Boom! Goes the commodities cycle

The global economy is firing up, inflation is on the rise, and over US$30 trillion will need to be spent on decarbonizing the grid in the coming years, if we’re to achieve carbon neutrality targets. These are the big drivers that have investors increasingly predicting a new boom in commodities.

“We think this de-carbonization impact on the commodity sector could be bigger than what that Chinese urbanisation impact was on the sector,” Ben Cleary, Portfolio Manager of the Tribeca Global Natural Resources Fund, told Livewire recently.

With investment banks beginning to raise long-term price forecasts, this should see activity in the sector start to pick up after nearly a decade of underperformance. We discuss the new commodities cycle and the metals best set to benefit below. We also hear about the sectors where he sees the most upside over the coming 12-18 months.

You've said in elsewhere that you think that there's a new commodities supercycle coming. Could you explain why?

We think that at least the next couple of years is going to be a very good environment for the natural resources sector. You're starting to hear a lot of talk about increasing inflation and higher yields, which has historically been great for the sector. 2020 was underwritten by very loose monetary policy across the G20, which saw the US dollar weakened because the US printed a lot more money than the rest of the world. Which again is historically good for the sector. Biden getting in last year has already eased Sino-US trade tensions, which had been a headwind for the sector.

I think the biggest driver for the sector in future is the de-carbonization and environmental strategies that all of the G20 are embracing. We think this de-carbonization impact on the commodity sector could be bigger than what that Chinese urbanisation impact was on the sector.

The long-term commodity prices are going to start going up, and that’s why the banks are getting so interested in this ‘supercycle’ term. We've already seen that in the first three months of this year. Margins will be much better with long-term pricing going up. It means that activity will pick up after a decade of muted activity. You’ll see a big increase in CapEx and M&A. So, I think the outlook for at least the next couple of years is looking pretty good.

Inflation has continually disappointed to the downside for the last 10 plus years. Why are you confident that it will rise in the medium term?

I guess most people in the city are thinking, “housing prices are up, stock markets are up. Why is headline inflation not going up?” We’ve had some interesting findings over the last few weeks travelling around regional Australia, seeing our investors and portfolio companies.

In regional Australia they are genuinely starting to see real inflation, as opposed to just financial inflation that we might see in the city. Crude oil prices are up 20% on pre-COVID prices, fertiliser prices are up a similar magnitude. The really big thing in regional Australia is labour availability – labour is hard to come by at the moment. Machinery prices are up and availabilities down because of the availability of trade out of places like China. Following all the weather events – fires and floods – in the last 18 months, cattle prices are up 30 or 40%. It's very hard for people to be restocking in this environment.

That's driving inflation in the regional sector, but it's going to drive inflation in the form of food prices in the cities. This is not just in Australia thing, this is globally.

So to your question, headline inflation has been low, but it's very hard not to see that it going higher over the next 12 months.

The urbanization of China and the associated consumption of bulk commodities such as iron ore were the defining features of the last cycle. Which commodities do you think will define the current cycle?

Base metals, principally copper and nickel, which will feed into this de-carbonization commodity consumption thematic. I think everyone's reasonably aware of electric vehicles and the demand-pull, that they're going to have a whole bunch of commodities, lithium and cobalt and graphite, et cetera. What we're most comfortable with in terms of electric vehicles is, if you look at the battery technologies of which there are many different ones, of all those different battery technologies, none of them substitute copper and very few substitute nickel.

Wind and solar power installation are also heavy in the need for copper and to a lesser degree, nickel.

An offshore wind turbine is around 16 times more copper intensive per kilowatt of energy compared to a thermal coal fired power station.

We think that as these de-carbonization policies really start to rev up, you've got multiple decades of very strong demand for those commodities. New nickel and copper deposits are very hard to find, which we like about those commodities. If you look at the top 10 copper mines in the world today, the average discovery was made in 1970. And with the demand shock of de-carbonization, we think there will be a material supply-demand deficit for the rest of this decade.

Tsingshan recently announced that it had successfully produced battery grade nickel from low grade laterite ore, which has previously been unsuitable for use in batteries. There seems to be a little bit of scepticism about their claims. What's your take on the announcement?

Look, it's been a poor strategy to bet against Tsingshan in the last two or three years. They've delivered on all of their production targets earlier than expected and from a cost perspective, lower than expected. So it would be I think, a very brave investor to say that they can't deliver on what they are saying. But only time will tell for sure whether they can indeed take this nickel pig iron through to matte or battery compliant nickel. This is potentially going to be a watershed moment for the nickel industry. They're not only talking about a competitive operating cost of production, but I think what we're most focused on is it is a much lower capital cost versus your traditional high pressure acid leach or HPAL technology.

This is something that's needed because the nickel demand is so significantly higher than current supply. The industry does need this. What impact it has on the cost curve, we'll see over coming years. But if you take them at their word, there is the potential that nickel sulphate, which is the battery grade. Nickel will have a price cap on it. Over the last six months, we've seen the nickel sulphate price, which previously had traded very much in line with the nickel pig iron price, get out to about a 50% premium. And what Tsingshan are talking about is being able to produce a sulphate equivalent product, from their current nickel pig iron feedstock.

