Base Metals & Iron Ore
The BCA Research Global Asset Allocation (GAA) Forum will take place online on May 18th. We have put together a great lineup of speakers to discuss issues of importance to CIOs and asset allocators. These include the latest thinking on portfolio construction, factor investing, alternatives, and ESG. Our keynote speaker will be Keith Ambachtsheer, founder of KPA Advisory and author of many books on investment management including "The Future of Pension Management: Integrating Design, Governance and Investing" (2016). His presentation will be followed by a panel discussion of top CIOs including Maxime Aucoin of CDPQ, James Davis of OPTrust, and Catherine Ulozas of the Drexel University Endowment. The event is complimentary for all GAA subscribers, who can see a full agenda and register here. Others can sign up here. We hope you can join us on May 18th for what should be a stimulating and informative day of ideas and discussion. Highlights Recommended Allocation Global growth will rebound later this year, fueled by an end of lockdowns and generous fiscal stimulus. Despite that, central banks will not move towards tightening until 2023 at the earliest. This remains a very positive environment for risk assets like equities, though the upside is inevitably limited given stretched valuations. We continue to recommend a risk-on position, with overweights in equities and higher-risk corporate bonds. It is unlikely that long-term rates will rise much further over the coming months. But there is a risk that they could, and so we become more wary on interest-sensitive assets. Accordingly, we cut our overweight on the IT sector to neutral, and go overweight Financials. We continue to prefer cyclical sectors, and stay overweight Industrials and Energy. Chinese growth is slowing and so we cut our recommendation on Chinese equities to underweight. Some Emerging Markets will suffer from tighter US financial conditions, so we would be selective in our positions in both EM equity and debt. We stay firmly underweight government bonds, and recommend an underweight on duration, and favor linkers. Within alternatives, we raise Private Equity to overweight. The return to normality will give PE funds a wider range of opportunities, and allow them to pick up distressed assets at attractive valuations. Overview What Higher Rates Mean For Asset Allocation The past few months have seen a sharp rise in long-term interest rates everywhere (Chart 1). These have reflected better growth prospects, but also a greater appreciation of the risk of inflation over the next few years (Chart 2). Our main message in this Quarterly Portfolio Outlook is that we do not expect long-term rates to rise much further over the coming months, but that there is a risk that they could. This would be unlikely to undermine the positive case for risk assets overall, but it would affect asset allocation towards interest-rate sensitive assets such as growth stocks and Emerging Markets, and could have an impact on the US dollar. Chart 1Rates Are Rising Everywhere Chart 2...Because Of Both Growth And Inflation Expectations We accordingly keep our recommendation for an overweight on equities and riskier corporate credit on the 12-month investment horizon, but are tweaking some of our other allocation recommendations. The macro environment for the rest of the year continues to look favorable. Pent-up consumer demand will be released once lockdowns end. In the US, this should be mid-July by when, at the current rate, the US will have vaccinated enough people to achieve herd immunity (Chart 3). Excess household savings in the major developed economies have reached almost $3 trillion (Chart 4). At least a part of that will be spent when consumers can go out for entertainment and travel again. Chart 3US On Track To Hit Herd Immunity By July Chart 4Global Excess Savings Total Trillion Fiscal stimulus remains generous, especially in the US after the passing of the $1.9 trillion package in March (with another $2 trillion dedicated towards infrastructure spending likely to be approved within the next six months). The OECD estimates that the recent US stimulus alone will boost US GDP growth by almost 3 percentage points in the first full year and have a significant knock-on effect on other economies (Chart 5). Central banks, too, remain wary of the uneven and fragile nature of the recovery and so will not move towards tightening in the next 12 months. The Fed is not signalling a rate hike before 2024 – and it is likely to be the first major central bank to raise rates. In this environment, it is not surprising that long-term rates have risen. We showed in March’s Monthly Portfolio Update that, since 1990, equities have almost always performed strongly when rates are rising. This is likely to continue unless there is either (1) an inflation scare, or (2) the Fed turns more hawkish than the market believes is appropriate. Inflation could spike temporarily over the coming months, which might spook markets (see What Our Clients Are Asking on page 9 for more discussion of this). But sustained inflation is improbable until the labor market recovers to a level where significant wage increases come through (Chart 6). This is unlikely before 2023 at the earliest. Chart 5US Fiscal Stimulus Will Help Everyone Chart 6Labor Market Still Well Away From Full Employment BCA Research’s fixed-income strategists do not see the US 10-year Treasury yield rising much above 1.8% this year.1 Inflation expectations should settle down around the current level (shown in Chart 2, panel 2) which is consistent with the Fed achieving its 2% PCE inflation target on average over the cycle. Treasury yields are largely driven by whether the Fed turns out to be more or less hawkish than the market expects (Chart 7). The market is already pricing in the first Fed rate hike in Q3 2022 (Chart 8). We think it unlikely that the market will start to price in an earlier hike than that. Chart 7The Fed Unlikely To Hike Ahead Of What Market Expects... Chart 8...Since This Is As Early As Q3 2022 How much would a further rise in rates hurt the economy and stock market? Rates are still well below a level that would trigger problems. First, long-term rates are considerably below trend nominal GDP growth, which is around 3.5% (Chart 9). Second, short-term real rates are well below r* – hard though that is to measure at the moment given the volatility of the economy in the past 12 months (Chart 10). Finally, one of the best indicators of economic pressure is a decline in cyclical sectors (consumer spending on durables, corporate capex, and residential investment) as a percentage of GDP (Chart 11). This is because these are the most interest-rate sensitive parts of the economy. But, at the moment, consumers are so cashed up they do not need to borrow to spend. The same is true of corporates, which raised huge amounts of cash last year. The only potential problem is real estate, buoyed last year by low rates which are now reversing (Chart 12). But mortgage rates are still very low and this is not a big enough sector to derail the broader economy. Chart 9Long-Term Rates Well Below Damaging Levels... Chart 10...Such As The R-Star Chart 11Interest-Rate Sensitive Sectors Are Robust... Chart 12...With The Possible Exception Of Housing Chart 13Debt Levels Are High In Emerging Markets... Chart 14...Which Makes Them Vulnerable To Tightening Financial Conditions This sanguine view may not apply to Emerging Markets, however. Given the amount of foreign-currency debt they have built up in the past decade (Chart 13), they are very sensitive to US financial conditions, particularly a rise in rates and an appreciation of the US dollar (Chart 14). Accordingly, we have become more cautious on the outlook for both EM equity and debt over the next 6-12 months. Garry Evans, Senior Vice President Chief Global Asset Allocation Strategist garry@bcaresearch.com What Our Clients Are Asking What will happen to inflation? How can we tell if it is trending up? Chart 15Watch The Trimmed Mean Inflation Measure How much inflation rises will be a key driver of asset performance over the next 12-18 months. Too much inflation will push up long-term rates and undermine the case for risk assets. But the picture is likely to be complicated. US inflation will rise sharply in year-on-year terms in March and April because of the base effect (comparison with the worst period of the pandemic in 2020), pricier gasoline, rising import prices due to the weaker dollar, and supply-chain bottlenecks that are pushing up manufacturing costs. Core PCE inflation could get close to 2.5% year-on-year (Chart 15, panel 1). In the second half, too, an end to lockdowns could push up service-sector inflation – which has unsurprisingly been weak in the past nine months – as consumers rush out to restaurants and on vacation (panel 3). The Fed has signalled that it will view these as temporary effects. But they may spook the market for a while. Next year, however, it would be surprising to see strong underlying inflation unless employment makes a miraculous recovery. Payrolls would have to increase by 420,000 a month to get back to “maximum employment” by end-2022.2 Absent that, wage growth is likely to stay muted. Conventional inflation gauges may not be very useful at indicating underlying inflation pressures, in a world where consumers switch their spending depending on what is currently allowed under pandemic regulations. The Dallas Fed’s Trimmed Mean Inflation indicator (which excludes the 31% of the 178 items in the consumer basket with the highest price rises each month, and the 24% with the lowest) may be the best true measure. Research shows that historically it has been closer to trend headline PCE inflation in the long run than the core inflation measure, and predicts future inflation better (panel 4). Currently it is at 1.6% year-on-year and trending down. Investors should focus on this measure to see whether rising inflation is becoming a risk. How can investors best protect against rising inflation? In May 2019 we released a report describing how to best to hedge against inflation.3 In that report, we analyzed every period of rising inflation dating back to the 1970s. Our conclusions were the following: The level of inflation will determine how rising inflation affects assets. When inflation goes from 1% to 2%, the macro environment is entirely different from when it goes from 5% to 6%. Thus, inflation hedging should not be thought of as a static exercise but a dynamic one (Table 1). Table 1Winners During Different Inflationary Regimes As long as the annual inflation rate is below about 3%, equities tend to be the best performing asset during high inflation periods, surpassing even commodities. This is because monetary policy tends to stay accommodative and cost pressures remain benign for most companies. However, as inflation passes this threshold, things start to change. Central banks start to become restrictive as they seek to curb inflation. This rise in policy rates starts to choke off the bull market. Meanwhile cost pressures become more significant and, as a result, equities begin to suffer. It is at this time when commodities – particularly oil and industrial metals – and US TIPS become a much better asset to hold. Finally, if the central bank fails to quash inflation, inflation expectations become unanchored, creating a toxic cocktail of rising prices and poor growth. During such periods, the best strategy is to hold the most defensive securities in each asset class, such as Health Care or Utilities within the equity market, or gold within commodities. Can the shift to renewables drive a new commodities supercycle? Chart 16The Shift To Renewables Is Likely To Be A Tailwind For Metal Prices... The rise in commodity prices in H2 2020 has made investors ask