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.