ICG Commodity Update – July 2022

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

 

Energy

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

 

Industrial Metals

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

 

Precious Metals

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

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ICG Commodity Update – June 2022

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

 

Energy

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

 

Industrial Metals

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

 

Precious Metals

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

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The thorny issue of oil majors and genuine ESG impact

Excluding all ‘old world’ players won’t cut it, so how can fund managers tap oil and gas giants as part of a meaningful energy transition? Pablo Gonzalez, our Senior Portfolio Manager, was interviewed by citywire to speak about investing in oil and gas companies and the ESG paradox.

 

“The investment industry is missing out on the chance to take a more responsible approach towards sustainable investment, such as engaging with management, rather than wholesale exclusion.”

 

Please read the full article below:

The thorny issue of oil majors and genuine ESG impact

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ICG Commodity Update – May 2022

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

 

Energy

Well three months into Russia’s invasion of Ukraine, global markets remain tense with oil prices holding firmly >$100/bl. The call to secure global energy supplies is getting more relevant than ever, with new actions adding to uncertainty, including a potential EU embargo on Russian oil on the horizon. Further to that, the WSJ has reported that some OPEC members are considering exempting Russia from the group’s production quotas currently in place (Russia’s target were set at 10.5mboe/d in May). No decision has been confirmed, but exemption wouldn’t be without precedents: Iran, Libya and Venezuela are already not subject to production quotas. Exemption would allow Russia to produce at maximum capacity, which is probably limited at ~11mboe/d due to export constraints through Europe. Nevertheless, an exemption of Russia would probably not impact the medium-term S/D balance according to JP Morgan. While Saudi Arabia and Iraq plan to increase production capacity, non-GCC supply continues to fall short of expectations. Some estimate that in April OPEC+ missed quotas by 1.8mboe/d. Some expect OPEC’s spare capacity (about 3.6mboe/d) to come even more into light as demand continues to recover, China reopens and the summer driving season starts in the Northern Hemisphere. It’s time to take a look at an unloved sector. Commodity prices have skyrocketed well >100% in the last 2 years. However, it’s not too late to invest. Though commodities are up, natural resource companies trade at more than a 60% discount relative to the S&P 500, a level that has almost never been seen. Indeed, also relative energy stocks are cheap discounting oil prices in the range of only $50-$70/bl. Furthermore, the current discount may be understated, as the recent spike in commodity prices has yet to flow through to the companies’ reported fundamentals. If commodity prices were to stay at current levels, many of the largest commodity producers on the planet could pay down all their debt and buy back all their shares in just a few years and keep their billions and billions of dollars of cash flow for themselves. The implication of these deeply discounted valuations is that investors don’t need commodity prices to continue to rise in order to expect strong returns. In fact, flat commodity prices would be brilliant. Energy now represents 9% and 11% of S&P net income and FCF using consensus estimates, while these would increase by 150-200bps at strip. When comparing earnings and FCF contribution with a 4.8% of S&P market cap and other sectors struggling, we think investors will find it difficult to remain underweight given greater performance slippage. If valuations remain depressed, investors will benefit from a combination of high dividend yields, special dividends, share repurchases, and M&A activity. While the exact mechanism is unknown, if you invest in profitable businesses at attractive valuations, you will be rewarded sooner or later.

 

Industrial Metals

May was a rollercoaster with most commodity prices posting a weak run and all major base metals fell on the LME as stocks and bonds slid and the U.S. dollar rose, while accelerating inflation, rising borrowing costs and lockdowns in China depressed sentiment. China’s stringent response to virus outbreaks are stoking angst over its impact on the economy. The country’s leaders warned against questioning Xi Jinping’s Covid-zero policy, reaffirming support for the lockdown-dependent approach despite pressure to relax restrictions and protect growth. Anyway, by the end of the month, commodities rebounded from a five-month low as the demand outlook was bolstered by a weaker US dollar and China’s loan-rate cut. Chinese authorities cut a key interest rate for long-term loans by a record amount. The move will help reduce mortgage costs and support the country’s beleaguered property sector, a key source of metals demand. The Stoxx 600 Basic Resources index has fallen 16% in the past month, at a time when analysts are still raising estimates. That’s left miners looking more of a bargain than they have in years, trading at about six times forward earnings, a 50% discount to the broader market. In recent history, the sector was only this cheap during the global financial crisis of 2008 and the European sovereign debt crisis in 2011, in absolute terms. Commodity prices have skyrocketed well over 100% in the last 2 years. Though commodities are up, resource companies trade at more than a 60% discount relative to the S&P 500, a level that has almost never been seen. Furthermore, the current discount may be understated, as the recent spike in commodity prices has yet to flow through to the companies’ reported fundamentals. According to GMO, the market is simply not valuing resource companies at reasonable levels given any plausible base case for how the world might play out. If commodity prices were to stay at current levels, many of the largest commodity producers on the planet could pay down all their debt and buy back all their shares in just a few years and keep their billions of dollars of cash flow for themselves. The implication of these deeply discounted valuations is that investors don’t need commodity prices to continue to rise in order to expect strong returns. In fact, flat commodity prices would be brilliant. If valuations remain depressed, investors will benefit from a combination of high dividend yields, special dividends, share repurchases, and M&A activity. While the exact mechanism is unknown, if you invest in profitable businesses at attractive valuations, you will be rewarded sooner or later.