whether we are on the verge of a new commodities “supercycle” (Chart 16). Our Commodity & Energy strategists argue that the fundamental drivers of each commodities segment differ. Here we focus on industrial metals – particularly those pertaining to renewable energy and transport electrification. Prices of metals used in electric vehicles (EVs) have risen by an average 53% since July 2020, reflecting strong demand that is outstripping supply (Chart 16). In the short-term, metals markets are likely to be in deficit, especially as demand recovers after the pandemic. Modelling longer-term demand is tricky since it relies on assumptions for the emergence of new technologies, metals’ efficiency, recycling rates, and the share of renewables. A study by the Institute for Sustainable Futures showed that, in the most positive scenarios, demand for some metals will exceed available resources and reserves (Table 2).4 The most pessimistic scenarios – which, for example, assume no major electrification of the transport system – show demand at approximately half of available resources. It is likely that demand will lay somewhere between those scenarios. Table 2...As Future Demand Exceeds Supply Supply is concentrated in a handful of countries: For example, the DR Congo is responsible for more than 65% of cobalt production and 50% of the world’s reserves;5 Australia supplies almost 50% of the world’s lithium and has 22% of its reserves.6 Production bottlenecks could therefore put significant upside pressures on prices. Factoring in supply/demand dynamics, as well as an assessment of future technological advancements, we conclude that industrial metals might be posed for a bull market over the upcoming years. How can we add alpha in the bond bear market? Chart 17Government Bond Yield Sensitivities To USTs For a portfolio benchmarked to the global Treasury index, one way to add alpha is through country allocation. BCA’s Fixed Income Strategy recommends overweighting low yield-beta countries (Germany, France, and Japan) and underweighting high yield-beta countries (Canada, Australia, and the UK).7 The yield beta is defined as the sensitivity of a country’s yield change to changes in the US 10-year Treasury yield, as shown in Chart 17. BCA’s view is that the Fed will be the first major central bank to lift interest rate, therefore investors' underweights should be concentrated in the US Treasury index. It’s worth noting, however, that yield beta is influenced by many factors, and can change over time. When applying this approach, it’s important to pay attention to key factors in each country, especially those that are critical to central bank policy decisions (Table 3). Table 3A Watch List For Bond Investors Global Economy Chart 18US Growth Already Looks Strong... Overview: Growth continues to recover from the pandemic, although the pace varies. Manufacturing has rebounded strongly, as consumers spend their fiscal handouts on computer and household equipment, but services remain very weak, especially in Europe and Japan. Successful vaccination programs and the end of lockdowns in many countries should lead to strong growth in H2, as consumers spend their accumulated savings and companies increase capex to meet this demand. Perhaps the biggest risk to growth is premature tightening in China, but the authorities there are very aware of this risk and so it is unlikely to drag much on global growth. US: Although the big upside surprises to economic growth are over (Chart 18, panel 1), the US continues to expand more strongly than other major economies, due to its relatively limited lockdowns and large fiscal stimulus (which last year and this combined reached 25% of GDP, with another $2 trillion package in the works). Fed NowCasts suggest that Q1 GDP will come in at around 5-6% quarter-on-quarter annualized, with the OECD’s full-year GDP growth forecast as high as 6.5%. Nonetheless, there is still some way to go: Consumer expenditure and capex remain weak by historical standards, and new jobless claims in March still averaged 727,000 a week. Euro Area: More stringent pandemic regulations and slow vaccine rollout mean that the European service sector has been slow to recover. The services PMI in March was still only 48.4, though manufacturing has rebounded strongly to 64.2 (Chart 19, panel 1). Fiscal stimulus is also much smaller than in the US, with the EUR750 billion approved in December to be spent mostly on infrastructure over a period of years. Growth should rebound in H2 if lockdowns end and the vaccination program accelerates. But the OECD forecasts full-year GDP growth of only 3.9%. Chart 19...But Chinese Growth Has Probably Peaked Japan has seen the weakest rebound among the major economies, slightly puzzlingly so given its heavy weight in manufacturing and large exposure to the Chinese economy. Industrial production still shrank 3% year-on-year in February (Chart 19, panel 2), exports were down 4.5% YoY in February, and the manufacturing PMI is barely above 50. The main culprit remains domestic consumption, with confidence very weak and wages still declining, leading to a 2.4% YoY decline in retail sales in January. The OECD full-year GDP growth forecast is just 2.4%. Emerging Markets: The Chinese authorities have been moderately tightening policy for six months and this is starting to impact growth. Both the manufacturing and services PMIs have peaked, though they remain above 50 (panel 3). The policy tightening is likely to be only moderate and so growth this year should not slow drastically. Nonetheless, there remains the risk of a policy mistake. Elsewhere, many EM central banks are struggling with the dilemma of whether to cut rates to boost growth, or raise rates to defend a weakening currency. Real policy rates range from over 2% in Indonesia to below -2% in Brazil and the Philippines. This will add to volatility in the EM universe. Interest Rates: Policy rates in developed economies will not rise any time soon. The Fed is signalling no rise until 2024 (although the futures are now pricing in the first hike in Q3 2022). Other major central banks are likely to wait even longer. A crucial question is whether long-term rates will rise further, after the jump in the US 10-year Treasury yield to a high of 1.73%, from 0.92% at the start of the year. We see only limited upside in yields over the next nine months, as underlying inflation pressures should remain weak and central banks will remain highly reluctant to bring forward the pace of monetary policy normalization. Global Equities Chart 20Has The Equity Market Priced In All The Earnings Growth? The global equities index eked out a 4% gain in Q1 2021, completely driven by a rebound in the profit outlook, since the forward PE multiple slightly contracted by 4%. Forward EPS has now recovered to the pre-pandemic level, while both the index level and PE multiple are 52% and 43% higher than at the end of March 2020 (Chart 20). While BCA’s global earnings model points to nearly 20% earnings growth over the next 12 months and analysts are still revising up earnings forecasts, the key question in our mind is whether the equity market has priced in all the earnings growth. Equity valuations are still not cheap by historical standards despite the small contraction in PEs in Q1. In addition, the VIX index has come down to 19.6, right at its historical average since January 1990, and profit margins in both EM and DM have come under pressure. As an asset class, however, stocks are still attractively valued compared to bonds (panel 5). Given our long-held approach of taking risk where risk will most likely be rewarded, we remain overweight equities versus bonds at the asset-class level, but we are taking some risk off the table in our country and sector allocations by downgrading China to underweight (from overweight) and upgrading the UK to overweight (from neutral), and by taking profits in our Tech overweight and upgrading Financials to overweight (see next two pages). To sum up, we are overweight the US and UK, underweight Japan, the euro area, and China, while neutral on Canada, Australia, and non-China EM. Sector-wise, we are overweight Industrials, Financials, Energy, and Health Care; underweight Consumer Staples, Utilities, and Real Estate; and neutral on Tech, Consumer Discretionary, Communication Services, and Materials. Country Allocation: Downgrade China To Underweight From Overweight Chart 21China Is Risking Overtightening We started to separate the overall EM into China and Other EM in the January Monthly Portfolio Update this year. We initiated China with an Overweight and “Other EM” with a Neutral weighting in the global equity portfolio. The key rationale was that Chinese growth would remain strong in H1 2021 due to its earlier stimulus, while some EM countries would benefit from Chinese growth but others were still suffering from structural issues. In Q1, China underperformed the global benchmark by 4.5%, while the other EM markets underperformed slightly. China’s National People’s Congress (NPC) indicated that Chinese policymakers will gradually pull back policy support this year. BCA’s China Investment Strategists think that fiscal thrust will be neutral in 2021 while credit expansion will be at a lower rate compared to 2020. The Chinese economy should remain strong in H1 but will slow to a benign and managed growth rate afterwards. Therefore, the risk of policy overtightening is not trivial and could threaten China’s economic growth and corporate profit outlook. The outperformance of Chinese stocks since the end of 2019 has been largely driven by multiple expansion (Chart 21, panel 1), but the slowdown in the credit impulse implies that the recent underperformance of Chinese equities has not run its course because multiple contraction will likely have to catch up and will therefore put more downward pressure on price (panels 2 and 3). We remain neutral on the non-China EM countries, implying an underweight for the overall EM universe. We use the proceeds to fund an upgrade of the UK to Overweight from Neutral because the UK index is comprised largely of globally exposed companies and because we have upgraded GBP to overweight (see page 21). Sector Allocation: Upgrade Financials To Overweight By Downgrading Tech To Neutral Chart 22Financials And Tech: Trading Places One year ago, we upgraded Tech to overweight and downgraded Financials to neutral given our views on the impact of the pandemic and interest rates.8 This position has netted out an alpha of 1123 basis points in one year. BCA Research’s House View now calls for somewhat higher global interest rates and steeper yield curves (especially in the US) over the next 9-12 months. Accordingly, we are downgrading Tech to neutral and upgrading Financials to overweight. Financials have outperformed the broad market by about 20% since September 2020 after global yields bottomed in July 2020. We do not expect yields to rise significantly from the current level, nor do we expect Tech earnings growth to slow significantly (Chart 22, panel 5). So why do we make such shift between Financials and Tech? There are three key reasons: First, the Tech sector is a long-duration asset with high sensitivity to changes in the discount rate. In contrast, Financials’ earnings benefit from steepening yield curves. If history is any guide, we should see more aggressive analyst earnings revisions going forward in favor of Financials (Chart 22, panel 3). Second, the performance of Financials relative to Tech has been on a long-term structural downtrend since the Global Financial Crisis. A countertrend rebound to the neutral zone from the currently very oversold level would imply further upside (Chart 22, panel 1). Last, Financials are trading at an extremely large discount to the Tech sector (Chart 22, panel 2). In an environment where overall