ICG Commodity Update – November 2020
The ICG Commodity Update is our monthly published comment on energy, industrial metals and precious metals market.
Energy
We see a light at the end of the tunnel. Crude oil prices are trading at their highest levels since early March, supported by positive market sentiment as a result of vaccine news and strong oil demand in Asia. Meanwhile, oil markets moved from oversupplied to undersupplied in 3Q 2020. The recent wave of COVID infections sweeping Europe and US has surprised by its intensity, leading to renewed lockdowns. Importantly, this is only a speed bump in the general expectation of a sharp tightening of oil fundamentals through 2021, driven by a recovery in demand boosted by vaccines and rapid testing as well as by the collapse in upstream investment and change in the shale reaction function. The winter COVID wave will delay but not derail the oil market rebalancing. Most analyst expect the market to stay undersupplied during 2021. Further to that, we think that most people underestimate the difficulties to increase the oil market supply chain after years of under-investment. Especially this year and in response to COVID, ESG issues have further reduced investment in the old economy. Goldman Sachs even thinks, that that this recovery in commodity prices will actually be the beginning of a much longer structural bull market. COVID is already ushering in a new era of policies aimed at social need instead of financial stability. This will likely create cyclically stronger, more commodity-intensive economic growth that should create the elusive cyclical upswing in demand. COVID has led to a massive rise in government spending, particularly in the US where the dollar was already facing headwinds. Although the dollar got a boost from a flight to safety at the beginning of the crisis, this support is likely to fade in 2021 and beyond, creating a positive feedback loop similar to what it did during 1970s and 200s when oil and gold reached historical highs. In addition, inflation tail risks are greater than at any other time since 1970s. Looking at the 2020s, Goldman believes that similar structural forces to those which drove commodities in the 2000s could be at play. Energy companies had a superlative month. The S&P 500 energy sector had its best month on record. This lagging YTD performance is driving the “catch up” trade as investors seek out laggard sectors which have not participated in this year’s equity rally. We think the rally may continue into 2021 as most analysts are. Nevertheless, is still a long way to “pre-COVID” levels, but we are persuaded that the whole oil and gas industry will come out much stronger. The oil and gas business has always been full of booms and busts. But this time companies have adapted very fast to the new price environment and there have been also several M&A showing efforts to consolidate and improve operations. Further to that, several oil and gas majors, mainly European, have started to improve its ESG perception and this is also very important and positive.
Industrial Metals
Copper extended a rally after capping the longest stretch of monthly advances in almost a decade, as China’s recovery continues and supply risks stack up. Caixin’s China November manufacturing purchasing managers’ index rose to the highest in a decade. That’s the latest indicator highlighting the economic strength in the top metals consumer, after the official PMI beat market expectations and showed the nation’s economic rebound is gathering pace. According to analysts, this year’s rally is starting to resemble the spike in prices seen in the early 2000s as a surge in Chinese orders ushered in the start of the commodities supercycle. Metals surged on a wave of bullish drivers including a weaker dollar, vaccine optimism, and a global move toward low-carbon power sources. Risks of supply disruptions in key mining countries also tightened the market, with analysts warning of unmanageable global deficits in the coming years. According to Goldman Sachs, the streak of poor commodity returns has reached an end in the aftermath of the Covid crisis. The bank believes that this recovery in commodity prices will actually be the beginning of a much long structural bull market driven by three key themes. 1) Under-investment in the old economy due to a decade of poor returns, especially in energy where ESG issues have further reduced investment, was accelerated during 2020 due to COVID, leaving inadequate production capacity to meet a V-shaped vaccine driven demand recovery. 2) COVID is already ushering in a new era of policies aimed at social need instead of financial stability. This will likely create cyclically stronger, more commodity-intensive economic growth that should create the elusive cyclical upswing in demand. Three global initiatives have the potential to REV the global demand for commodities: Redistributional policies, Environmental policies and Versatile supply chain initiatives. 3) COVID has led to a massive rise in government spending, particularly in the US where the dollar was already facing headwinds. Although the dollar got a boost from a flight to safety at the beginning of the crisis, this support is likely to fade in 2021 and beyond, creating a positive feedback loop similar to what it did during 1970s and 200s when oil and gold reached historical highs. In addition, inflation tail risks are greater than at any other time since 1970s due to the REV policies above. Looking at the 2020s, Goldman believes that similar structural forces to those which drove commodities in the 2000s could be at play. Not only can the green capex increase be as big as BRIC’s investment 20 years ago, but the redistributive push in DMs, and in China this time, is likely to lead to a large boost to consumer spending, comparable to the lending-fueled consumption increase in the 2000s. Finally, similar to 2000s, there is structural under-investment in supply of almost all commodities.
Precious Metals
Gold lost -5.4% in November as investors bolting out of precious metal exchange traded funds in anticipation of the COVID-19 vaccines have outweighed the impact of a record volume of bonds trading at negative yields. Gold’s current weakness is accompanied by a depreciating dollar, which normally has an inverse price correlation with the yellow metal. Gold has had a stellar year, rising 16% year-to-date. However, the recent fall has been fast and furious but not without precedent. In 2H11, a short-lived revival in US real interest rates, linked to policy uncertainties as well as communication missteps by the Federal Reserve, triggered profit-taking from its then record high. This time, gold prices have sold off on earlier-than-expected COVID-19 vaccine progress. Uncertainty about the Fed’s next steps and improving macro data also played a part. On both occasions, there was one common theme – outflows from exchanged-traded funds, which is a frequent reaction to diminished appetite for safe havens. Also, according to Goldman Sachs, COVID has led to a massive rise in government spending, particularly in the US where the dollar was already facing headwinds. Although the dollar got a boost from a flight to safety at the beginning of the crisis, this support is likely to fade in 2021 and beyond, creating a positive feedback loop similar to what it did during the 1970s and 2000s when oil and gold reached historical highs. In addition, inflation tails risks are greater than at any other time since the 1970s. Similar to after the global financial crisis, gold markets will likely be pulled higher as reflation concerns grow with the recovery and investors look to buy the currency of last resort. Economists believe near-term breakeven inflation has further room to run, supporting higher prices for precious metals and commodities in general. Gold miners suffered this month but we think the investment case remains intact. We had several “virtual” conferences with CEOs und industry experts that agree that the vaccine news should be positive for the economy, the companies and of course for the humans in general. Back to normality also is positive for the precious metals sector. Indeed, most companies still generate record high free cash flow and are distributing decent dividends. This has been visible on the last earning season and we expect the PMC portfolio to generate a dividend yield at least twice the universe going forward.