 

Precious Metals

Gold has recovered some lost ground recently and is now hovering just below its 200-day moving average of USD 1,840/oz. This consolidation has been underpinned by an uptick in buying of exchange-traded funds following a decline in these holdings by more than 2 million ounces since the mid-April peak. The moderation in 10-year US real yields and the topping out of US dollar strength has supported some demand, with gold’s correlation with the US dollar index turning more negative of late. Despite the commencement of the much anticipated Fed tightening cycle in March and a general sell-off in equities, which likely also weighed on gold as it is typically used initially as a source of liquidity, the gold price is only down around 10% in dollar terms from its recent $2,000+ highs. Analysts believe gold’s robust performance has been driven by increasing concerns around the prospects for growth, inflation and the extent to which central bank policy can balance the mix of the two successfully. Looking at PGMs, platinum supply could contract slightly over the next two years as the industry struggles to recover from Covid-related supply chain disruptions, labor and power stoppages in South Africa and Russia’s isolation. Southern African producers have pushed the growth button potentially boosting output from 2026 should favorable market conditions hold. From 2024, platinum supply could increase by 1.5-2% a year as new projects offset reserve depletion and grade decline. The gold sector showed some M&A-activity by the end of May with Gold Fields offering 0.6 of one of its shares for each Yamana share which will make the combined company the world’s number 4 producer. The $7bn purchase implies a 34% premium to Yamana’s closing share price on May 27th. That premium offered by Gold Fields contrasts with the shift in recent years to mergers of equals in the gold industry. Those zero-premium deals, which consolidate assets to minimize costs and maximize shareholder returns, began with the $5.4 billion mega merger of Barrick Gold and Randgold announced in 2018. Yamana Gold considered other options before agreeing to be acquired by Gold Fields, suggesting there are discussions for other prospective deals in the gold industry, the Canadian firm’s executive chairman said. This is no surprise to most market participants as the so called M&A-wave is long overdue in the still segmented gold industry. Even though gold prices have risen over 40% in the last 5 years, equities of the miners are still looking cheap – companies of the precious metals champions fund producing an ounce of gold at roughly $800/oz while being almost debt-free and highly profitable (EBITDA margin >50% and a free cash flow yield 2023E >11%), this with a price-to-cashflow ratio of only 2.9x, a price-to-book ratio of 1.7x and a dividend-yield of 2.9%.

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ICG Commodity Update – April 2022

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

 