equity valuations are stretched by historical standards, it is prudent to rotate into an extremely cheap sector from an extremely expensive sector. Government Bonds Chart 23Policy Mix Is Bond-Bearish Maintain Below-Benchmark Duration. Global bond yields have climbed sharply in Q1, supported by strong economic growth, mostly smooth rollout of vaccination and the Biden Administration’s very stimulative fiscal package of USD1.9 trillion. The US stimulus package changes the trajectory of the 2021 US fiscal impulse from a $0.8 trillion contraction to a $0.3 trillion expansion, according to estimates from the US Committee for a Responsible Federal Budget. Going forward, the path of least resistance for global yields is still up, though the upside will be limited given the resolve of central banks to maintain accommodative monetary policies (Chart 23). Chart 24Stay Long TIPS Still Favor Linkers Vs. Nominal Bonds. Our overweight position in inflation-linked bonds relative to nominal bonds has panned out well so far this year, as has our positioning for a flattening inflation-protection curve. Even though inflation expectations have run up quickly, the 5 year-5 year forward inflation breakeven rate is still below 2.3-2.5%, the range that is consistent with core PCE reaching the Fed’s 2% target in a sustainable fashion (Chart 24). The US TIPS 5/10-year curve is inverted already, but our fixed income strategists are still reluctant to exit the curve-flattening position for two key reasons: 1) The Fed has indicated that it will tolerate core PCE overshooting the 2% target because it will try to hit the target from above rather than from below; and 2) the short end of the inflation expectation curve is more sensitive to actual inflation than the long end. There are signs (core producer prices, prices paid in the ISM manufacturing survey, and NFIB reported prices are all rising) that core PCE will reach 2% in the next 12 months. Corporate Bonds Chart 25High-Yield Offers Best Value In Fixed Income Since the beginning of the year, investment-grade bonds have outperformed duration-matched Treasurys by 62 basis points, while high-yield bonds have outperformed duration-marched Treasurys by 232 basis points. In the current reflationary environment, we believe that the best strategy within fixed-income portfolios is to overweight low-duration assets and maximize credit exposure where the spread makes a large portion of the yield. Thus, we remain overweight high-yield bonds. We believe that high yield offers much better value than higher quality credits. Currently spreads for high-yield bonds are in the middle of their historical distribution – a stark contrast from their investment-grade counterparts, which are trading at very expensive levels (Chart 25, panel 1). Moreover, the reopening of the economy should help the more cyclical sectors of the bond market, where the lower credit qualities are concentrated. But could a rise in yields start hurting sub-investment-grade companies and increase their borrowing costs? We do not think this is likely for now. Most of the bonds in the US high-yield index mature in more than three years, which means that high-risk corporates will not have to finance themselves with higher rates yet (Chart 25, panel 2). On the other hand, we remain underweight investment-grade credit. Not only are these bonds expensive, but they offer very little upside in any scenario. On the one hand, these bonds should underperform further if raise continue to rise – a result of their high duration. On the other hand, if a severe recession were to hit, spreads would most likely widen, which will also result in underperformance. Commodities Chart 26Limited Upside For Oil From Here Energy (Overweight): Despite the recent mid-March selloff, which was most likely triggered by profit taking, oil prices are still up 25% since the beginning of the year. This happened on the back of the restoration of some economic activity, the OPEC 2.0 coalition maintaining production discipline and therefore keeping supply in check, and the recovery in crude demand drawing down inventory. However, earlier forecasts of the 2021 oil demand recovery were a bit too optimistic amid continuing pandemic uncertainty. There is now, therefore, only limited upside for the oil price, at least this year. Our Commodity & Energy strategists expect the Brent crude price to average $65/bbl this year (Chart 26, panels 1 & 2). Industrial Metals (Neutral): We have previously highlighted that Chinese restocking activity in 2020 was a big factor behind the rally in industrial metals prices. As this eases, and Chinese growth slows, commodity prices might correct somewhat in the short term. However, fundamental changes in demand for alternative energy makes us ask whether we are now entering a new commodities “supercycle” for certain metals (for more analysis of this, see What Our Clients Are Asking on page 11). If history is any guide, however, the commodities bear market may have a little longer to run. Historically, commodity bear cycles lasted 17 years on average and we are only 10 years into this one (panel 3). On balance, therefore, we remain neutral on industrial metals for now. Precious Metals (Neutral): After peaking last August, the gold price has continued to tumble, down almost 19% since and 11% since the beginning of the year. We have been wary of the metal’s lofty valuation – the real price of gold remains near a historical high. The recent rise in real rates put more downside pressure on gold. However, the pullback in prices should provide investors who see gold as a long-term inflation hedge and do not buy the metal with a view to strong absolute performance over the next 12 months, with an attractive entry point. We maintain a slight overweight position to hedge against inflation and unexpected tail risks (panel 4). Currencies US Dollar Chart 27Vaccinations will help USD and GBP in 2021 While we still believe that the dollar is in a major bear market, the current environment could see a significant dollar countertrend. Thanks to its gargantuan fiscal stimulus as well as its relatively fast vaccination campaign, the US is likely to grow faster than the rest of the world during 2021 (Chart 27, panel 1). This dynamic should put further upward pressure on US real rates relative to the rest of the world, helping the dollar in the process. To hedge this risk, we are upgrading the US dollar from underweight to neutral in our currency portfolio. Euro The euro should experience a temporary pullback. Economic activity in Europe, particularly in the service sector is lagging the US – a consequence of Europe’s slow vaccination campaign. This sluggishness in economic activity will translate into a worse real rate differential vis-a-vis the US, dragging the euro lower in the process. Thus, we are downgrading the euro from overweight to neutral. British Pound One currency that might perform well in this environment is the British pound. Consumer spending in the UK was particularly hard hit during the pandemic, since such a high share of it is geared towards social activities like restaurants and hotels (Chart 27, panel 2). However, thanks to Britain’s successful vaccination campaign, UK consumption is likely to experience a sharp snapback. As growth expectations improve, real rates should grind higher vis-à-vis the rest of the world, pushing the pound higher. Moreover, valuations for this currency are attractive: The pound currently trades at a 10% discount to purchasing power parity fair value. As a result, we are upgrading the GBP from neutral to overweight. Alternatives Chart 28Turning More Positive On Private Equity Return Enhancers: In last October’s Quarterly Outlook, we advised investors to prepare for new opportunities in Private Equity (PE) as fund managers look to deploy record high dry power. A gradual return to normality is likely to provide PE funds with a wider range of opportunities, while still allowing them to pick up distressed assets at attractive valuations. This is illustrated by the annualized quarterly returns of PE funds in Q2 and Q3 2020, which reached 43% and 56% respectively. PE funds raised in recession and early-cycle years tend to have a higher median net IRR than those raised in the latter stages of bull markets. This suggests that returns from the 2020 and 2021 vintages should be strong. In recent years, capital flows have increasingly gone to the longer established and larger funds, which tend to have better access to the most attractive deals and therefore record the strongest returns. This trend is likely to continue. Given the time it takes to shift allocations in private assets, we increase our recommended allocation in PE to overweight. Inflation Hedges: It is not clear that inflation will come roaring back in the next couple of years. But what is certain is that market participants are concerned about this risk, which should give a boost to inflation-hedge assets. Given this backdrop, we continue to favor commodity futures (Chart 28, panel 2). In other circumstances, real estate would also have been a beneficiary in this environment. But the slowdown in commercial real estate, as many corporate tenants review whether they need expensive city-center space, makes us remain cautious on real estate. Volatility Dampeners: We continue to favor farmland and timberland over structured products, particularly mortgage-backed securities (MBS). Farmland offers attractive yields and should continue to provide the best portfolio protection in the event of any market distress (Chart 28, panel 3). Risks To Our View The main risks to our central view are to the downside. Because global equities have risen by 55% over the past 12 months, and with the forward PE of the MSCI ACWI index at 19.5x (Chart 29), the room for price appreciation over the next 12 months is inevitably limited. There are several things that could undermine the economic recovery and equity bull market. The COVID-19 pandemic remains the greatest unknown. The vaccination rollout has been very uneven (Chart 30). New strains, especially the one first identified in Brazil, are highly contagious and people who previously had COVID-19 do not seem to have immunity against them. Behavior once COVID cases decline is also hard to predict. Will people be happy again to fly, attend events in large stadiums, and socialize in crowded bars, or will many remain wary for years? This would undermine the case for a strong rebound in consumption. Chart 29Is Perfection Priced In? Chart 30Vaccination Has Been Spotty Vaccination Has Been Spotty Chart 31China Slowing Again? As often, a slowdown in China is a risk. The authorities there have signalled a pullback in stimulus, and the credit impulse has begun to slow (Chart 31). Our China strategists think the authorities will be careful not to tighten too drastically (with the fiscal thrust expected to be neutral this year), and that growth will slow only to a benign and moderate rate in the second half.9 But there is a lot of room for policy error. Finally, inflation. As we argue elsewhere in this Quarterly, it will inevitably pick up for technical reasons in March and April, and then again in late 2021 as renewed consumer demand for services (especially travel and entertainment) pushes up prices. The Fed has emphasized that these phenomena are temporary and that underlying inflation will not emerge until the economy returns to full employment. But the market might get spooked for a while when inflation jumps, pushing up long-term interest rates and triggering an equity market correction. Footnotes 1 Please see US Bond Strategy Report, “The Fed Looks Backward While Markets Look Forward,” dated March 23, 2021. 2 Please see US Bond Strategy Report, “The Fed Looks Backward While Markets Look Forward,” dated March 23, 2021, 3 Please see Global Asset Allocation Special Report, “Investors’ Guide To Inflation Hedging: How To Invest When Inflation Rises,” dated May 22, 2019. 4 Dominish, E., Florin, N. and Teske, S., 2019, Responsible Minerals Sourcing for Renewable Energy. Report prepared for Earthworks by the Institute for Sustainable Futures, University of Technology Sydney. The optimistic scenario is referred to as “total metals demand” scenario, which assumed current materials intensity and market share continues into the future without recycling or efficiency improvements. This study is based on 2018 production levels and therefore expansion of future production may vary results. 5US Geological Survey, Mineral Commodity Summaries 2021. 6 Chile is estimated to have the largest reserve of lithium. 7 Please see Global Fixed Income Strategy Report, “Harder, Better, Faster, Stronger,” dated March 16, 2021. 8 Please see Global Asset Allocation, “Quarterly Portfolio Outlook: Playing The Optionality,” dated April 1, 2020. 9 Please see China Investment Strategy Report, “National People’s Congress Sets Tone For 2021 Growth,” dated March 17, 2021. GAA Asset Allocation
