Goehring & Rozencwajg's Quarterly Report
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Natural Resources Market Overview
03/21/2024
The article below is an excerpt from our Q4 2023 commentary.
Commodities were mixed during the fourth quarter. The Goldman Sachs Commodity Index (GSCI), heavily weighted toward energy, fell by a sharp 12%. In contrast, the Rodgers International Commodity Index, weighted more towards metals and agriculture, fell less than 6%. Natural resource equities were also mixed. With its sizable energy weighting, the S&P North American Natural Resource Stock Index pulled back 1.3% while the S&P Global Natural Resources Stock Index, with its higher metals, forest products, and agriculture weightings, rose 3.5%. Broad equity markets were robust: the MSCI, ACWI and S&P 500 advanced between 11% and 12%.
Commodities and natural resource equities have been trending lower for nearly eighteen months. After peaking in the spring of 2022, the GSCI and Rodgers International Commodity Index fell by 33% and 18%, respectively. Although natural resource equities peaked around the same time, their sell-off has been much milder. The S&P North American and Global Natural Resource Stock Indices are within 5% of their May 2022 highs. We expect to see these indices move higher as commodity market fundamentals get stronger during the year.
Oil
Oil investors turned extremely bearish during the fourth quarter. Worries over perceived strength in US shale production and fears of potential recession-related demand weakness drove prices lower. West Texas Intermediate and Brent fell by 21 and 17%, respectively. Oil-related equities fell, albeit less than the commodity. The XLE ETF, dominated by large-capitalization integrated energy companies, fell by 6.4%. In comparison, the smaller-cap S&P Exploration and Production Index fell by 6.7%, and the OIH, which tracks oilfield service stocks, fell by 9.1%.
Throughout the second half of 2023, the Energy Information Agency (EIA) released bearish data suggesting US production again surged after several consecutive years of disappointing growth. As of November 2023, the EIA claims that US production was still growing by a robust 1 m b/d year-on-year. Our models tell us these figures are simply incorrect, resulting from a subtle change in the EIA’s methodology rolled out last July. Although rarely commented upon, adjusting for this change, US production growth appears to have slowed dramatically throughout 2023, just as we predicted. We dissect the recent change and its impact on US production trends in the oil section of this letter.
Although few people care to admit it, global oil markets slipped into a “structural deficit” in the summer of 2020, causing OECD crude and refined product inventories to fall by 600 mm bbl over the next twenty-four months – a record. To prevent a price spike, OECD governments arranged a coordinated release of 320 mm barrels from their strategic petroleum reserves. In response to the government’s SPR releases, commercial inventories rose. Since March of 2022, when SPR releases commenced, OECD commercial stocks have risen by almost 175 mm barrels. Many analysts, including the International Energy Agency (IEA), have failed to comment on the true reasoning why commercial inventories have risen—SPR releases. Instead, the IEA has implied inventories rose simply because supply exceeded demand. However, if one adjusts for SPR liquidations, inventories are unchanged, suggesting a market that is not in surplus—but balanced. Given our models of both supply and demand, we firmly believe oil markets will once again fall into a sustained deficit in 2024. Although few people agree, we believe the deficit could prove so acute as to require further SPR liquidation later this year. The last period of structural deficit, between 2020 and 2022, saw crude prices advance three-fold from $40 to $120 per barrel. Could we experience the same again now? We recommend investors position themselves accordingly.
Natural Gas
Natural gas prices fell in North America and internationally during the fourth quarter.
Henry Hub fell a significant 21% in the US, while European and Asian natural gas fell by 18% and 21%, respectively. Milder weather in all regions reduced fourth-quarter heating demand. Since the beginning of the withdrawal season, the US has experienced 10% fewer heating degree days than average. The mild weather materially affected inventories. At the start of the withdrawal season, US inventory levels had nearly returned to the long-term seasonal average after ballooning following the Freeport LNG export terminal fire and the mild 2022/23 winter heating season. After peaking about 300 bcf above normal last June, inventories were a mere 50 bcf (or 1.4%) above average by early November. A very mild November and December swelled inventories again, reaching 340 bcf (or 10%) above average by the end of December.