Energy

Oil climbed for a fifth month in April, marking the longest monthly winning streak since January 2018 before falling at the beginning of May. Oil demand keeps holding up on a global level. Most oil products have fully or almost fully recovered back to 2019 levels. Particularly China’s oil demand was very strong this year until the recent lockdown. According to JP Morgan energy demand is expected to exceed supply by 20% and would require $1.3tn of incremental capital to close the gap by 2030. Therefore energy investment needs to rise 45% to $2.7tn annually by 2030, to meet rising energy demand. US oil and gas producers are suddenly under pressure to accelerate the pace of supply additions and contribute to the security of global energy markets. Certain public producers already started revising their capital and production guidance for 2022 up. While the upside for production in 2H22 remains limited amid ongoing supply chain bottlenecks and cost escalation, the outlook for the rig counts keeps improving and nationwide growth capacity for 2023 looks much more favourable than it looked like two months ago. Nevertheless, Rystad expects the US to grow by 1mboe/d but labour and equipment shortages may reduce growth potential by half. Particularly fascinating is that total free cash flow generated by upstream for all the public E&P companies is expected to increase from $460bn in 2021 to almost $850bn this year! This will be the highest value on record. Indeed, our ECF portfolio has a weighted avg. FCF yield for 2022E of 19.3%! Energy stocks are far from pricing in strong and sustainable outlooks for fundamentals and shareholder return. For instance, Energy S&P 500 weight is only 4% (vs. 20yr average of 8% and 2008 peak of 16%). For a sector that is a direct input into every segment of the economy and a natural hedge against geopolitics and inflation. In ours view, energy’s earnings stream is worth more than the 2022E PE of 10.3x (ECF with a PE of 5.6x) which is a steep discount relative to long-term average of 16.5x since 1990. During 2013-2014 it traded at 13.5x when oil price was at a similar level though profit margins were much lower and credit risk was higher. Interestingly, all US publicly-listed energy companies have a combined market cap of only $2.2tn, which is lower than Apple’s market cap even though these companies collectively generate 5x higher revenues. Energy continues to be the cheapest sector on all valuation metrics despite the strong performance over the last 2 years. Also relative energy stocks are cheap discounting oil prices in the range of $50-$70/bl vs spot prices of $100/bl. No wonder to us that W. Buffett increased its energy exposure heavily this year making Chevron it’s 4th biggest position. However, with anti-Energy constraints likely loosening given increasing ESG performance pressure and with many reconsidering how to define ESG, we expect a positive impact to energy equity flows in the future.

 

Industrial Metals

Concerns around the Fed’s tightening and China’s widening COVID outbreaks have weighed on markets last month. Strict lockdowns are wreaking havoc on consumer spending and snarling supply chains in China, putting its growth target for GDP of about 5.5% this year under increasing pressure. Chinese authorities have already taken some steps to stem the economic damage, including accelerating government borrowing and spending to boost infrastructure investment. Still, virus concerns persist as flareups intensified, along with looming interest-rate hikes by western governments. Looking at inventories, there have been continued inventory challenges this year for base metals and upward squeezes remain possible. While Goldman says copper is “sleepwalking” toward a depletion of stockpiles, Barclays highlights that the most significant disruption is currently occurring downstream, as activity in China is disrupted. Also, copper output in Chile, the worlds largest copper producing country, is facing significant underperformance so far this year due to a combination of widespread water shortages, ore grade disappointments and technical issues that are disrupting close to half of supply in the country. On top, MMG is facing the possibility of a prolonged disruption at its Las Bambas copper mine in Peru, which represents 2% of world supply, after failing to clear the site of all protesters in an operation that has further inflamed tensions with indigenous groups. On the company side, Glencore’s trading business is headed for another year of bumper profits as the company cashes in on soaring prices and market volatility. The volatile markets have helped boost earnings for commodities traders, with merchants including Mercuria and Gunvor earning windfall profits last year. However, surging prices have also created liquidity pressures for traders, as they face massive margin calls on derivative hedging positions. Still, like several other big miners, Glencore has had problems operationally. The company cut its zinc production goal for the year and also said it would produce less copper. Anglo American and Freeport both tumbled after forecasting steep cost rises, while other miners such as BHP disappointed as COVID absenteeism and operational missteps curb output across the sector. The recent pressure on the equity side could be an attractive entry point for investors, as financial ratios remain extremely favourable. For example, the average price-to-book-ratio of the fund is currently at 2.3x, combined with an EV/EBITDA 2022E of 4x and a price-to-earnings ratio of 7x makes the portfolio look cheap compared to benchmark figures or other sectors. Also, the companies are incredibly healthy with a net-debt/equity of only 12% and profitable: free-cash-flow yield 2022E 13.2%, EBITDA margin 2022E 44%, dividend yield 3.4%.

 