Last October, we highlighted a tactical opportunity to go long Brent / short copper. The argument then was that although the long-term outlook is likely to favor copper, fundamentals as wells as relative net speculative positions and sentiment measures showed…
Highlights The recent backup in bond yields could cause stocks to fall further in the near term. However, history suggests that as long as yields remain low in absolute terms, as they are now, equities will recover. Market angst that the Fed is about to turn more hawkish is unwarranted. Central banks around the world have both the tools and the inclination to keep bond yields from rising excessively. Despite the jump in bond yields, the forward earnings yield is 540 basis points above the real bond yield in the US. Outside the US, the forward earnings yield is 615 basis points above the real bond yield. In 2000, the earnings yield was below the real bond yield. Just as value stocks began to outperform growth stocks in mid-2000, the end of the pandemic will herald a similar period of value-oriented outperformance. Commodity producers and banks will lead the way. Some Parallels Between Today And 2000… Stock prices have buckled in recent weeks, raising concerns that global bourses are at risk of a major crash, just like they were in early 2000. There are certainly some notable similarities between 2000 and the present: In both cases, the preceding rise in stock prices was fueled by the Federal Reserve’s desire to prevent an exogenous shock from causing a major recession (Chart 1). Last year, the shock was the pandemic. In 1998, it was the collapse of Long-Term Capital Management (LTCM). The Connecticut-based hedge fund imploded shortly after Russia defaulted on its debt, leading to a gut-wrenching 22% decline in the S&P 500. The brewing crisis prompted the Fed to cut rates by a total of 75 basis points. Spurred on by fears of Y2K, the Fed also injected vast amounts of liquidity into the financial system. Tech stocks led the market higher both in the late 1990s and last year. The NASDAQ Composite rose 68% between its intra-day low in October 1998 and March 2000. In 2020, the NASDAQ outperformed the S&P 500 by 24% and returned 44% overall. Chart 1The NASDAQ's 1999 Surge Followed The 1998 “Insurance Cuts” And Coincided With The Fed’s Balance-Sheet Expansion Chart 2Low-Priced Stocks Have Been The Winners In The First Quarter The speculative mania in the 1990s spread from large-cap tech stocks to small-cap companies. We saw the same pattern earlier this year, with prices and trading volumes exploding among smaller, low-priced stocks (Chart 2). As was the case in the late 1990s, retail investors – this time armed with “stimmy” checks and access to zero-commission trading accounts – plowed into the market. Chart 3Some Pockets Of Bullish Equity Sentiment Chart 4Some Pockets Of Bullish Equity Sentiment Bullish equity investor sentiment was rampant at the peak of the stock market in 2000. Although not quite to the same extent as back then, most measures of investor sentiment turned bullish prior to the recent selloff (Chart 3). Like most investors, analysts were wildly optimistic on stocks in the late 1990s (Chart 4). Long-term earnings growth projections are very optimistic today, a potentially ominous signal given that (unlike in the late 1990s), productivity growth is now more anemic. Rising stock prices in the late 1990s allowed corporate insiders to cash in their options, while enabling new companies to go public. Recently, we have seen a flurry of companies list their shares, in some cases through dubious SPAC vehicles (Chart 5). Valuations reached nosebleed levels in 2000. While the forward P/E ratio on the S&P 500 is somewhat below its 2000 peak, other valuation measures such as price-to-sales, Tobin’s Q, and enterprise value-to-EBITDA are above where they were in 2000 (Chart 6). Chart 5Renewed Interest In Listing Stocks Chart 6Stretched Valuations, Then And Now … But One Important Difference Despite the parallels between today and 2000, there is an important difference: The Federal Reserve. Having cut rates in 1998, the Fed reversed course in mid-1999, eventually taking the fed funds rate up to 6.5% in May 2000. The yield curve inverted in February of that year, shortly after the 10-year yield reached a high of 6.79%. Chart 7What Happens To Equities When Treasury Yields Rise? Bond yields have risen briskly over the past six months. However, they remain very low in absolute terms. While rising yields can produce a temporary stock market correction, they need to move into restrictive territory in order to trigger a recession and an accompanying bear market in equities. Chart 7 highlights some research that Garry Evans and BCA’s Global Asset Allocation team recently produced. It shows eight episodes since 1990 of a sharp rise in the 10-year Treasury yield. On every occasion (except in 1993-94, when the Fed unexpectedly raised rates in February 1994), equities performed strongly while rates were rising (Table 1). Today, the forward earnings yield on the S&P 500 is 540 basis points above the real yield. In 2000, the real bond yield was higher than the earnings yield (Chart 8). The gap between earnings yields and real bond yields is even greater outside the US, where valuations are generally more attractive. By the same token, the S&P 500 dividend yield was well below the bond yield in 2000. Today, they are roughly the same. Even if one were to pessimistically assume that US companies are unable to raise nominal dividend payments at all for the next decade, the S&P 500 would need to fall by 21% in real terms for equities to underperform bonds. Many other stock markets would have to decline by more than that (Chart 9). Table 1As Long As Bond Yields Don't Rise Into Restrictive Territory, Stocks Will Recover Chart 8Relative To Bonds, Stocks Are More Favorably Valued Now Than in 2000 Chart 9Stocks Would Need To Fall A Lot For Equities To Underperform Bonds Central Banks Will Lean Against Rising Bond Yields Stocks sold off earlier today on the perception that Jay Powell had failed to push back forcefully against the recent increase in bond yields. We think this angst is unwarranted. As Powell noted, most of the rise in bond yields reflected economic optimism. If yields were to continue rising in the absence of further economic improvements, the Fed would dial up the rhetoric, stressing its ability to buy bonds in unlimited quantities in order to support the economy. Despite all the fiscal stimulus, the unemployment rate remains elevated – perhaps as high as 10% according to some Fed measures. The prime-age employment-to-population ratio is four percentage points below where it was before the pandemic (Chart 10). Moreover, many stimulus measures will expire towards the end of the year. With the prospect of a “fiscal cliff” in 2022, we expect the Fed to want to tread carefully in withdrawing monetary support. What would really rattle investors is if long-term inflation expectations were to rise above the Fed’s comfort zone. However, considering the 5-year/5-year forward inflation breakevens are still below where they were in 2012-13, this is not an imminent risk (Chart 11). Chart 10The Fed Will Remain Accommodative To Aid The Labor Market Recovery Chart 11Inflation Expectations Have Recovered But Are Still Low Like the Fed, the ECB wants to keep financial conditions highly accommodative. On Tuesday, ECB Executive Board member Fabio Panetta, echoing comments made by other senior ECB officials, said that higher yields were “unwelcome and must be resisted.” He noted that “We are already seeing undesirable contagion from rising US yields into the euro area yield curve,” adding that the ECB “should not hesitate” to increase the pace of bond purchases. The ECB’s threat is credible. Already, its purchases have deviated significantly from its capital key, revealing Frankfurt’s willingness to act where and when it is needed. In the same spirit, the Reserve Bank of Australia boosted its government bond purchases earlier this week after the 10-year yield backed up from 0.7% last October to over 1.9% late last week. The RBA also reaffirmed its intent to maintain the current 3-year Yield Curve Control target at 0.1%, stating that “The Board will not increase the cash rate until actual inflation is sustainably within the 2-to-3 percent target range. For this to occur, wages growth will have to be materially higher than it is currently. This will require significant gains in employment and a return to a tight labour market. The Board does not expect these conditions to be met until 2024 at the earliest.” The RBA’s determination to keep bond yields down is noteworthy given that the neutral rate of interest is higher in Australia than in most other developed economies.1 If the RBA does not intend to raise rates for the next three years, it may take even longer for other central banks to take away the punch bowl. Will Value Stocks Begin To Outperform As They Did Starting In Mid-2000? There is another potential parallel with 2000 that is worth mentioning. This was the year that the outperformance of growth stocks came to a halt and value stocks began to shine. In fact, outside of the tech sector, the S&P 500 did not peak until May 2001 (Chart 12). Value continued to outperform right through to 2007. Since February 12th of this year, the price of the highly liquid Vanguard Growth ETF (VUG, market cap of $143 billion) has fallen by 8.9% while the price of the Vanguard Value ETF (VTV, market cap of $97 billion) has risen 0.5%. Despite the nascent outperformance of value names, they still remain relatively cheap. According to a simple valuation measure that combines price-to-earnings, price-to-book, and dividend yields, value stocks are more than three standard deviations cheap relative to growth stocks – a bigger valuation gap than seen at the height of the dotcom bubble (Chart 13). Chart 12The Non-Tech Portion Of The Stock Market Peaked More Than A Year After The Tech Bubble Burst Chart 13The Tech Bust Of 2000 Also Marked The Start Of A Multi-Year Outperformance By Value The Outlook For Commodity Stocks And Bank Shares Commodity producers are overrepresented in value indices. Strong global growth against a backdrop of tight supply should heat up the commodity complex over the next 12-to-18 months. Chart 14 shows that capital investment in the oil and gas sector has fallen by more than 50% since 2014. BCA’s Commodity & Energy Strategy service, led by Robert Ryan, expects crude oil demand to outstrip supply over the remainder of this year (Chart 15). Chart 14Oil + Gas Capex Collapses In COVID-19’s Wake Chart 15Crude Oil Demand To Outstrip Supply Over The Remainder Of This Year A physical deficit in the