising inventories in most metals, with some increases even defying typical seasonal trends. The steel market, in particular, has been impacted, as weak construction activity in China has resulted in growing inventories of steel and iron ore, putting downward pressure on prices. While this usually results in an influx of cheap foreign steel, despite protective tariffs, US steel executives remain optimistic about a recovery in 2025, driven by an improving US economy and large infrastructure projects. In the copper market, supply growth, primarily from the Democratic Republic of Congo, has surged by 7% this year, outpacing historical norms. Global copper demand has also risen by 6.7% during the same period, largely driven by China. Notably, BHP’s recent commodity outlook highlights that China’s copper-in-use stock per capita is only half that of the US. Moreover, India’s copper market is projected to grow five times by 2050. BHP is confident in copper’s long-term fundamentals, estimating a need for 10mtpa of new supply over the next decade, requiring around $250bn in investment. Despite this short-term turbulence, Goldman maintains its structural view that the growth in green metals demand and the long-cycle nature of copper supply, along with declining investment, will ultimately lead to inventory depletion and, consequently, scarcity pricing.

Precious Metals

Gold has surged more than 20% this year, maintaining its position around $2,500/oz. This robust performance has been fueled by several factors, including optimism surrounding monetary easing, a weakening dollar, and substantial central-bank buying. Additionally, gold’s appeal as a safe-haven asset has been amplified by ongoing geopolitical conflicts worldwide. In the near term, market participants are closely watching the upcoming nonfarm payrolls report, scheduled for release this Friday, which could provide crucial insights into the central bank’s rate-cutting trajectory. A weaker labor market could raise expectations for more aggressive easing, which typically benefits gold due to its non-interest-bearing nature. Despite the record-high gold prices, gold mining companies have not seen a corresponding boost in performance. As highlighted by Barron’s last weekend, gold miners have significantly underperformed over the last few years, though this trend may be starting to reverse. The NYSE Arca Gold Bugs Index (HUI) is currently only 10% above its level from August 2016, when gold was trading at just $1,300/oz. Two primary factors explain this underperformance. First, between 2011 and 2015, the five largest gold miners took $80bn in impairments from overpaid mergers and cost-overrun projects. This history of capital mismanagement has made investors hesitant to return to mining stocks until they see evidence that management teams have learned from past mistakes. The second factor was that from 2020 to 2022, operating cost inflation outpaced the rise in gold prices, squeezing miners’ margins. However, costs have recently moderated, improving the outlook. Notably, the HUI’s earnings per share are expected to quadruple this year compared to 2016. Despite these positive developments, gold stocks remain undervalued, making up just 0.5% of the S&P 500 – a proportion similar to the market bottom in 2015, when the industry’s profit margins were only about 12%. Today, those margins are nearing 40%, offering a much greater margin of safety. Our PMC portfolio is expected to achieve EBITDA margins of 51% next year, with even more significant growth in free cash flow with a yield of 12.2% in 2025 and 13.9% in 2026. This positions gold equities as an unprecedented opportunity, combining low valuations with high potential returns – an opportunity the market has yet to fully recognize. Paradoxically, the gold equity ETF GDX has seen $1.5bn in redemptions so far in 2024. However, we think this may change.

ICG Commodity Update – July 2024

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

Energy

Recession fears crept into the market at the end of July, leading to a sell-off of economically sensitive commodities. Both oil benchmarks have lost more than 7% over the month in the longest run of weekly losses this year, reaching a new seven-month low at the beginning of August. Economic data from top oil importer China, combined with a survey showing weaker manufacturing activity across Asia, Europe, and the US, raised the risk of a sluggish global economic recovery that would weigh on oil consumption. According to a Bloomberg survey, China’s crude imports in the 2H24 are projected to stagnate compared to the previous year. Nevertheless, oil demand is expected to show a seasonal improvement after August, driven by higher runs, restocking in coastal cities, National Day weeks in Sep/Oct, and the SPR/CPR refilling program in the 4Q24. On the other side, OPEC crude production remained broadly flat month-on-month. Geopolitical concerns have not had a significant impact on prices so far, despite the escalating conflict in the Middle East raising concerns that the conflict may spiral into a broader war involving the US and Iran, possibly hampering crude exports. On the corporate side, the battle between Chevron and Exxon over Guyana’s $1 trillion oil field took another twist last week when arbitrators announced they would need nearly a year to settle the dispute. Chevron’s stock plunged as the news meant its $53bn acquisition of Hess, which holds a 30% stake in the Guyana field operated by Exxon, would be further delayed. The shares took another hit later in the week when Chevron missed earnings estimates. Adding salt to the wound, Exxon handily beat earnings expectations, largely due to completing the $60bn purchase of Pioneer. By the way, Chevron is relocating its headquarters to Houston from California after repeatedly warning that the Golden State’s regulatory regime was making it a tough place to do business. A similar situation is unfolding in the UK, where the government has decided to increase the windfall tax on oil and gas producers, bringing the headline rate of tax to 78%, one of the highest in the world. This measure aims to fund the country’s push towards renewable energy. However, it remains to be seen whether this tax increase will effectively boost the share of renewable energies in the UK.