Precious Metals

According to Analysts, Gold has been hamstrung by expectations the U.S. Federal Reserve will now act quite aggressively to bring inflation under control. The prospect of further U.S. interest rate hikes adds to the relative attractions of the dollar over real assets like gold that have no yield. Gold investors are balancing searing inflation against more aggressive monetary policy tightening, while digesting the added complications of a weakening economic growth backdrop and elevated geopolitical risks. Higher inflation prints, geopolitical risk and recessionary fears, in isolation, should support prices, however, central bank tightening to rein in this inflationary juggernaut will likely take some shine off gold. Looking at silver, demand is expected to climb to a record level this year thanks to increasing use of solar panels as governments boost renewable energy to meet climate goals, setting the stage for years of supply deficits, an industry report said in April. Global silver demand is expected to rise to 1.1 billion ounces this year, up 5% from 2021, consultants Metals Focus said in an annual report compiled for the Silver Institute. On the equity side, miners face shrinking margins as inflationary pressures abound. Inflation is flowing through to labor, consumables, freight, diesel, power, and royalties, while easing COVID restrictions, rising by-product credits, and an appreciating U.S. dollar offer some potential reprieve. While prices for industrial metals have risen sharper this year than inflation, gold and silver prices remain flat by end of April. Independent Capital Group attended this years European Gold Forum in April to get some insight into the industry, as gold mining companies still struggle with investors’ attention in recent years due to bad management, overspending on acquisitions and projects and in general weak communication to the public. We want to highlight that the industry is still heavily undervalued, debt free and is rewarding its shareholders for their loyalty either with dividends, share buy-backs or a combination of both, which means that shareholder returns are steadily growing. Also, the value proposition of large-caps is starting to fade. Investors will start looking for great mid-tier companies which should drive share prices and speaks for diversification instead of a single stock pick. In addition, the industry stays extremely disciplined and keeping their budgets under control – while M&A is still on everyone’s mind, an acquisition has to come at the right price. No one wants to pay high premiums anymore as many recent zero-premium acquisitions and mergers showed.

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Conference Distillate – The Denver Gold Group Gold Forum – April 2022

Independent Capital Group attended this years Denver Gold Group Gold Forum – Virtual Event from 12th to 14th 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 3 of our Precious Metals Champions Fund portfolio companies we met during the last 3 days.

 

– Pan American Silver – The world’s premier silver mining company

 

– Yamana Gold – On the road to 1.5 million ounces per year

 

– Alamos Gold – Leading growth profile

 

Detailed company level abstracts are available upon request. Contact us at research@independent-capital.com.

 

 

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ICG Commodity Update – March 2022

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

 

Energy

The storm of supply disruptions, logistic issues, sanctions, financial short squeezes and purchasing manager panic has seen some of the most dramatic commodity price moves seen in history over 1Q 2022. Especially, the oil market is potentially facing its most severe supply crisis since the 1990 Gulf War. In these most uncertain times defined by war in Ukraine, a new Covid-19 outbreak in China, and an overall wobbly economic and financial market backdrop, volatility is very high. This has been demonstrated by more than $30/bl price swings in the span of a week. Meanwhile, the impact of Western energy companies’ self-sanctioning against buying Russian crude and oil products is starting to become visible. Rystad considers the mildest case for lost Russian supply to be 1.2mboe/d, and the most extreme estimated at 4.5mboe/d. On top of these supply scenarios, analysts consider how OPEC countries with robust levels of spare capacity would respond. In the most bearish case, OPEC could boost production by 2.2mboe/d for May-22, while in the bullish case, Rystad keeps OPEC in the status quo of incremental increases and actual production continuing to lag stated targets. The analysts of Rystad said that OPEC has ample spare capacity in theory, but only KSA and UAE have “manageable” capacity by year-end. Meanwhile, the US Federal Government announced the release of up to 180mboe from its strategic petroleum reserves (SPR), during a period of up to 6 months (every day 1mboe). This is the largest release in US history and the clearest indication that the future availability of production capacity is at risk owing to limited shale and OPEC+ spare capacity coupled with prevailing strong demand. Therefore, the release may alleviate some market tightness, but it won’t resolve the structural imbalances resulting from years of underinvestment at a time of recovering global demand for oil, we think. Importantly, it should be supportive of the back-end of the forward curve and the SPR stocks will have to be replaced, lending further support to 2023-2024 prices probably. Of note this announcement is made on the day of the OPEC+ meeting, which as expected, agreed to increase quotas by the expected volume of 432 kb/d in May. On the company level, oil and gas companies continue to generate record cash flows and profits. Interestingly, some US shale companies are now facing pressure to fast track production growth and contribute to the stability of the global energy system. However, equipment lead times in the supply chain and labour bottlenecks restrict the ability of operators to bring additional rigs and frac spreads into the operation. US E&P companies have reduced hedges for 2022 to 35% of total oil output as they seek to benefit from rising oil prices.

