Sidestepping the supply driven carnage

The carnage in lithium and nickel markets through 2023 should be a stark reminder for all investors: supply matters.
Dion Hershan

Yarra Capital Management

Investors and commentators who were enamoured with the long-term structural trends towards decarbonisation – and as a result have been heavily exposed to the battery minerals complex – have had a painful lesson.

Unpicking the longer term story, however, reveals what are in fact more a series of short-term drivers:

  • Pricing in the lithium spodumene market crashed 85% in 2023 to finish the year at US$970/t, a price many thought was inconceivable but is actually where it was in mid-2021 prior to the speculative frenzy.
  • Nickel has fallen by a more 'modest' 44% over that period, as surging Indonesian production (mostly funded by Chinese SOEs) flooded the market.
  • This collapse in the pricing of both commodities (refer Chart 1) is despite strong EV demand, with sales up +34% globally in 2023 (slightly below expectations but representing more than 100% of the growth of the auto industry).
  • The central issue with these two commodities is that supply has grown faster than demand, and when commodity prices move a mile away from their cost curves it typically ends in a blood bath. We have since observed lithium and nickel projects being deferred, mothballed, or curtailed. All of which is part of the natural business cycle.

Chart 1: The Lithium and Nickel Pricing Rollercoaster

Source: YCM, Bloomberg, Feb 2024.

Source: YCM, Bloomberg, Feb 2024.

Notwithstanding real time case studies being readily observable, there appears to be obvious complacency on Iron Ore which, inconveniently, is Australia's largest export ($144bn in 2023) and speaks for 17% of ASX 200 earnings (and 16% of dividends).

Demand for iron ore is stagnating. China – which represents 71% of the global seaborne market – has a housing sector which is in a deep funk and an economy showing clear signs of maturity and saturation.

Yet despite this malaise, iron ore supply is set to surge from 2025, with Africa's Pilbara (the Simandou region) commencing production which – unless mitigated by supply cuts elsewhere – will push the market 5-10% into surplus (refer Chart 2). As with nickel, China has an incentive to over-invest in the commodity, flood the market and drive down prices for one of their largest imports.

Chart 2: Outlook for Iron Ore Supply is Concerning

Source: YCM, UBS, Wood Mackenzie, Feb 2024.

Source: YCM, UBS, Wood Mackenzie, Feb 2024.

Logic would suggest this could result in a US$50/t plus drop in the iron price (to ~US$80/t, in line with the cost curve) which would slash earnings at BHP/RIO/FMG by 49%/49%/65% and ASX 200 earnings by 10%.

Rather than waiting for history to actually repeat, investors would be wise to look through the current temporary earnings strength in iron ore stocks and reposition to avoid what could potentially be carnage.

With trouble somewhere on the horizon, we remain significantly underweight iron ore stocks across all of our Australian equity portfolios.

Other Sources: Platts, ABS, Goldman Sachs, YCM. Data as at Feb 2024.

Access companies offering strong growth potential

The Yarra Ex-20 Australian Equities Fund seeks superior returns, providing investors with access to a diverse and balanced portfolio offering strong growth potential over the medium to long-term.

Managed Fund
Yarra Ex-20 Australian Equities Fund
Australian Shares
........
This material is distributed by Yarra Funds Management Limited ABN 63 005 885 567, AFSL 230251 and is intended for viewing only by wholesale clients for the purposes of section 761G of the Corporations Act 2001 (Cth). This document may not be distributed to retail clients in Australia (as that term is defined in the Corporations Act 2001 (Cth)) or to the general public. This document may not be reproduced or distributed to any person without the prior consent of Yarra Funds Management Limited. The information set out has been prepared in good faith and while Yarra Funds Management Limited and its related bodies corporate (together, the “Yarra Capital Management Group”) reasonably believe the information and opinions to be current, accurate, or reasonably held at the time of publication, to the maximum extent permitted by law, the Yarra Capital Management Group: (a) makes no warranty as to the content’s accuracy or reliability; and (b) accepts no liability for any direct or indirect loss or damage arising from any errors, omissions, or information that is not up to date. To the extent that any content set out in this document discusses market activity, macroeconomic views, industry or sector trends, such statements should be construed as general advice only. Any references to specific securities are not intended to be a recommendation to buy, sell, or hold such securities. Holdings may change by the time you receive this report. Portfolio holdings may not be representative or future investments. Future portfolio holdings may not be profitable. The information should not be deemed representative of future characteristics for the strategies listed herein. Past performance is not an indication of, and does not guarantee, future performance. References to indices, benchmarks or other measures of relative market performance over a specified period of time are provided for your information only and do not imply that the portfolio will achieve similar results. The index composition may not reflect the manner in which a portfolio is constructed. Portfolio characteristics take into account risk and return features which will distinguish them from those of the benchmark. There can be no assurance that any targets stated in this presentation can be achieved. Please be advised that any targets shown are subject to change at any time and are current as of the date of this presentation only. Targets are objectives and should not be construed as providing any assurance or guarantee as to the results that may be realized in the future from investments in any asset or asset class described herein. If any of the assumptions used do not prove to be true, results may vary substantially. These targets are being shown for informational purposes only. Whilst we seek to design portfolios which will reflect certain risk and return features such as sector weights and capitalization ranges, by accepting the presentation as a wholesale client you are taken to understand that such characteristics of the portfolio, as well as its volatility, may deviate to varying degrees from those of the benchmark. FOR DISTRIBUTION ONLY TO FINANCIAL INSTITUTIONS, FINANCIAL SERVICES LICENSEES AND THEIR ADVISERS. NOT FOR VIEWING BY RETAIL CLIENTS OR MEMBERS OF THE GENERAL PUBLIC. © Yarra Capital Management, 2024.

1 fund mentioned

Dion Hershan
Executive Chairman and Head of Australian Equities
Yarra Capital Management

Dion is Executive Chairman and Head of Australian Equities. He is responsible for leading the Australian Equities team, and is a Porfolio Manager focussed on large cap equities. Prior to transitioning to Yarra Capital Management, Dion was the...

I would like to

Only to be used for sending genuine email enquiries to the Contributor. Livewire Markets Pty Ltd reserves its right to take any legal or other appropriate action in relation to misuse of this service.

Personal Information Collection Statement
Your personal information will be passed to the Contributor and/or its authorised service provider to assist the Contributor to contact you about your investment enquiry. They are required not to use your information for any other purpose. Our privacy policy explains how we store personal information and how you may access, correct or complain about the handling of personal information.

Comments

Sign In or Join Free to comment
Elf Footer