Industrial Metals

China’s substantial accumulation of commodities, including record-high copper reserves, is reshaping the global industrial metals market. This buildup has been driven by various factors, including uncertainties surrounding US elections, potential trade restrictions, and geopolitical tensions, such as possible conflicts with Taiwan. These concerns have led to weaker performance in commodity prices recently, especially in industrial metals like copper. However, several bullish indicators suggest a positive long-term outlook for the sector. China’s State Grid Corp, the world’s largest copper consumer, has announced a 13% increase in its annual budget, raising it to RMB600 billion. This significant boost is intended to support the expansion of infrastructure, including ultra-high-voltage lines for renewable energy projects. Although this shift may initially reduce copper demand in favor of aluminum, the substantial budget increase and focus on infrastructure indicate a potential rebound in copper consumption. The market is expected to adjust from recent weak discretionary purchases and lower operating rates for wire and cable fabricators. Additionally, China has mandated that all energy-intensive industries in Inner Mongolia use renewable energy by 2025. This policy is likely to increase copper demand due to the need for improved power distribution networks, even as aluminum substitution slightly reduces copper use. The global copper market remains optimistic, anticipating significant supply deficits in the coming years due to increased investments and ongoing infrastructure projects. On the company side, the mining industry is experiencing a resurgence in mergers and acquisitions. Teck Resources, having recently sold its coal business, is now a prime target due to its valuable copper assets. Major players such as Anglo American, Vale, BHP, Rio Tinto, and Freeport-McMoRan are actively exploring potential deals with Teck. Vale’s interest in expanding its base metals division and Anglo American’s focus on restructuring highlight a strategic shift towards copper. Despite facing operational challenges and regulatory scrutiny, the increased M&A activity and investment commitments from major industry players reflect a bullish sentiment for copper and industrial metals. As global demand for metals rises, driven by infrastructure development and renewable energy mandates, the industrial metals sector is poised for significant growth and investment opportunities in the coming years.

Precious Metals

Gold has demonstrated significant volatility and resilience recently, reflecting broader market dynamics and geopolitical tensions. In the past quarter, gold prices surged to record levels, reaching around $2,400 per ounce in April and May, and peaking at approximately $2,480 per ounce in July. This impressive performance has been driven by escalating geopolitical risks, including tensions in the Middle East where conflicts have heightened gold’s appeal as a safe-haven asset. Despite these gains, gold prices have experienced notable fluctuations. Gold’s volatility has been influenced by a global stock market rout, prompting some traders to liquidate gold positions to cover margin calls on other assets. However, the anticipation of Federal Reserve rate cuts and ongoing geopolitical uncertainties continue to support gold prices. The strong performance of gold has translated into impressive financial results for major gold mining companies. Over the past three months, Agnico Eagle, Kinross Gold, and Alamos Gold collectively generated over $1 billion in free cash flow. Specifically, Agnico Eagle reported a 5.7% FCF yield based on Q2 FCF of $557 million, Kinross achieved a remarkable 12.4% FCF yield from $364 million in Q2, and Alamos posted a 6.0% FCF yield with $107 million in Q2 FCF. This substantial increase in free cash flows, alongside stabilizing costs, underscores a positive shift in the sector and highlights the attractiveness of these companies to investors. Analysts are focusing on commentary regarding capital allocation and shareholder returns, as these factors will be crucial for investors navigating this period of high FCF generation. Additionally, gold’s traditional role as a safe-haven asset has been reinforced by central bank buying and strong demand from Asian consumers. Despite recent reductions in gold ETF holdings and significant net sales (ETFs saw record outflows in first half), the sector’s fundamentals remain strong. In fact, gold ETF inflows surged to their highest level since March 2022 in July. With its strategic role in uncertain times and positive financial indicators, gold’s long-term outlook remains optimistic, supported by its enduring appeal as a safe-haven investment.

ICG Commodity Update – June 2024

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

Energy

Brent crude oil prices recovered to $85/bl in June, rebounding from a post-OPEC+ meeting low. The decision to start adding barrels to the market from October (about 200kboe/d each month) caused a brief decline to $77/bl at the beginning of the month. Additionally, the perception that geopolitical risks to crude supplies are diminishing contributed to the initial decline. OPEC+ compliance remained relatively flat month-over-month, but the market saw robust supplies from outside the group, with the US reaching 13.25mboe/d in April, the highest since December last year. Demand remains the most significant area of uncertainty. The IEA and OPEC have diverging outlooks. OPEC maintained its estimate for consumption growth this year at 2.25mboe/d, while the IEA cut its forecast by 100kboe/d to 960kboe/d. China’s economic outlook is a major factor weighing on the market. Weak May data from China led some refiners to cut operating rates and extend maintenance. Nevertheless, the Energy Institute’s Statistical Review of World Energy reported that China now consumes more energy on a per-capita basis than Europe, driven by greater demand from the industrial sector. Meanwhile, energy demand from industrial producers in Europe is declining due to high prices. While China’s energy consumption has increased, its carbon intensity has decreased. The Energy Institute highlighted that China leads in new coal power plant construction but also in wind and solar capacity additions. Last year, China’s additions in these renewable sectors exceeded the total new wind and solar capacity added by the rest of the world, leading to a downward trend in carbon intensity. Interestingly, despite the increased oil prices this year, oil and gas equities have not seen a significant rise. Historically over the last few years, oil and gas companies were less sensitive to price drops, but now, even with higher prices, their shares are lagging. Analysts attribute this to equity investors’ concerns with cyclical stocks in the current environment. Fundamentally, companies in the upstream sector are performing well. Cash margins are at record highs, free cash flow yields remain in double digits, and valuations continue to be at record lows. Recognizing this, companies are actively pursuing M&A across the industry.