 

Industrial Metals

In March, nickel spiked briefly above $100’000 a ton on the LME amid a short squeeze and encouraged rule changes from one of the world’s top commodity exchanges. The LME decided to allow traders to defer delivery obligations on all its main contract in an unusual shift for a 145-years-old institution that touts itself as the “market of last resort” for metals. Weeks after, the Financial Conduct Authority and Bank of England announced that they will undertake reviews into the governance, market oversight and risk management of the LME after the massive short squeeze led to weeks of turmoil that paralyzed the nickel market. Most controversially, the exchange cancelled billions of dollars of trades that had occurred, arguing that not to do so would have led to multiple defaults. The short squeeze was focused on Chinese Tsingshan Holding, which built up a giant bet on lower nickel prices and faced billions of dollars in losses when the market spiked. The exchange has been criticized by investors for its handling of the crisis. While the LME said that the price spike posed a systemic risk to its market, the decision to cancel several hours of trades at the highest prices also served as a bailout of Tsingshan and its banks to the tune of several billion dollars. In general, the storm of supply disruptions, logistical issues, sanctions, financial short squeezes and purchasing manager panic has seen some of the most dramatic metals and bulk commodity price moves seen in history over Q1 2022. Such market dislocations naturally alter commodity outlooks, both in the short and longer term. Given the biggest changes has been in energy dynamics, this also feed through into potential commodity exposures and preferences, particularly in an environment of wider commodity inflation. Meanwhile, China’s pivot to growth, while still yet to be evidenced in hard data, simply cannot be ignored. According to BMO, many of the global dynamics now expected over the coming years, whether a renewed push for energy independence or a segmentation of global trade flows, are inherently inflationary in the medium term. As a result, analysts raised the majority of their price forecasts upwards. BMO states that all-time price records in a number of metals and bulk commodities has been touched, while each and every one is trading above its respective cost curve – a very rare event. There is no doubt that physical markets that were already fundamentally tight have been further dislocated by the war and the knock-on ramifications. Although analysts expect a wave of cost inflation pressures is on its way to mining companies, they expect that there is a lag of approximately 3-6 months before higher input costs flow through to higher contract prices. Analysts expect the top end of commodity cost curves to rise at least 10% this year, though in a situation where prices are in general trading at a decent premium to cost support this has limited influence on price formation.

 

Precious Metals

Gold has pulled back from over $2,000/oz reached in March as investors balance soaring inflation against more aggressive rate hikes and quantitative tightening, while digesting the added complication of a weakening economic growth backdrop. According to BMO, higher inflation prints and recessionary fears, in isolation, should support gold; however, central bank tightening to rein in inflation will likely take some shine off gold. If central bank policy tightening does not prove effective and stagflation materializes, or if they serve to stifle economic growth, gold could likely find favor. Policymakers have the unenviable task of balancing doing too much too soon and doing too little too late, with some believing the latter already. Analysts think this uncertainty alone could be enough to keep gold prices fundamentally well supported. Also, the sizeable ETF inflows seen year to date should help propel gold to yet another annual average record in terms of nominal price. According to analysts, traditional physical buying also seems to be holding up relatively well. Looking at PGMs. The platinum market whipsawed from a significant deficit last year to a surplus owing to a 20% increase in total platinum supply. According to BMO, with average loadings per vehicle rising quickly alongside more stringent emissions legislation and more muted supply growth, the market should be back in balance by 2023. Beyond this, the culmination of increasing vehicle loadings and the growing hydrogen economy should see sustained market deficits emerge through much of the middle of this decade. That said, as more economies push toward greater energy independence and ambitious climate targets, analysts expect to see a more marked acceleration in green hydrogen production capacity, in addition to greater fuel cell adoption in the commercial vehicle segment. Both of which would provide a boost to platinum demand. Palladium on the other hand is arguably the commodity most exposed to supply disruptions arising from the conflict, with Russia accounting for 39% of global refined supply. Palladium is vital to the functioning of catalytic converters, specifically in gasoline vehicles, and fears of impending shortages initially propelled prices to an all-time record in March. On the company side, Canada’s Centerra Gold has agreed to hand control of its expropriated gold mine to Kyrgyzstan’s government. In exchange, Kyrgyzaltyn is to transfer its 26% stake in Centerra back to the company, which plans to cancel the shares. The planned deal comes nearly a year after Kyrgyzstan’s forced local managers to hand over control of Centerra’s Kumtor mine. Analysts see the deal as positive for Centerra which will be left with $1bn in cash, with production mainly in Canada and Turkey now as the deal removes a significant overhang on the stock.

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Commodities to become mainstream – again.