Despite the mild weather, growing inventories, and falling prices, we remain incredibly bullish. Analysts underestimate the impact of slowing shale growth ahead of the looming wave of new LNG export capacity arriving later this year. Despite pervasive bearishness, we believe 2024 will be the year Henry Hub converges with international prices, which are currently nearly six times higher.
Coal
Coal prices were mixed in the fourth quarter. High-quality Appalachian thermal coal advanced by 10%, Illinois Basin coal fell by 10%, and Powder River coal was flat. Internationally, Australian and South African thermal coal fell by nearly 10 and 20%, respectively. Surprisingly resilient Chinese steel production drove metallurgical coal sharply higher by 37% during the quarter.
Commodities are mainly cyclical, primarily driven by the capital investment cycle. Generally, finding the sector most starved for capital is a sound investment strategy. Over the past fifteen years, we cannot identify a sector more capital-starved than coal mining. At the same time, global demand has remained resilient. The combination will likely lead to higher prices. In 3Q23 alone, China permitted more new coal-fired power plants than in all of 2021. Recent reports by the Development and Research Center, a Chinese think-tank advising the government, suggest China must add a staggering 200 GW of new coal-fired power by 2030 – 15% more than today and equivalent to all of Canada’s electricity generation capacity. India also plans to build nearly 90 GW of additional coal-fired electricity by 2032, representing an increase of almost 40%.
Robust demand combined with chronic underinvestment in new mine supply has already driven thermal coal prices to levels nearly three times higher than the prior bull market peak made in 2011. Although coal has pulled back from 2022 record levels, we remain bullish. Coal equities have been the winners in every prior commodity bull market, from each sector’s low to their respective highs. They have already assumed their leadership position in the unfolding bull market and we believe this will continue for the duration of this bull market as well.
Base Metals
Base metals were mainly flat to slightly higher in the fourth quarter. Copper rose 4.2%, aluminum and zinc advanced 1.6% and 0.3%, respectively, and nickel fell 11.2%. Copper equities, as measured by the COPX ETF, rose 4%, while base metal stocks, as measured by the XBM ETF, were flat.
Copper investors have turned very bearish in the near term due to fears of economic slowdown and Chinese property concerns. At the same time, these same investors remain wildly bullish over the medium and long term due to a shortage of new expected mine supply. Our outlook remains very different: we are increasingly bullish in the near term but are beginning to worry about a possible supply response in the long term.
The World Bureau of Metal Statistics (WBMS) confirms copper demand remains robust, particularly in non-OECD countries. Despite all the talk of Chinese economic problems, their copper demand surged 13% year-on-year over the first ten months of 2023. Strong non-OECD copper demand growth was not limited to China. India’s copper demand grew 30% and, although seldom mentioned, Indonesian demand grew an astounding 40% over the same period.
In past letters, we discussed why we believed Indian copper demand had now reached an inflection point, similar to what China experienced around 1998-2000, immediately preceding a sharp rise in demand. Could Indonesia now be at a similar point in its development? In the copper section of this letter, we will discuss the societal trends taking place in Indonesia that we believe will lead to accelerating domestic demand growth.
In the near term, copper mine supply trends are also highly bullish. In 2023, the Panamanian government ordered First Quantum to cease mining at its flagship Cobre Panama operation. The mine, the world’s eighth largest copper mine, produced over 350,000 tonnes of copper concentrate in 2022 – nearly 2% of the global mine supply. Making matters worse, Anglo-American announced that its 2024 Chilean production would disappoint between 210,000 and 270,000 tonnes owing to head grade declines and logistical issues at its Los Bronces mine.
