Today’s commodity super cycle
3 months ago, traders and investors received the good news that big financial institutions like Goldman Sachs and BlackRock were proclaiming a new commodity supercycle. The reflation trade is well underway as economies re-open and global trade begins to show less friction and the Risk-On environment echoes a 1970’s-esque boom.
China is competing with the USA for global dominance, so we have to consider how well these two global leaders are doing at getting back to pre-covid levels in economic activity. New Chinese trade balance data for February 2021 year-on-year, shows an increase in imports and exports, coming in at 22.2% v’s Exp. 15.0% and 60.6% v’s Exp. 38.9% respectively. At the start of 2020, these were hit massively due to COVID-19 and had fallen to 6.5% for imports and 18.1% for exports.
An increase in economic activity plus a commodity super cycle has got to be an investment opportunity of a lifetime. The supercycle is a multi-decade period in which retrospectively we witness commodity prices going through extended periods of boom and busts, generally driven by large or un-expected demand shocks and reduced supply. Studies have shown that positive rates of change in global economic growth measured in the gross domestic product (GDP), has an oversized effect on the prices of commodities. In 2016 a Bank of Canada study stated that a 1% uptick in global GDP resulted in a 14% rise in Oil prices and 9.2% rise in base metals pricing.
In hindsight if you had the capital and the foresight to buy the March 2020 lows in the iShares MSCI Global Metals & Mining Producers ETF, your investment would have returned 180% over the last 11 months, and looking at the way the materials sector XLB ETF is tracking equities and recently outperforming the DJIA, we can assume that the reflation trade should continue while the equities are supported by loose central bank monetary policies.
From what we have learned so far from the new Biden administration, it doesn’t look like the underlying economic conditions which create a weaker dollar are set to change. We still have massive fiscal spending and an increasing fiscal deficit and a widening trade deficit.
The US dollar index (DXY) is currently sitting on a multi-decade mean price of approximately $89-$90 and the lower the currency goes, the better that will be for commodities.
The Biden era is, however, likely to be the start of the real push towards Green Tech as the administration looks into electrification of vehicles and renewable energies alike and is targeting climate change with a Green New Deal.
In 2014 the Committee on Energy and Natural Resources published a Critical Minerals Act, following on from the supply shock of 2009 when China restricted the exports of rare earth minerals. There is now an increased sense of urgency among corporations and governments alike, to have access to rare earth minerals and to secure the critical minerals supply chains, which are increasingly needed in this new green economy.
Other current market themes are the steepening sovereign yield curves which are a proxy for inflation expectations and maybe the catalyst in the correction of Gold from the August 2020 highs. The inflation hedge against massive stimulus sounds like a good idea, but we’re beginning to realise that all of this stimulus is not creating inflation let alone hyper-inflation as measured in the CPI or PCE metrics, which is what the Fed looks at when deciding on whether to raise interest rates.
So why would yields be rising currently and when may they start to contract again? In my opinion, we have to look back at what happened in March and April of 2020 and which monetary policies and key decisions put in a level of support, halting the broad market crash. The first one was the central bank’s stimulus, the second was the decision to allow banks to increase their holdings of US Treasuries and ignore them from the Supplementary Leverage Ratio (SLR), third being the fiscal stimulus that the US government has been able to do and continues to do, in part because of the suspension of the debt ceiling.
We’re approaching a critical decision on whether the SLR extension will be granted, and it is very highly probable that the banks are selling treasuries into this deadline bringing down the price of notes and bonds, raising the yields. If this is the reason, we only have to wait for the banks to digest this change and when they don’t have to dump the treasuries onto the market, yields would come down and Gold could resume its uptrend. There is political pressure on the Fed and the FDIC to bring back the legislation requiring banks to adhere to the SLR in which case there could be much more market turmoil, but the fact remains when we see yields falling that could be the Gold signal we’re waiting for.
If you look to buy any precious metals and especially Silver, the premiums are still high and the delivery dates long, showing a lack of supply in the Silver market and sustained demand. We have already seen it in Palladium and Copper, and also in Iron Ore with futures in Iron up 92% over 1 year and up 232% over 5 years. One way to join in on this trade is through mining royalty companies who have exposure to precious metals and will do well when the tailwinds in Gold are pushing the precious metals much higher.
Vox royalty is weighted towards precious metals and also has other interests in the commodity super cycle like their 2.0% interest in the Koolyanobbing mine in Australia, which is rich in Iron ore. The mine is targeting 7.5Mtpa and is on track to increase production to 11.0Mtpa and is owned by Mineral Resources who is Australia’s largest contract minerals processor. But it is not just base metals and precious metals, they also have plays in critical minerals.
In their South African royalty with Bushveld Minerals, the Brits asset is heavily into Vanadium. This critical mineral is used in Sulfuric acid production and also in Vanadium redox batteries which are used for energy storage in large power facilities, such as wind farms. Allowing investors access to the mining and materials sector and the green tech play.
Over the last 3 months, the Gold Miners ETF has fallen with the spot gold price and we have seen the SLV ETF do its best to hold up against the headwinds but the price of Vox Royalty although in a sideways consolidation, is really holding its own and maintaining its value for shareholders and shows that the diversification of their royalties and ability to find value is their true unique selling point.