KEY TAKE-AWAY

 

  • The war in the Ukraine has destabilized global commodity markets heavily

 

  • Many commodity markets had already tightened significantly prior to the invasion

 

  • The bull case for commodities rests not on the current geopolitical unrest, it only reinforces it

 

  • A lower correlation between commodities and other asset classes speaks for commodities in a portfolio context

 

  • Metals are in the heart of the super-cycle

 

  • Natural resource equities are the cheapest they’ve been in the last 100 years on some metrics and on top in their best shape in history

 

  • Investors should not view commodities as risk assets, they are an all-weather asset

 

  • Our ICG Investment Solutions have done exceptionally well absolute as well as relative

 

 

 

A crisis is unfolding – A crisis of commodities

The brutal Russian invasion of the Ukraine is terrible and causes awful human suffering with unpredictable consequences. Indeed, the war in the Ukraine has destabilized global commodity markets heavily. The storm of supply disruptions, logistic issues, sanctions, and purchasing manager panic has seen some of the most dramatic rises seen in history. Anyone in the commodities world is experiencing a perfect storm as correlations suddenly shot to 1, which is never a good thing. But that’s precisely what happens when the Western sanctions the single-largest commodity producer of the world, which sells virtually everything. What we are seeing at the 50-year anniversary of the 1973 OPEC supply shock is something similar but substantially worse – the 2022 Russia supply shock, which isn’t driven by the supplier but the consumer.

 

 

Russia is an important producer and player in the world of commodities

 

 

Russia is the world’s third largest producer of oil (11.5% of global output) and second largest exporter of oil. At risk in total on the energy side is 4.3mboe/d of oil, 2.8mboe/d of oil products and 120bcm of gas. While commodities are fully carved out from the sanctions package, it is clear that Russian oil is being ostracized. About 2/ 3 of Russian oil was struggling to find buyers even at hugely discounted prices. In metals the risk amounts to 3mt aluminum, 700kt copper, 135kt nickel, 3moz palladium and 700koz platinum. So far no metals producers have explicitly been sanctioned. There has not been any significant disruptions to the flow of base and precious metals exports from Russia, particularly for long term contracts, though prices are reflecting an immense risk. (as of 15th March 2022)

 

 

 

The importance of commodity security

Nearly every single commodity is trading well above its respective cost curve, and higher than seen three months ago – a very rare event. Undeniably, the Russian invasion of Ukraine has played a key role in this. As such, some commodities are rallying for the wrong reasons – significantly higher global risk and disruptions to not only trade flows but also fears around security and stability disruptions not seen in a generation. However, some commodity markets had already tightened significantly prior to the invasion. Much of the past two years have seen a positive fundamental trend helping prices higher on the back of supply underinvestment and recovering demand. While this break from the trend has been a positive one for prices, not even producers truly believe this is a good thing. Steady, managed price rises are good for the industry value chain. Under a scenario of broad self-sanctioning, demand destruction becomes an immediate necessity. So far we have seen limited signs of demand easing. Strong economic growth is boosting consumption of energy and metals. Nevertheless, the market for commodities is not going to be what it was.

 

 

Investors need to increase commodity exposure

Commodities were one of the best-performing asset classes of 2021.

 

  • The Bloomberg Commodity Index was up 25% in 2021 and as of 15th of March, up another 22% in 2022

 

Indeed, commodity markets have moved in the opposite direction of global equities so far this year. The bull case for commodities rests not on the current geopolitical unrest, it only reinforces it. With commodities also providing an effective hedge against this risk, the case for owning commodities has never been stronger. However, investor exposure to commodities is still record low (below 2% ex-gold).

 

 

Historically commodities and gold can be a good inflation hedge

A lower correlation between commodities and other asset classes speaks for commodities in a portfolio context. The commodities chaos caused by Russia’s war in Ukraine will reverberate through the global economy, sparking industry shortages and quickening inflation already at the highest in decades. While the exact path for inflation remains highly uncertain, commodities are one of the best assets to position against rising inflation given their high correlation to market-based measures of inflation expectations.

 

 

 

Metals are in the heart of the super-cycle

Government ambitions globally have grown markedly in the past few years pointing to new, increased momentum in tackling climate change. Indeed, plans to make the world fossil fuel independent increased significantly with the Russia invasion of Ukraine. Further to that, the structure of energy demand changes, with the importance of fossil fuels gradually declining, replaced by a growing share of renewable energy and increasing electrification.