Industrial Metals

Following a robust Q2 2024 performance by base metal equities, particularly those linked to copper and AI themes, recent copper price declines have led to cautious and selective investor positioning. Investors now await stronger signals of Chinese buyers returning to the market. As copper hit record highs last month, senior Chinese traders began contacting Western hedge fund managers, seeking insights. Historically, these veteran traders leveraged their knowledge of China’s economy to gain an edge in the copper market. A tug of war is unfolding between bullish fund managers, who have invested heavily in copper anticipating future shortages, and Chinese buyers, who are more focused on current market conditions. The outcome of this struggle will likely dictate copper prices: sustained recovery signs in Chinese buying could propel the market to new highs in the second half of the year. The surge in NVIDIA shares and the growth of data centers have significantly influenced commodity market interest and price dynamics in 2024. Despite the advent of photon-based data transfer in new data center designs, the broader narrative is simpler: the world is entering a more electricity-intensive growth phase. This will drive incremental demand for metal conductors to transmit electricity. The International Energy Agency forecasts global grid spending to reach $450 billion this year, up from $300 billion in recent years. Additionally, the U.S. electrical equipment manufacturing index is now 14% above pre-pandemic levels, compared to a 1% rise in overall industrial output. As electricity production is part of industrial output (and tend to go hand in hand with metals demand), this should enhance global industrial growth and bolster the capital expenditure cycle. On the supply side, raw material markets are facing significant constraints. For copper, lead, and zinc, treatment charges paid to smelters are well below historical norms, even turning negative recently. Some miners have secured low terms for 2025, indicating expectations that supply issues will persist. Unlike the quick resolution of market constraints seen in nickel, lithium, or iron ore through aggressive Chinese investment, copper presents a tougher challenge. However, there is potential for China to increase its investments in Africa, particularly in the Democratic Republic of Congo, and in smaller, less explored countries. China views these investments strategically, prioritizing long-term supply security over immediate project returns and prices.

Precious Metals

Gold held steady at the start of the second half, as traders assessed whether soft US economic data might prompt the Federal Reserve to consider monetary easing. Last friday’s release of the core personal consumption expenditures price index, the Fed’s preferred measure of US inflation, showed a 2.6% year-over-year increase – the slowest since March 2021. Though above the Fed’s 2% target, this deceleration could pave the way for lower interest rates, potentially benefiting non-interest-bearing assets like gold. Additionally, the 2024 Central Bank Gold Reserves survey revealed that 29% of central banks plan to increase their gold reserves in the next 12 months, marking the highest level recorded since the survey’s inception in 2018. Spot gold prices surged to record highs in Q2 2024, stabilizing around $2,300 per ounce and lifting gold miners’ share prices. However, current valuation multiples suggest market skepticism about sustaining profit margins at these levels – Investors closely watch miners’ cost management and efforts to enhance shareholder returns. Despite cost inflation and a tight labor market, these pressures appear to have eased. Stable gold prices are expected to generate strong free cash flows, bolstering cash reserves given the sector’s modest debt levels. Assuming gold prices hold, stronger cash flows are anticipated in H2 2024, with many miners forecasting a backend-loaded production profile. Investors await clarity on miners’ capital allocation strategies in their Q2 2024 reports, expecting enhanced returns such as special dividends and significant share buybacks to further drive shareholder value. In contrast, platinum group metal (PGM) equities face continued uncertainty, with only a fraction of producers operating at a loss due to reluctance to cut production amid market challenges. Looking ahead to 2024, supply risks loom larger due to power issues in South Africa and operational hurdles in Russian mines. As the gold market navigates these dynamics, the interplay between economic data, Federal Reserve policies, and operational efficiencies will shape outlooks for both gold miners and PGM producers. Investor focus remains on maximizing returns amid favorable gold prices while managing ongoing challenges. The ability of gold miners to adapt to evolving market conditions and effectively allocate capital will be crucial in maintaining investor confidence and sustaining growth momentum in the sector.

ICG Commodity Update – May 2024

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

Energy

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

Industrial Metals

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

Precious Metals

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

ICG Commodity Update – April 2024

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

Energy

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

Industrial Metals

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

Precious Metals

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

Summary: Gold Forum Europe 2024

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

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

Highlights

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

Find out more in the PDF

ICG Commodity Update – March 2024

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

Energy

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

Industrial Metals

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

Precious Metals

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

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

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

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

Highlights

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

Find out more in the PDF

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

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

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

Highlights

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

Find out more in the PDF