metals markets – particularly for copper and aluminum – should also persist this year (Charts 16A & 16B). While the boom in electric vehicle (EV) production represents a long-term threat to oil, it is manna from heaven for many metals. A battery-powered EV can contain more than 180 pounds of copper compared with 50 pounds for conventional autos. By 2030, the demand from EVs alone should amount to close to 4mm tonnes of copper per year, a big slug of demand in a market that consumes about 26mm tonnes per year. Chart 16ACopper Will Be In Physical Deficit... Chart 16B...As Will Aluminum Ongoing strong demand for metals from China should also buoy metals prices. While trend GDP growth in China has slowed, the economy is much bigger than it was in the 2000s. China’s annual aggregate consumption of metals is five times as high as it was back then. The incremental increase in China’s metal consumption, as measured by the volume of commodities consumed, is also double what it was 20 years ago (Chart 17). As we discussed in our report To Deleverage Its Economy, China Needs MORE Debt, the Chinese government has no choice but to continue to recycle persistently elevated household savings into commodity-intensive capital investment. This will ensure ample commodity demand from China for years to come. Chart 17China Keeps Buying More And More Commodities Chart 18Credit Growth Has Been Recovering Along with commodity producers, financials helped propel value indices during the 2000s. While credit growth is unlikely to revert to its pre-GFC days, it has been trending higher in both the US and Europe (Chart 18). Analysts are starting to take note of improving bank earnings prospects. EPS estimates for banks are rising more quickly than for tech companies on both sides of the Atlantic (Chart 19). Not only is the “E” in the P/E ratio for banks likely to rise, the ratio itself will increase. Currently, US and European banks are trading at 14 and 10-times forward earnings, respectively, a huge discount to the broad market in general, and tech stocks in particular (Chart 20). Chart 19EPS Estimates For Banks Are Rising More Quickly Than For Tech Companies (I) Chart 19EPS Estimates For Banks Are Rising More Quickly Than For Tech Companies (II) Chart 20Banks Are Cheap Bottom Line: Despite near-term uncertainty, investors should overweight stocks on a 12-month horizon, while pivoting away from last year’s winners (growth stocks) towards last year’s losers (value stocks). Peter Berezin Chief Global Strategist pberezin@bcaresearch.com Footnotes 1 According to RBA’s estimates, the neutral rate of interest in Australia is at the high end of developed market estimates. Specifically, Australia’s R-star is higher than the average of the US and euro area R-stars and is slightly lower than the average of the Canadian and UK neutral rates. Global Investment Strategy View Matrix Special Trade Recommendations Current MacroQuant Model Scores
BCA Research’s Commodity & Energy Strategy service concludes that over the short term – to the end of 2022 – oil and base metals will appear to be in the early stages of a commodity super-cycle. But, upon closer examination, it is apparent the fundamental…
Highlights As the global economy ex-China recovers from COVID-19, pent-up demand for consumer goods like cars and appliances will lift demand for stainless steel, which, in turn, will push up prices for the nickel required to make it (Chart of the Week). Developing new nickel supply will become more expensive, as governments respond to carmakers’ and ESG investors’ environmental concerns, as well as consumer preferences for cleaner transportation technology. This already is apparent in Indonesia, where the government has stopped permitting deep-sea disposal of mine tailings. Increasing use of nickel in electric-vehicle (EV) batteries is additive to existing demand. Over the next 20 years, as EVs’ share of the global fleet continues to grow, nickel-intensive battery technology could lift demand by close to 300%. By 2050, demand could increase exponentially from there, depending on battery technology. Against this backdrop, EV manufacturers have begun seeking long-term supply contracts directly with governments, to get out ahead of an increasingly tighter market. The balance of risks in the nickel market is to the upside. Our tactical long nickel position recommended last week is up ~1%. We are lowering our target to $26k/MT by July, which would represent a ~23% gain if realized. Feature At present, ~ 70% of the 2.5mm MT of nickel consumed annually goes into the stainless steel used in everything from cars and planes to operating tables, waste-water treatment plants and toasters.1 As government subsidies and other incentives propel consumers’ demand for lower-carbon transportation technologies, an increasing share of nickel consumption will be accounted for by EV batteries. The global nickel supply-demand balance is narrowing, as consumption converges on production (Chart 2). Chart of the WeekPent Up Consumer Demand Ex China Will Keep Nickel Well Bid Chart 2Tighter Nickel Balances Going Forward Will Push Prices Higher This year, we expect pent-up consumer demand ex-China to be unleashed in the wake of the global recovery from the COVID-19 pandemic. Massive government income-support and fiscal-stimulus programs supporting household budgets will be augmented by organic wage growth this year, which will fuel demand for white goods, autos and other consumer products made with stainless steel (Chart 3).2 Chart 3Pandemic Recovery Will Spur Pent-Up Demand Lower Nickel Ore Output On the supply side, following steady growth in unrefined nickel production from 2016 to 2019, production in the world’s top five nickel producers accounting for ~ 70% of total ore output fell close to 20% in 2020 (Chart 4). This is partly due to the COVID-19 pandemic’s impact on mining operations, and residual effects of Indonesia’s nickel ore ban implemented in 2019, which caused nickel ore supply to contract at the margin. Indonesia is the largest producer in the world, accounting for ~20% of global nickel ore output. Earlier this month its government said it no longer would permit deep-sea tailings (DST) disposal of mine waste. Environmentalists and EV manufacturers, which will be huge consumers of nickel going forward, are pressuring miners to maintain an environmentally conscious public image, as they do not want to be associated with the dumping of mine waste into coral reefs, even if this raises costs. The Philippines also is demanding that mine operators adopt environmentally sensitive practices. Host governments like Indonesia will have greater control over environmental regulations, as more and more of the value-added in nickel supply chains is vertically integrated domestically with ore mining. Nickel is one of the few base-metals markets in which China’s share of global refined production is less than 50%, which reflects Indonesia’s efforts to capture more of the value added in supply chains via such integration (Chart 5). Chart 4Nickel Ore Production Is Falling Chart 5Nickel Production More Competitive COVID-19-induced demand destruction kept refined nickel demand in the top five countries representing ~ 72% of global consumption flat y/y. This offset the slight increase in refined nickel supplies. This likely reflected lower aggregate demand for consumer products ex-China. China accounts for ~56% of global refined-nickel consumption as seen in Chart 5. EV Nickel Demand Could Surge EVs still are a small slice of the global nickel market – ~ 5% to 6% – given they represent ~ 1% of the global fleet (Chart 6). The IEA estimates there were just over 7mm EVs on the road in 2019, the last year for which data are available from the Agency. Close to 50% of those EVs were in China. According to Adamas Intelligence, global EV registrations in 2H20 were up close to 60%, with 3.5mm units sold.3 Going forward, demand for high-grade nickel used in electric-vehicle (EV) batteries will continue to grow, if the demand trends in 2H20 are any indication. By 2030, EV battery demand could hit 36% of total nickel demand, according to Roskill Information Services.4 As EV sales increase over the next 20 years and their share of the global fleet expands, nickel-intensive battery technology could lift demand by close to 300%, based on an analysis done by Roskill for the EU earlier this year: “Automotive electrification is expected to represent the single-largest growth sector for nickel demand over the next twenty years. Within this sector alone, we forecast global demand to increase by 2.6Mt Ni to 2040, up from only 92kt Ni in 2020.” Chart 6EV Nickel Demand Will Grow Sharply In The 2020s Depending on how quickly EVs are adopted and how their battery technology evolves, nickel demand – along with other battery materials like lithium and cobalt – could increase exponentially beyond 2030. Xu, Dai and Gaines (XDG, 2020) et al used the IEA’s Stated Policies (STEP) and Sustainable Development (SD) scenarios to examine possible metals-demand scenarios out to 2050.5 In XDG’s modeling, EVs could account for up to 14% of the light-duty vehicle fleet (166mm) by 2030. They extend this model to 2050 to assess long-term demand for lithium, cobalt and nickel. While the assumptions of the model could be viewed as aggressive, the results are interesting. Over the next 50 years, the XDG model’s expectation for the world EV fleet rises to ~ 1 billion vehicles under the STEP scenario – an increase of 72x current levels – with annual sales hitting just under 110mm units. Under the SD scenario, the fleet expands to 2 billion units (an increase of 102x), with annual sales of 211mm. Nickel demand soars under these scenarios, increasing from 0.13mm tons to between 1.5mm and 3.7mm tons, depending on whether the lower demand STEP scenario plays out or the SD is used (Chart 7). Lithium and cobalt demand soars as well, going, respectively, from 0.036mm tons to 0.62mm to 0.77mm tons, and from 0.035mm tons to 0.25mm to 0.62mm tons. Chart 7Nickel Rally Is Just Getting Started EV Carmakers Lining Up Nickel Supply Anything close to the neighborhood of these estimates would require a massive increase in supply or a major battery technology breakthrough to satisfy such demand. Against this backdrop, EV manufacturers have begun seeking long-term supply contracts directly with governments, to get out ahead of an increasingly tighter market. Elon Musk’s Tesla is believed to have entered negotiations with the government of Indonesia for long-term nickel supplies, as have other battery makers. Bottom Line: Base metals demand – particularly for nickel and copper – is set to surge if EV sales pick up sharply in the post-COVID-19 world, and governments around the globe begin to follow through on their plans to dramatically expand renewable generation. We are bullish base metals for the next 5-10 years on the back of this expected demand increase. Higher prices will be required to incentivize the build-out of base metals supplies required to meet this demand. We remain tactically long nickel, which is up ~1% since our recommendation last week. We are lowering our price target to $26k/MT from $29k/MT by July, but expect to see nickel close in on our earlier target later in the year. Robert P. Ryan Chief Commodity & Energy Strategist rryan@bcaresearch.com Commodities Round-Up Energy: Bullish We expect the Kingdom of Saudi Arabia (KSA) and fellow OPEC 2.0 member states to use their massive 7mm-plus b/d of spare capacity – and short-haul crude inventories situated close to refining centers – to make up for the ~ 7mm barrel loss of US crude production that resulted from the massive winter storm that engulfed the US Midwest and Gulf regions last week. The global recovery, particularly in EM economies, remains fragile. We do not believe the leadership of OPEC 2.0 (KSA and Russia) wants to risk a global oil-demand recovery with a price shock at this point. We expect April deliveries to be increased out of spare capacity, and for this to be communicated to the market at next week’s OPEC 2.0 meeting. This should keep Brent and WTI crude oil prices below $70/bbl in 1H21, in our estimation (Chart 8). In the wake of the Polar Vortex wake, US distillate and propane inventories used in space heating led a US oil inventory drawdown of almost 14mm barrels in the week ended 19 February, according to the US EIA. Base Metals: Bullish Copper prices are poised to challenge long-term resistance of $4.45/lb on the COMEX, following this week’s huge rally above $4.25/lb (Chart 9). Markets appear to be dialed into the supply constraints and tight inventories we have been highlighting in our research.6 Our long Dec21 copper futures position recommended on September 10, 2020 is up ~37%, while the PICK ETF recommended on December 10, 2020 is up ~20%. Precious Metals: Bullish Our long COMEX silver position is up ~2% from last week when we recommended the position. As markets continue to price in a recovery ex-China this year, we expect silver prices to continue to rally on the back of supportive fiscal and monetary conditions and a revival in organic growth. Ags/Softs: Neutral The Brazilian soybean harvest is off to a decade-low seasonal start, as rainfall slows work in the field, according to agriculture.com Chart 8 Chart 9 Footnotes 1 Please see the Nickel Institute’s website post Stainless steel: The role of nickel for additional information. 