 

  • An energy system powered by clean energy technologies differs profoundly from one fueled by traditional hydrocarbon resources as they generally require more minerals than their fossil fuel based counterparts. These raw materials are a significant element in the cost structure of many technologies required in the energy transition

 

  • Metal demand for clean energy technologies would rise at least 4x by 2040 to meet climate goals, particularly EV related metals

 

 

Metal demand for renewable energy technologies to quadruplicate

Metal demand* according to the IEA “the role of critical minerals” excludes steel and aluminium that are also very important in the green energy transition. IEA Sustainable Development Scenario (SDS) estimates that a surge in clean energy policies and investment puts the energy system on track to achieve sustainable energy objectives, including the Paris Agreement, energy access and air quality goals.

 

 

 

Producers are in their best shape in history

The exposure to natural resource equities remains very low by historical standards and in relation to the earnings contribution to the market. Balance sheets are healthier that at any point in history and natural resource equities are the cheapest they’ve been in the last 100 years on some metrics

 

  • Energy makes only 4% of the S&P 500 Index weight, but the Oil & Gas producers account for 9% of the market’s earnings and 12% of free cash flow

 

  • The precious metal producers have accumulated a net debt/equity ratio that is negative resp. more cash than debt, therefore debt-free

 

  • While the S&P 500 price to cash flow increased over the last year, the one of the natural resource space declined. This means, that the prices of the stocks of the S&P500 increased more than their cash flow. However, the cash flow of the natural resource space increased much more than their share price. And this after a strong performance already

 

 

Big gap between the S&P 500 Index P/CF to that of the natural resource producers

 

In addition to attractive returns, natural resource equities offer investors diversification, inflation protection, a margin of safety, inefficiencies, and optionality. We remain convinced, as with commodities, natural resource equities should be part of a portfolio as the companies are in their best shape in history and valuation metrics continue to stay at attractive levels.

 

 

Investors should not view commodities as risk assets

commodities are an all-weather asset

 

 

 

Investment Solutions

 

Industrial Metals Champions Fund +207.7% over 2 years

Energy Champions Fund +207.5% over 2 years

Precious Metals Champions Fund +8.4% over 1 year

 

We invest in the top 25 producers on each sub-sector thanks to a qualitative and quantitative scorecard investment process and those companies resp. natural resource producers are currently very attractive. Therefore all investment funds managed by Independent Capital Group AG are based on proven quantitative multi-factor models that are solely based on unemotional systematic and methodological processes.

 

  • For example, country risk management has always been an integral part of our ICG Alpha Scorecard. We began reducing the direct Russian exposure towards the end of 4th Q 2021 when the country risk factor signaled an increasing geopolitical risk dynamic. As a consequence we have now no Russian exposure left.

 

Feel free to contact us if you want to have more information on our funds, our investment process, a commodity update or a second opinion on any natural resource company.

 

Sources: ICG Database, Clocktower Group, Credit Suisse, Goldman Sachs, JP Morgan, BMO, IEA, Bloomberg, OpenFunds, FT, WSJ
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Fossil Fuels & Energy Transition: OpenTalk with Pablo Gonzalez

OpenTalk with our Senior Portfolio Manager Pablo Gonzalez, CFA

 

Global energy demand is increasing, while governments and private companies around the world are proclaiming goals to reach net-zero, prompting further investment in metal-intensive energy technologies. As a result of the Ukraine conflict, European leaders are now asking the bloc to speed up the transition to renewable energy. Even if the energy plan encourages a green reaction, achieving the necessary energy transformation will cost time and money. Independent Capital Group AG is a firm that specializes in asset management and financial advice. Pragmatic Sustainable Investing is incorporated into all of their investment strategies.

 

See the full interview in the video below.

 

 

 

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ICG Commodity & Russia/Ukraine Exposure Update

General

The brutal Russian invasion of the Ukraine is terrible and causes awful human suffering with unpredictable consequences. The unfolding war in Ukraine raises the risk of disruptions to commodity flows. Even though natural resources have avoided direct sanctions, traders, banks and shipowners are increasingly avoiding trade with Russia. The reasons include confusion about what is legally permitted, fears about reputational damage, or moral objections.

 

Nevertheless, the commodities chaos caused by Russia’s war in Ukraine will reverberate through the global economy, sparking industry shortages and quickening inflation already at the highest in decades. The bull case for commodities rests not on the current geopolitical unrest, it only reinforces it. With commodities also providing an effective hedge against this risk, the case for owning commodities has never been stronger. Indeed, commodity markets have moved in the opposite direction of global equities so far this year. A lower correlation between the two asset classes speaks for commodities in a portfolio context.

