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.