2 Please see Requiem For Volcker And The Gipper, a Special Report written by Doug Peta and Matt Gertken, BCA Research’s managing editors for US Investment Strategy and Geopolitical Strategy. In their excellent analysis, they note government policy in the US, which has deployed massive income-support and fiscal stimulus, continues to move to the left and will be more progressive (in the US usage, meaning more populist): “The problems of slow growth, inadequate health and education, racial injustice, creaky public services, and stagnant wages are by far the more prevalent concerns – and they require more, not less, spending and government involvement.” Practically speaking, for commodities this means policy will be directed toward restoring purchasing power of working-class households in the US, which will translate into higher demand for commodities generally, as these households tend to spend income as opposed to save it. 3 The Adamas Intelligence report is cited in mining.com’s article Global EV sales pushed battery metals deployment in H2 2020 – report, published 22 February 2021. 4 Please see Fraser, Jake; Anderson, Jack; Lazuen, Jose; Lu, Ying; Heathman, Oliver; Brewster, Neal; Bedder, Jack; Masson, Oliver, Study on future demand and supply security of nickel for electric vehicle batteries, Publications Office of the European Union, Luxembourg, 2021. 5 The STEP and SD scenarios reflect, respectively, current government policies and regulations and the Paris Agreement’s goals augmented by the IEA’s EV30@30 scenario Please see Xu, C., Dai, Q., Gaines, L. et al. “Future material demand for automotive lithium-based batteries.” Commun Mater 1, published 9 December 2020 by nature.com. The IEA’s EV30@30 represents an aspirational goal of 30% of global auto sales being EVs by 2030. It can be seen at IEA EV30@30. 6 Please see Copper Surge Welcomes Metal Ox Year, which we published 11 February 2021. It is available at ces.bcaresearch.com. Investment Views and Themes Recommendations Strategic Recommendations Tactical Trades Commodity Prices and Plays Reference Table Summary of Closed Trades
Highlights The multiple paid for oil sector profits is collapsing because the market fears that the profits slump will not be short-lived. The fear is not just of a lasting hit to aviation and a slower recovery in road mobility, but an existential fear for fossil-fuelled road transportation in the post-pandemic world. Stay structurally underweight oil and gas. Within the cyclical and value segments of the equity market, overweight metals and miners versus oil and gas. Structurally underweight the stock markets of Norway and the UK which are oil and gas heavy. Structurally overweight the stock markets of Germany, Switzerland, and Denmark which have zero exposure to oil and gas or basic resources. Fractal trade: tin’s near-vertical rally is at high risk of correction. Feature Chart of the WeekOil Production Has Gone Nowhere The Brent crude oil price recently hit $65, not far below its pre-pandemic level of $69. Yet in the stock market, oil and gas equities remain the dogs, languishing 32 percent below their pre-pandemic price level. Relative to the market, the oil and gas sector has underperformed by 42 percent, and the underperformance has been almost a straight line down. Moreover, since last June when the crude oil price has risen by 50 percent, oil and gas equity prices have gone nowhere. This massive divergence of a surging crude oil price from slumping oil and gas equities raises the obvious question, what can explain this dichotomy? (Chart I-2 and Chart I-3) Chart I-2Oil And Gas Equities Have Slumped In Absolute Terms... Chart I-3...And In Relative ##br##Terms One apparent puzzle is that the oil sector’s profits have underperformed their established relationship with the crude oil price. In fact, there is no puzzle. The oil sector’s profits might appear to track the oil price, but the reality is that profits track the value of oil production, meaning the product of oil production and the oil price. Clearly though, if output is flat, then profits will appear to track the oil price. But as it took a massive cut in oil output to support the oil price, the value of oil production and therefore, the oil sector’s profits, have significantly underperformed the oil price. Put another way, if you need to cut output to boost the commodity price it might help the commodity price, but it doesn’t much help the equity sector’s profits! (Chart I-4 and Chart I-5). Chart I-4Oil And Gas Profits Appear To Track The Oil Price Chart I-5In Reality, Oil And Gas Profits Track The Value Of Oil Output Will Fossil-Fuelled Road Transportation Be Driven To Extinction? We can now explain the 42 percent underperformance of oil equities, and perhaps more importantly, forecast what will happen next. When the pandemic took hold, and economic mobility ground to a halt, the oil sector’s 12-month forward profits slumped. Bear in mind that aviation accounts for 8 percent of oil consumption but, more crucially, road transportation accounts for half of all oil consumption. However, as the pandemic’s impact was expected to be short-lived, the multiple paid for those depressed 12-month forward profits rose. This partly compensated for the profit slump, but still left oil equity prices much lower. The multiple paid for oil sector profits is collapsing because the market fears that the profit slump will not be short-lived. When profits started to recover – albeit, as just discussed, by much less than the oil price rise – it should have boosted oil equity prices. The problem was that the multiple paid for those profits fell by much more than the recovery in profits, with the result that oil equities continued to underperform. Begging the question, why is the multiple paid for oil sector profits collapsing? (Chart I-6) Chart I-6Why Is The Multiple Paid For Oil Sector Profits Collapsing? The multiple paid for oil sector profits is collapsing because the market fears that the profit slump will not be short-lived. The fear is not just of a lasting hit to aviation and a slower recovery in road mobility. The fear has become existential. Governments’ plans for pandemic stimulus and recovery have put green energy at front and centre stage. Thereby the recovery has fast-tracked the ultimate nemesis of the oil industry – the extinction of fossil-fuelled road transportation. Are the fears for oil consumption justified? Yes. Aviation is not likely to reach its pre-pandemic level of oil consumption for many years, and long-haul aviation may never get there. But the much bigger threat is fossil-fuelled road transportation. From October 2021, London will extend its Ultra Low Emission Zone (ULEZ) to an 8 mile radius from the city centre.1 The effect will be to banish from London all diesel-fuelled vehicles made before 2015 as well as some older petrol-fuelled vehicles. We expect other major cities to follow London’s example. In most cases, this initiative will happen regardless of the success (or not) of electric vehicles (EVs). Combined with other green initiatives around the world, policymakers’ unashamed aim is to drive fossil-fuelled road transportation to extinction. To repeat, road transportation accounts for half of all oil consumption. The upshot is that the structural downtrend in oil consumption will persist unless the shift away from fossil-fuelled road transportation hits a brick wall, or at least a bottleneck. We do not see such a brick wall or a bottleneck in the foreseeable future. We conclude that though the sector may offer occasional countertrend tactical buying opportunities, long-term equity investors should underweight oil and gas. Structurally Prefer Metals And Miners To Oil And Gas The preceding analysis of the oil sector can be extended to other commodity equities, like the metals and miners. To reiterate, it is the total value of commodity output – the product of commodity production and the commodity price – that drives the profits of commodity equities. On this basis, the long-term prospects for the metals and miners appear somewhat brighter than for oil and gas equities (Chart I-7). Chart I-7Commodity Sector Profits Track The Value Of Commodity Output Looking at the production of copper, it has increased by around 25 percent over the past decade, albeit this is just in line with world real GDP. By comparison, the production of oil has gone nowhere (Chart of the Week). It is the total value of commodity output that drives the profits of commodity equities. Turning to price, relative to the 2011 high the copper price is around 15 percent lower, whereas the oil price is 50 percent lower (Chart I-8). Chart I-8The Copper Price Has Outperformed The Oil Price Hence, on the all-important value of output, copper has moved in a sideways channel over the past decade while oil has been in an unmistakeable structural downtrend, with lower highs and lower lows (Chart I-9). Chart I-9The Value Of Output Is Trending Sideways For Copper, But Downwards For Oil This relative trend is likely to continue as the shift from fossil-fuelled road transportation to EVs will weigh on oil demand, while supporting copper (and other metal) demand. We do not recommend an outright overweight in metals and miners given that their profits are just moving in a sideways channel. However, within the cyclical and value segments of the equity market, a good structural position is to overweight metals and miners versus oil and gas. When Oil And Gas Underperforms, So Does Norway’s OBX And The UK’s FTSE 100 Regional and country equity market performances is driven by the dominant sectors within each stock market. In relative terms, it is also driven by the sectors that are missing. If the oil and gas sector is a structural underperformer, then oil and gas heavy stock markets such as Norway and the UK will be structural underperformers too. If the oil and gas sector is a structural underperformer, it inevitably means that oil and gas heavy stock markets such as Norway and the UK will be structural underperformers too (Chart I-10 and Chart I-11). Chart I-10When Oil And Gas Underperforms, Norway's OBX Underperforms... Chart I-11...And The UK's FTSE 100 ##br##Underperforms The corollary is that stock markets which are under-exposed to the structurally underperforming sector will be at a relative advantage. This supports our structural overweighting to the stock markets of Germany, Switzerland, and Denmark, which all have zero exposure to oil and gas and basic resources. Fractal Trading System* Tin’s near-vertical rally is at high risk of correction based on fragility on all three fractal structures: 65-day, 130-day, and 260-day. A good trade is to short tin versus lead, setting a profit target and symmetrical stop-loss at 13 percent. In other trades, the underweights to China and Korea surged, but short AUD/JPY and short copper/gold reached their stop-losses. The rolling 12-month win ratio stands at 57 percent. Chart I-12Tin Vs. Lead When the fractal dimension approaches the lower limit after an investment has been in an established trend it is a potential trigger for a liquidity-triggered trend reversal. Therefore, open a countertrend position. The profit target is a one-third reversal of the preceding 13-week move. Apply a symmetrical stop-loss. Close the position at the profit target or stop-loss. Otherwise close the position after 13 weeks. * For more details please see the European Investment Strategy Special Report “Fractals, Liquidity & A Trading Model,” dated December 11, 2014, available at eis.bcaresearch.com. Dhaval Joshi Chief European Investment Strategist dhaval@bcaresearch.com Footnotes 1 ULEZ will be the zone inside London’s North Circular and South Circular Roads. 