 

We remain convinced, as with commodities, natural resource equities should be part of a portfolio  as the companies are in their best shape in history and valuation metrics continue to stay at attractive levels.

 

Country risk management has always been an integral part of our ICG Alpha Scorecard. We began reducing direct Russian exposure towards the end of 4th Q 2021 when the country risk factor signaled an increasing geopolitical risk dynamic.

 

Energy

The global energy market had already tightened significantly prior to the invasion. Crude oil and natural gas prices increased significantly over the last few days. The price gap between a barrel of Brent delivered now and in one year has widened to a record of more than $23.50/bl, surpassing the level after Iraq invaded Kuwait almost 32 years ago. A large chunk of Russian crude and refined products exports are not finding buyers now. Russia is the world’s third-largest producer and second-largest exporter of oil. It accounts for 11.5% of global oil output, and it exports 5mboe/d of crude and 2.85mboe/d of oil products. However, the IEA on Tuesday agreed to release 60 million barrels from its members’ strategic petroleum reserves, but that’s not close enough to cover the potential drop in Russian oil exports if self-sanctioning continues. If the release intends to cover only 30 days, it equals 2mboe/d, matching what traders believe are current losses. But the losses may be larger. IEA members hold emergency stockpiles of 1.5 billion barrels – so they can release far more oil, and quicker. OPEC+ ministers gather on Wednesday. The group is expected to stick to its existing plan and ratify another supply hike of 400kboe/d for April. Nevertheless, the situation is sensitive as Russia is the second-biggest member of the group. But OPEC has handled many conflicts in its 60-year history, including bloody wars between its own members.

 

At the start of the month our exposure was already cut to 4%. Meanwhile, we have no direct Russian exposure left and our indirect exposure in Russia is 1.5% through the partnerships of BP, Shell and Equinor with Russian companies. However, those companies have already announced to divest from Russia.

 

Industrial Metals

Industrial metal flows out of Russia have been reduced sharply over the past week. Even with trade exemptions, it is unlikely that metals export volumes will normalize quickly, with heavy logistical disruptions to metals flows through the Black Sea, both from Ukraine itself but also Kazakhstan and Uzbekistan (which are important routes for copper and zinc). With materially reduced export volume out of Russia, Kazakhstan and Uzbekistan, all the base metal markets will face accelerated tightening in the near-term against a backdrop of already multi-year low visible inventories. Elevated energy prices in Europe could also aggravate the situation. This will support a further rally in prices across physical premia, flat price and time spreads according to Goldman Sachs. Mainly, aluminium and nickel stand as the most exposed base metals given Russia’s significant supply role.

 

At the end of the year our Russia exposure was already cut to 0%. However, we have a 0.3% Ukraine exposure via ArcelorMittal. They have a steel plant and an iron mine in Ukraine with an asset value of $2.2bn according to the FY20 annual report (4% of total assets). It’s the only position with some kind of direct risk but manageable, we think. We have an indirect Russian exposure with Glencore, that has an accumulated $1.2bn stake in two Russian companies (EN+ Group and Rosneft) but they already announced to divest from Russia. Because some natural resource producers are buying raw materials from Russia like steel producers (iron ore, coking coal) and aluminium producers (bauxite, alumina) we are currently in discussion with our companies on that – the risk seems very low and manageable though.

 

Precious Metals

Gold gained last month as investors weighed mounting risks to global growth from sanctions on Russia. The metal posted its best February since 2016 as demand for the metal as a store of value climbed. The rebound underscores worries among market participants confronting high inflation at the same time war clouds the economic outlook. Gold was also supported from falling bond yields, which are further weighing on real yields with inflation continuing to soar. Investors are reducing their expectations about aggressive tightening from central banks. According to Goldman Sachs, the recent escalation with Russia create clear stagflationary risks to the broader economy, driven by higher energy prices, which reinforce the banks conviction in higher gold prices in coming months. Other investment banks followed and raised their price targets not only for gold but also for silver and palladium – Russia mines over 40% of the world’s palladium supply.

 

At the start of the month our Russia exposure was already cut to 4%. Meanwhile, we have no direct or indirect Russian or Ukraine exposure left. The Precious Metals Champions Fund is running very strong this year as the portfolio has a 17.1% PGM (Platinum Group Metals) exposure – mainly via South African producers which rallied strongly in the wake of the Russian invasion. In this case our “country risk factor” worked in the opposite direction as we also weight the commodity supply and demand with a geopolitical risk factor and this resulted in an increasing exposure to PGMs over the year.

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