While copper bears had projected a moderate surplus in 2024, the nearly 600,000 tonnes of unanticipated mine supply cuts suggest a tight near-term market. Quickly mobilized copper inventories, located at the COMEX, LME, and Shanghai metal exchanges, continue to drift lower after having grown slightly throughout the third and early part of the fourth quarter.
In the long term, we are concerned that new discoveries and technologies may set up a new supply cycle. Please read our copper section, where we will discuss these trends in detail.
Uranium
Uranium nearly doubled in 2023, rising 30% in the fourth quarter alone, making it the year’s best-performing commodity. We believe 2024 will be strong as well.
As we predicted, financial buyers (mostly hedge funds) have emerged as a source of new demand that few analysts expected. While this new source of demand came as a surprise to many, we wrote about its potential as early as 3Q2018: “Since we last wrote [in 1Q18], another source of unexpected physical demand has entered the market—one that we believe could become substantial as this bull market unfolds. We are referring to the emergence of investor demand for physical uranium.”
Although it took longer than expected, material financial demand is finally here. Writing in the Telegraph on January 1st, 2024, reporter Matt Oliver explained how: “Hedge funds are stockpiling barrels of raw uranium as the nuclear fuels price surges to 16 years high. As many as 50 funds are believed to have bought and stored uranium concentrate, known as “yellowcake,” at a facility run by US processing firm ConverDyn alone, as speculators bet that prices are set to spike […] Other players amassing even larger stockpiles include uranium investment trusts which have built portfolios worth billions of dollars at today’s prices, such as London-listed Yellow Cake Plc and the Toronto-listed Sprott Uranium Trust.” Given the current substantial uranium deficit, financial speculators will only serve to spike prices even higher over the short term.
We believe the uranium rally has only started. The benefits of nuclear power, which is highly efficient and free from carbon, are only now becoming widely recognized.
Energy analysts are also awakening to the benefits of new Small Modular Reactors. These new reactor designs, notably those based upon molten salt instead of pressurized water, promise to improve nuclear power’s efficiency and cost further. Molten salt reactors operate at near-atmospheric pressures, reducing the need for steel and high-pressure welding. In turn, less weight means much less cement needed for foundational support. The result is improved energy return on investment (EROI), which is expected to approach 180:1 compared with less than 10:1 for renewables and 30:1 for combined cycle natural gas turbines. The nuclear industry is on the verge of a massive global investment cycle, with uranium being the primary beneficiary. The uranium section of the letter will discuss further supply issues that will strongly impact 2024 and 2025 supply dynamics.
Precious Metals
Responding to a 4% pullback in the US dollar, gold and silver were strong in the fourth quarter. Gold rose 12%, while silver advanced by 7%. Precious metal equities did even better. Gold equities, as measured by the GDX ETF, rose 17%, while silver equities, as measured by the SIL ETF, rose 19%.
Demand trends in the third quarter continued into the fourth as Western investors continued to liquidate gold while central banks aggressively accumulated metal.
Real interest rates surged throughout 2023. In our last letter, we explained how periods of rising real interest rates typically drove Western investors to liquidate their gold holdings. Last year was no exception. The eighteen physical gold ETFs we monitor shed 239 tonnes – 67 tonnes in the fourth quarter of last year alone. This trend has continued into 2024, with Western investors having shed another 50 tonnes in January. Western investors have been divesting silver holdings as well. The eight physical ETFs we monitor shed 1,515 tonnes in 2023, with 430 tonnes in the fourth quarter. Similar to gold, western investors shed another 100 tonnes in January 2024.
Despite the massive investor liquidation, gold made a new all-time high of $2,077 per ounce on December 27th, as relentless central bank buying more than made up the difference. Over the first three quarters of 2023, central banks purchased 800 tonnes of gold. Preliminary data for the fourth quarter suggests they have not stopped. According to the World Gold Council, central banks bought 42 and 44 tonnes in October and November 2023, respectively. Notably, the People Bank of China (PBOC) purchased 216 tonnes in the first eleven months of 2023, pushing their purchasing streak to thirteen months and counting.