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Highlights Copper prices will continue to rally, following a surge this week to highs not seen since early 2013 on the back of falling inventories, particularly in China, where physical demand has taken stocks to their lowest levels in almost 10 years (Chart of the Week). Physical premiums for the copper cathodes delivered to off-exchange bonded warehouses in China this week are up almost 60% since November – to $73/MT – providing further evidence of market tightness. Mine output in Peru, the second largest producer behind Chile, was down 12.5% to 2.15mm MT last year in the wake of COVID-19 containment measures. Given this large decline in output, the multi-year flattening of supply growth will continue. Upside demand pressure is building, as COVID-19 vaccination rates rise. Funding for the build-out of renewable energy generation is ramping up, and now includes expected US fiscal stimulus focused on renewables. Recovering global GDP, and China’s metals-intensive Five-Year Plan also will contribute to demand growth. We continue to expect COMEX copper to trade above $4/lb this year, but the likelihood this occurs in 1H21 (vs 2H21 as we earlier forecast) is increasing. Forward curves will become more backwardated, as markets continue to tighten. Feature Copper prices will continue to surge on the back of unexpected strength in Chinese demand, which has taken inventory levels to near-decade lows. This is something of an anomaly going into a Lunar New Year – the year of the Metal Ox – when activity typically slows. The big draw from global stocks that went into China’s inventories last year means global stocks will remain tight as the rest of the world continues its recovery from the COVID-19 pandemic (Chart 2). Particularly noteworthy are the huge drops in copper inventories held in the Shanghai Futures Exchange (SHFE, panel 3), and the London Metal Exchange (LME, panel 5), which are driving global drawdowns. Away from the commodity-exchange inventories, premiums for delivery of copper cathodes from bonded warehouses into China surged close to 60% from November levels to $73/MT earlier this week, as demand for physical material surges, according to reuters.com. Cathodes are used to make wire, tubes, for melting stock and in copper alloys. Demand for cathodes is rising outside China, which indicates they will retain a physical premium, even with exports from Chile restored to normal following weather-related disruptions. Chart of the WeekCopper Prices Surge As Global Storage Draws Chart 2Falling Global Inventories Support Copper Prices Chart 3Sources of Copper Demand Strength This year’s departure from a seasonal demand downturn in Chinese copper demand likely is due to government efforts to limit travel to contain COVID-19 contagion, which means workers remain available to meet stronger demand for manufactured goods domestically and abroad. In addition, domestic demand – from electrification and infrastructure to housing – is particularly robust, which has kept pressure on inventories (Chart 3). Longer-Term Copper Demand Strength Baseline industrial, construction and infrastructure demand for copper – what’s already in place and continues to grow in line with the expansion of global GDP – will be augmented by the global build-out of renewables-based electricity generation, as the world moves toward a low-carbon future (Chart 4). Chart 4Incremental Renewables Demand Requires Significant Capex While this will not tax existing resources to the extent other materials will – e.g., copper demand from renewables will require less than 20% of existing identified reserves to meet cumulative demand to 2050 vs. the more than 100% of reserves required to meet cobalt demand by 2050 – this is still significant in a market requiring large capex increases to battle declining ore quality (Chart 5).1 Chart 5Higher Prices Needed To Spur Mining CAPEX Copper Supply Side Remains Challenged Short- and long-term challenges to global copper supply abound. Peru’s mine output was down 12.5% last year – to 2.15mm MT – in the wake of COVID-19 containment measures (Chart 6). Given Peru’s unexpectedly large decline in output, the multi-year flattening of supply growth we highlighted last month will continue.2 Indeed, we expect mined and refined output to show little or no growth this year, as was the case last year. This can partly be blamed on a lethargic recovery in mining capex, which hit a 10-year low in 2017. Longer term, as the continued global inventory drawdowns illustrate, the rate of growth in mined and refined production is far below the rate of growth in consumption globally. This is occurring as the pace of China’s recovery from COVID-19 aggregate demand destruction can be expected to start winding down later this year and growth ex-China ramps up (Chart 7). Chart 6Peru Posts Sharply Lower Output Prices for ore and refined copper will have to move higher to incentivize new production over the near term just to meet existing demand, to say nothing of new demand coming on from the global buildout in renewable-energy generation.3 Chart 7Supply Growth Lags Demand Growth Investment Implications As the rates of COVID-19 infection, hospitalization and deaths continue to fall globally, markets will begin to see evidence of an organic recovery in aggregate demand globally taking hold (Chart 8). We also expect this will remove a significant amount of the embedded risk premium in the broad trade-weighted USD, which will be bullish for commodities generally. The combination of organic growth and a weaker USD will boost the level of copper demand globally, even if China is slowing in 2H21, as our China Investment Strategy expects. This will put the weak y/y production growth in mined and refined copper in sharp perspective vis-à-vis copper demand, and will push copper prices higher. These fundamentals also will deepen the backwardation in CME COMEX copper futures for high-grade refined metal, as inventories continue to draw, and markets continue to tighten. We remain long the PICK ETF, and December 2021 COMEX copper futures, which are up 8.42% and 21.7% respectively since their inception dates on December 10, 2020 and September 10, 2020. Chart 8As COVID-19 Receeds Copper Demand Will Increase Robert P. Ryan Chief Commodity & Energy Strategist rryan@bcaresearch.com Commodities Round-Up Energy: Bullish The US EIA estimates December and January LNG exports will hover close to 10 BCF/d, continuing a trend noted at the end of last year (Chart 9). November and December LNG exports last year were at record levels – 9.4 BCF/d and 9.8 BCF/d. In January, LNG exports were 9.8 BCF/d, another record for that month. Below-normal temperatures in Asia have spurred demand for US LNG at a time when spot outages at other exporting states reduced global supplies. The EIA expects US LNG exports to average 8.5 BCF/d and 9.2 BCF/d this year and next. Working natural gas stocks at the end of January were 2.7 BCF, up 2% y/y and 8% over the rolling five-year average inventory level. Base Metals: Bullish The European Commission estimates EV nickel demand will be the “single-largest growth sector for nickel demand over the next twenty years.” In a study released by the Commission, global nickel demand is expected to increase by 2.6mm tons by 2040, versus 92k tons in 2020. Internal supply will be sufficient to meet demand for the 27 EU states to 2024/25, according to the study, and thereafter physical deficits will follow. The study notes that without an end-of-life recycling buildout, this deficit will persist, as mining.com noted in its report on the study. Precious Metals: Bullish After sustaining a triple bottom in at ~ $840/oz, platinum prices have rallied almost $400/oz since November (Chart 10). Lower supplies and investor demand drove the rally. Going forward, we expect increasing auto demand – first in China, and then, later, in the rest of the world as organic growth revives – will support demand for platinum-group metals, particularly for platinum and palladium. Platinum posted a 390k-ounce deficit in 2020, while palladium demand exceeded supply by just over 600k oz, according to Johnson Matthey, the PGM refiner. The world consumes ~ 10mm ounces of palladium and ~ 7mm ounces of platinum p.a. Ags/Softs: Neutral Corn, wheat and soybeans were trading 2 – 3% lower, following the USDA’s February 2021 World Agricultural Supply and Demand Estimates (WASDE) released on Tuesday. Markets drastically overestimated the amount by which the USDA would cut ending stocks for the 2020/21 crop year, with the Department trimming corn stocks to 1.5mm bushels (vs a 1.4mm bushel estimate of analysts), according to farmprogress.com. Chart 9 Chart 10 Footnotes 1 Please see Table 13, p. 27 in Dominish, E., Florin, N. and Teske, S., 2019, Responsible Minerals Sourcing for Renewable Energy. Report prepared for Earthworks by the Institute for Sustainable Futures, University of Technology Sydney. 2 Please see Pandemic Uncertainty Will Fall, Weakening USD, Boosting Metals, published 28 January 2021. It is available at ces.bcaresearch.com. 3 Please see Renewables, China's FYP Underpin Metals Demand, published 26 November 2020. It is available at ces.bcaresearch.com. Investment Views and Themes Recommendations Strategic Recommendations Commodity Prices and Plays Reference Table Summary of Closed Trades
