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.