There’s potential for those spreads to compress. The beautiful thing for Tsingshan is that they can take advantage of those spreads. If the spreads reduce, Tsingshan can produce more pig iron. If the spreads blow out, they can produce more nickel matte. So, they are certainly the biggest beneficiaries of this technology and companies like Nickel Mines (NIC), which is a joint venture partner with them and listed on the ASX, should be a major beneficiary over the next couple of years.

Uranium equities have rallied hard, some are up 300 or 400%. However, the spot price is still well below what would be required for some of these projects to restart. Could you explain what the disconnect is between the spot market and the equities at the moment?

The listed equities are starting to get quite a bit of attention from the broader market with several of the ESG issues that have been percolating for the last six months.

Earlier this year after the Texas storms there was a very iconic image of a frozen turbine. At the same, time the German solar grid that was under 10 inches of snow. And both of those grids went down for multiple days. Bill Gates coined the phrase, "Weather dependent energy." It's been a watershed moment for people that were previously very anti-nuclear. Uranium is a very low carbon source of base load power.

I believe that has been the catalyst for the sector to start to move. You're right that most stocks are already pricing in materially higher spot prices, which I think will start to play out over the course of this year. We also haven't seen a lot of contracting, and the spot market is fairly illiquid.

The potential for more capital to come into the sector is really driven by ESG. There were reports on the weekend that the EU will allow nuclear power to qualify for the green investment label. We think that is very important. It will mean the potential for more nuclear generation in Europe. ESG funds take a lot of attention to that green investment label, because it considers nuclear waste. It’s one of the reasons that uranium stocks have not previously been in any ESG ETFs.

The final decision is in a couple of months’ time, but it could have a significant impact on the sector. If uranium became 1% of ESG ETFs, being a close to zero emission baseline electricity, that would be about 300% of the total market cap of the sector, today. So, that is a big driver, and you are going to see spot prices move higher. However, the sector is possibly little bit of ahead of current spot economics at the moment.

Given that dynamic, would you prefer to be earning companies with uranium projects or companies that buy and hold physical uranium at this stage of the cycle?

We've had a portfolio construction approach of having roughly around 50% of our uranium has been in spot-linked companies over the last couple of years. We've had about 30% in producers like Cameco in Canada. And then about 20% in developers, like some of the Australian stocks. As the spot price starts to move and the developers start to move, we have been pivoting away from spot and more production and development. Because that's where you’ll get more torque in your portfolios.

Spot is still a core part of any uranium portfolio. Companies like Yellowcake in London or Uranium Participation Corp in Canada are the traditional ways to get exposure to physical uranium. But we're starting to see some of the development companies like Denison Mines and Australia's Boss Energy (BOE) buy physical uranium, which gives investors access to both physical and development projects.

In your view, what commodity has the best outlook over the next year or two, and what do you think are the best equity exposures?

We still see uranium as having the most upside at around US$30 a pound. We say upside of anywhere from two to three times, over the next 12 to 18 month period. So it's hard to go past uranium as a commodity.

However, we probably see the most upside in gold equities, particularly after this pullback we've seen since last August.

The sector is trading about as cheap as it has in the last 30 years relative to itself, the broader commodity sector, and the broader equity market. We see gold equities as very valuable, and a very good risk-reward bet over the next 12 to 18 months.

Gold, has sold off on rising US yields, but history would tell you that in increasing inflation expectations, and yields have in fact been very good for the gold industry.

We do expect to see some support in the gold price over that period, but the sector doesn't need a higher gold price for equities to go higher.

When looking at equities, there’s no need to go searching through small caps. I'm happy just to own a basket of the Aussie gold producers. Whether it's Northern Star (NST) or Newcrest (NCM) at the big end, or the mid-caps, like Ramelius (RMS), Silverlake (SLR), or Westgold (WGX), which will give you great exposure to that theme.

We've also been following the hydrogen sector closely and in Europe and North America and have seen some of the biggest gains of any equity sectors coming out of hydrogen. Australia is lacking listed hydrogen plays at this stage. But I think that will be changing over the next 12 months.

Australia's richest man, Andrew Forrest, is pledging to make material investments into the sector. Somewhere around 10% of Fortescue’s (FMG) net profit after tax will be invested in sectors like hydrogen. I think Australia could end up becoming one of the key suppliers to Asia of hydrogen, as it has been with natural gas for the last 30 years.

The infrastructure required for hydrogen is very similar to natural gas. In fact, hydrogen can be pushed down the same pipes. So as we've seen this in the US, which has a very similar gas infrastructure network to Australia. The incumbents with the gas infrastructure have done particularly well out of hydrogen. Companies like Santos (STO) or Origin Energy (ORG) that have very significant processing hubs and related infrastructure could potentially become major players in the hydrogen sector.

There’s also a bunch of interesting, smaller companies like Hexagon (HXG), which has a major hydrogen project in the Northern Territory. Or some of the more technology focused hydrogen plays that could look very interesting. We've spent a lot of time in North America and Europe research hydrogen, and I think the opportunities will be in the Asian region. And Australia is very well-placed to benefit.