Highlights Pandemic uncertainty is keeping the USD well bid by raising global economic policy uncertainty. When this breaks – i.e., as higher vaccination rates push contagion rates down – the USD will resume its bear market. Renewable-energy output surpassed fossil-fuel generation in Europe for the first time in 2020. With the Biden administration re-committing to renewables, and China and Europe continuing their build-outs, copper demand will rise to meet grid-expansion needs. Copper mine output fell 0.5% in Jan-Oct 2020. Treatment and refining charges – already at 10-year lows – will remain depressed as supplies tighten. Major exchanges’ refined copper inventories were down 17% y/y in December, suggesting weak mine output continued into end-2020. Stocks will continue to fall this year, backwardating the COMEX's copper forward curve (Chart of the Week). Based on the World Bank’s forecast for real global GDP growth of 4% this year, and our expectation for a weaker USD, COMEX copper prices will likely breach $4.00/lb by 2H21. COVID-19 uncertainty drives metals: If infection and hospitalization rates outpace vaccinations, additional lockdowns in the US and Europe will stymie the recovery. Success in expanding vaccinations will push economic activity higher. We expect the latter outcome. Feature Pandemic uncertainty is driving global economic policy uncertainty, which is keeping a safe-haven bid under the USD (Chart 2). Chart of the WeekPhysical Copper Deficit Signals Continued Inventory Draws This continues to stymie the recovery in industrial commodity prices, particularly oil and base metals.1 The uncertainty caused by the COVID-19 pandemic feeds directly into global economic policy uncertainty, which drives USD safe-haven demand. Chart 2USD Remains In The Thrall Of Pandemic Uncertainty Pandemic uncertainty will not abate until vaccination distribution is sufficient to put infection, hospitalization and death rates on a clear downward trajectory, and remove the threat of widespread lockdowns, which once again are required to deal with rampant contagion rates and the possible spread of vaccine-resistant COVID-19 mutations locally and globally. As markets see empirical evidence of falling COVID-19-related infection, hospitalization and mortality, safe-haven demand for USD will weaken. Massive fiscal and monetary support will continue to support GDP globally, until organic growth takes off after sufficient populations are vaccinated, per the World Bank’s assumptions (Chart 3).2 Fiscal stimulus in the US exceeds 25% of GDP, and will continue to expand as the Biden administration rolls out additional spending measures. With the Fed remaining willing and able to accommodate this massive fiscal profligacy in the US, the USD will face increasing pressure on the downside as normalcy returns. Chart 3Massive Fiscal Support Globally Will Be Replaced By Organic Growth A weaker USD and stronger economic growth would boost copper prices this year and the next. A 5% decline in the broad trade-weighted USD this year would push spot COMEX copper prices above $4.30/lb, all else equal, while a 4% boost in world GDP – in line with the World Bank’s forecast for real growth this year – would lift prices to just under $4.05/lb, based on our modeling (Chart 4).3 Chart 4Lower USD, Stronger GDP Bullish For Copper Prices Renewable Generation Will Boost Copper Demand In addition to these stronger fundamentals, base metals demand – particularly for copper – will continue to benefit from the build-out of renewable-energy electricity generation globally, particularly in Europe and China. The return of the US to the Paris Agreement to combat climate change, and a renewed effort by the Biden administration to fund expanded renewable-energy resources will add to the increase in base-metals demand accompanying this global build-out (Chart 5).4 Europe is moving out ahead of the US in its deployment of renewable electricity generation, which, for the first time ever, surpassed fossil-fuel generation in 2020.5 S&P Global Market Intelligence this week reported renewable energy sources accounted for 38% of electricity generation in the EU vs 37% for fossil fuels. Renewables also surpassed fossil-fuel generation in the UK last year. Wind, solar and hydro all saw strong gains. Chart 5Copper Is Indispensible For A Low-Carbon Future Copper Supply Continues To Tighten It is important to once again note that all of these, and other renewable technologies, will require higher base metals output, none moreso than copper, which spans all renewable technologies. With copper-mining capex still weak and ore qualities falling in the mines that are producing, the supply side remains challenged (Chart 6). Over the past two years, p.a. supply growth on the mining side has been close to flat. The International Copper Study Group (ICSG) this week reported copper mine output fell 0.5% in the first 10 months of 2020. Refined copper output was up 1.5% over the same interval. Treatment and refining charges – already at 10-year lows – will remain depressed as supplies tighten. We expect full-year mined and refined output to fall on either side of zero growth for 2020, and 2021 (Chart 7).6 Major exchanges’ refined copper inventories were down 17% y/y in December, according to the ICSG, suggesting weak mine output continued into end-2020. An apparent increase in refined copper consumption of 2% noted by the ICSG also contributed to lower inventories. The Group estimates global refined copper balances adjusted for changes in Chinese bonded stocks, which are believed to have increased 105k tons y/y in the Jan-Dec 2020 interval, posted a physical deficit of ~ 380k tons. Chart 6Weak Capex, Lower Copper Ore Quality Remain Chief Supply-Side Challenges Chart 7Mined, Refined Copper Supply Growth Remains WeakWe expect inventories will continue to fall this year – as seen in the Chart of the Week – as demand strengthens and supply growth remains weak, which will backwardate the COMEX copper forward curve. Metal Ox Year Brings Short-Term Uncertainties The approach of the Chinese New Year beginning 12 February 2021 normally would herald massive travel and celebration, which, all else equal, would dampen economic growth until festivities ended. This year, however, reports of a re-emergence of COVID-19 infections is casting doubt on this year’s celebrations. In addition, winter industrial curtailments to reduce pollution also should reduce short-term demand for metals generally. These transitory factors should show up in lower levels of economic activity on the industrial side. For this reason, we expect seasonal weakness to show up in 1Q21 activity, to be followed in 2Q21 by higher growth y/y. Bottom Line: Copper fundamentals continue to paint a bullish price picture, particularly on the supply side. Although risks abound on both sides of the market, we expect the massive support being provided by fiscal and monetary policy globally to transition to organic growth in 2H21, in line with the World Bank’s expectations. The enormous fiscal stimulus being unleashed by the US – coupled with an ultra-accommodative Fed – will result in a weakening of the USD that will provide a tailwind to copper prices in 2H21 and next year. We remain long the PICK ETF, expecting copper miners and traders to benefit from this bullish backdrop, which we expect to persist for the next decade. The recommendation is up 6.4% since inception December 10, 2020. We also remain long December 2021 copper, which is up 19.6% since it was recommended on September 10, 2020. Robert P. Ryan Chief Commodity & Energy Strategist rryan@bcaresearch.com Commodities Round-Up Energy: Bullish After falling 11% in 2020 due to COVID-19-induced demand destruction, US energy-related CO2 emissions will rebound this year and next, according to the Energy Information Administration (Chart 8). The EIA forecasts US energy-related CO2 emissions this year and next will be 4.8 and 4.9 billion MT, which would amount to a 4.7% and 3.2% gains, respectively. The EIA tracks emissions from coal, petroleum and natural gas usage in the US in its estimates. Petroleum accounts for ~ 46% of total emissions in 2021 and 2022, while natgas contributes ~ 33% of all energy-related emissions in both years, on average. Reflecting its market-share loss in the power-generation market, coal accounts for ~ 21% of total US energy-related CO2 emissions in 2021 and 2022. Base Metals: Bullish Globally, crude steel production was down 0.9% y/y at 1.864 billion MT, the World Steel Association reported this week. China’s steel production was up 5.2% last year, to 1.053 billion MT, the country a market share of 56.5%, up from 2019’s level of 53.3%. Output in all of Asia totalled 1.375 billion MT, up 1.5% y/y, with India’s production falling close to 11% to 99.6 billion MT. China’s iron-ore imports set a record last year on the back of its strong steel-making performance, reaching 1.2 billion tonnes, a 9.5% increase y/y. Higher infrastructure spending was the primary driver of increased steel demand last year. Iron ore delivered to the Chinese port of Tianjin (62% Fe) closed just above $169/MT on Tuesday, up ~ 9% YTD. Precious Metals: Bullish Gold continues to trade ~ $1,850/oz, down more than $100/oz from its highs earlier this month on the back of persistent USD strength (Chart 9). The pandemic uncertainty feeding into global economic policy uncertainty is the proximate cause of dollar strength. COVID-19 vaccine rates are increasing, and governments remain committed to widespread distribution, which likely will be visible to markets during 1H21. Once this occurs, we expect gold to rally along with other commodities, as the safe-have bid is priced out of the USD. Ags/Softs: Neutral US corn prices rallied on the back of stronger China purchases of the grain on Tuesday. Farm Futures reported a 53.5mm-bushel order out of China on Tuesday was responsible for the gain earlier this week. Farmers continue to expect Chinese buying to remain strong, given falling corn stocks in China. Chart 8 Chart 9 Footnotes 1 At the margin, this increases the cost of purchasing commodities and lowers the cost of producing them ex-US in local-currency terms, both of which depress prices. Pandemic uncertainty and global economic policy uncertainty (GEPU) are cointegrated; the USD and GEPU also are cointegrated. We discussed the effects of pandemic uncertainty on the USD and its impact on oil prices in last week’s balances and price forecast update entitled Brent Forecast: $63 This Year, $71 Next Year. This report is available at ces.bcaresearch.com. 2 Please see the Bank's Global Economic Prospects released 5 January 2021 entitled Subdued Global Economic Recovery. The IMF upgraded its global growth outlook to 5.5% this year and 4.2% next year, in its World Economic Outlook Update released this week. We continue to use the more conservative World Bank forecasts. The Israeli economy is providing something of a natural experiment vis-à-vis the rate of COVID-19 vaccination and economic growth. According to reuters.com, the country got an early start on vaccinations, and has one of the highest rates in the world. If maintained, this will result in GDP growth of 6.3% in 2021 and 5.8% next year. Without these early and intensive vaccination rates, 2021 growth likely would be 3.5%. 3 The models in Chart 4 use the broad trade-weighted USD and global copper stocks as common regressors, and estimate copper prices given the World Bank estimates for World, EM ex-China, China and DM real GDPs. In the discussion above, we use elasticities from the World GDP model to highlight the impact of changes in copper prices from the different variables. 4 Please see Renewables, China's FYP Underpin Metals Demand, which we published 26 November 2020. We discuss the implications of essentially rebuilding the global electric-generation grid to accommodate more renewable energy resources vis-à-vis base metals demand. Copper, in particular, spans all technologies that will be deployed to achieve a low-carbon generation pool globally, as Chart 5 illustrates. 5 Please see For 1st time, renewables surpass fossil fuels in EU power mix published by S&P Global Market Intelligence 25 January 2021. 6 Benchmark treatment and refining fees charged by smelters to refine raw ore fell to 5.9 cent/lb this year, down from 6.2 cent/lb last year, according to reuters.com. This 10-year low reflects an abundance of smelting capacity relative to concentrates on the supply side needing to be refined. Investment Views and Themes Recommendations Strategic Recommendations Commodity Prices and Plays Reference Table Summary of Closed Trades
Copper prices have rallied roughly 70% since late March, fueled by a weak dollar, generous global liquidity conditions, expectations of a robust economic recovery, and supply constraints. Most of these fundamental tailwinds remain broadly in place,…