Central bank purchases have buoyed the gold price. During the prior period of rising interest rates, between 2013 and 2015, western investors liquidated 1,100 tonnes of gold. The liquidation pushed gold down nearly 45% compared with the 2011 high. Central banks were inactive during this period. In this current cycle, Western investors have liquidated nearly 850 tonnes in response to rising real rates. However, instead of falling 45%, gold made a new all-time high. The difference: the aggressive buying of central banks.
Our readers know that we expect a monetary regime change in the not-too-distant future. In past letters, we have explained how a change follows every period where commodities become radically undervalued relative to financial assets in the global monetary system. This occurred in 1929-30, 1968-71 and 1997-99. By every metric, commodities today are more undervalued relative to financial assets than at any point in the last 140 years. Intense central bank gold accumulation is likely a tip-off, and this change may come sooner rather than later.
As the recent US inflation data fell to 3.4% and the Federal Reserve has decided to leave rates unchanged at 5.3%, real rates have edged slightly higher. We are not surprised to see Western investors continuing to liquidate gold. Recently, the Fed has suggested lower inflation data will lead to a rapid reduction in interest rates. The Fed fund rate futures trading is now pricing six or seven rate cuts in 2024. Were the Fed to cut rates, the Western investor would likely turn from seller to buyer, butting up against massive central bank accumulation. We believe this dynamic will start the next leg of the gold bull market. Gold equities are likely one of the most undervalued asset classes in the world today. In our following letter, we will discuss the investment potential in detail.
Agriculture
Corn and soybeans were mostly flat in the fourth quarter, falling 1% and 2%, respectively, while wheat rose 15%, driven by strong export demand and ongoing conflicts in the Black Sea between Russia and Ukraine.
Fertilizer prices were weak. After rallying sharply in the third quarter, urea (a solid form of nitrogen) returned all of its gains, falling 25%. Phosphate and potash fell by 7 and 6%, respectively.
Since peaking in the summer of 2022, grain prices have been in a persistent downward trend, with soybeans, corn, and wheat falling by 30, 40, and 55%, respectively. Ongoing weakness has led to near-record investor bearishness – a topic we will discuss in the agriculture section of this letter.
With the 2023/24 Northern Hemisphere growing season having wholly wrapped up in the middle of the fourth quarter, news flow remains very light. In the Southern Hemisphere, extremely challenging planting and growing conditions persist across most critical areas in northern Brazil. Persistent dryness and extreme heat have prompted the USDA to reduce Brazil’s corn crop estimate to 129 mm tonnes, compared with 137 mm tonnes last year. The USDA also reduced Brazil’s soybean estimates to 157 mm tonnes, compared with 163 mm tonnes last year, with many analysts expecting further negative revisions.
A notable weather pattern – the La Nina Modiki – has developed in the Pacific and is responsible for the extreme drought plaguing northern Brazil’s croplands. Meteorologists expect the Modiki to last well into the second half of Brazil’s growing season, offering little relief. Brazil’s soybean exports now dwarf US exports, and we are monitoring weather conditions accordingly.
We would also like to point out the recent significant upward revisions made by the USDA to their 2023 corn yield assumptions. In their January 2024 World Agricultural Supply and Demand Estimate report (WASDE), 2023 corn yield assumptions went from 174.9 to 177.3 bushels per acre – a new record. The revision pushed the estimated corn harvest to 15.564 bn bushels – the largest in history. After ending 2022/23 at 1.36 bn bushels, corn-ending stocks are expected to reach 2.26 bn bushels. Although these revisions are definitively bearish, we believe traders have already incorporated much of the negative news into their positioning – a topic we will discuss in the agriculture section of this letter. If we are right and 2024 brings another year of disruptive weather, agricultural-related equities should prove rewarding. We continue to maintain positions in fertilizers equities. The stocks have now pulled back, on average, 40% over the last sixteen months and represent excellent value.
Slide Deck
