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Macro Metals Update:Case for Commodities Getting Back On Track

The big event in the last month was the US midterm elections. While I’m not one to obsess over politics, this event matters to the metals markets.

To explain why, let me step back a bit.

 At the start of 2018, metals investors were pretty excited. It looked like increasingly volatile stock market was encouraging investors to start seeking value, a search that would return metals and miners as one of the only undervalued sectors out there. At the same time, global growth continued to push commodities towards their reliable late-cycle outperformance. Things looked good.

Then two things happened: anxiety over trade wars derailed commodities and the stock market calmed down and continued up. Instead of an exciting 2018, metals went back to being underpriced but ignored.

Trade Wars

The trade war situation has been uncertain from the start and there are still no guarantees how it will play out. However, there are forces now at play that suggest the tariff rhetoric should ease, rather than worsen, from here. Trump and his team have taken a softer tone towards China of late. China reportedly sent a letter to Trump outlining possible concessions. Trade officials are once again talking. Xi and Trump are finally set to meet, at the G20 in Argentina at the end of November. And some of the more hawkish members of Trump’s team have been sidelined, including Peter Navarro, the ultra-protectionist trade advisor who wrote the book Death By China. Why the thaw? Several reasons. A solid economy in America has helped Trump maintain support. He knows that, and so also knows that any long-term damage from a drawn-out trade war would undermine the strongest argument in his arsenal going into 2020. Business investment is already slowing, with companies complaining that all the uncertainty of tariffs and the costs of imports have forced many to postpone major investments. Then there’s the agricultural side, where soybeans are the clear canary in the coalmine. Soybean exports to China, a business worth $14 billion that makes up 10% of all US agricultural exports, are down more than 90%. Trump needs to be tough with China, but he also needs to get a deal done and keep business going. With Democrats now in control of the House, a thaw now could mean actually passing a deal. All told, there are lots of reasons and signs to think the worst of the trade wars are behind us. (That said, Trump is an unpredictable character. If he’s in a bad mood in Argentina, there’s room for the trade war to get worse.) An easing of tariff talk should let commodities respond to fundamentals again, instead of anxieties – and those fundamentals are far stronger now than they were 11 months ago, with stockpiles low, prices oversold, and supply gaps very much still looming. That’s a bullish setup for base metals.Now things look to be shifting back to the bright side. With Democrats in the House, a TrumpXi meeting imminent, tech stocks sliding, and market volatility again on the rise, it looks like the commodities argument is getting back on track.

Wavering Markets

Strong commodity fundamentals are half of the argument. The other half – the half that makes prices actually move in response to those strong fundamentals – is generalist investors seeking value amidst a wavering market and, as a result, rotating some of their dollars into mining. And now those wavers are back. Banks are starting to warn that risks are rising. Analysts at the Bank of America Merrill Lynch on Friday warned that signs of a “flash crash” are appearing, after a week in which Bitcoin once again tumbled, oil sank, and investors moved money into safer arenas. One that last point: last week US investors put $1 billion into value funds while pulling $600 million out of growth funds. Defensive sectors like healthcare and utilities led the inflows. In October stock market took a 10% correction. It bounced quickly, but importantly the tech stocks that have fueled this bull market were left lagging. If FAANG stocks lose their magic, a powerful force behind the bull will have evaporated. Tech stocks have outperformed for their own reasons but they have also poured fuel on the fire through buybacks. Companies keep pouring more and more capital into buybacks but the impact is starting to wear off. For instance, this year has seen a record $800 billion of US buybacks so far, yet the S&P 500 buyback index - which tracks the performance of the 100 stocks in the index with the highest buyback ratios - is up just 0.9% year to date and down 5.9 per cent this quarter. With buybacks returning less benefit and corporate debt loads incredibly high, companies are going to step back on using debt to buy their own shares…and a major driver of this bull market will be gone.

 

Because of slowing tech stocks, because of rising bond yields, because of general anxiety about overvaluations, because crazy high corporate debt levels look to finally be slowing share buybacks – this bull market is going to get more volatile. It’s already happening. And it’s good for gold.

This chart is from Goldman Sachs’ latest gold report. It shows that investors bought gold – specifically they bought into gold ETFs, which have to buy physical gold in response – as VIX, the market ‘fear’ index, jumped.

That is a clear safe haven action. In recent years I have often hear the complaint that gold hasn’t been attracting safe haven buying, but my response has always been: what would they be safe haven-ing from? When the broad stock market is marching reliably skyward, there’s no need to hide. So it wasn’t that gold had lost its safe haven allure; it’s that safe havens haven’t been needed.

Now that’s changing.

I’m Not The Only One

The commodities argument relies on generalist investors rotating into metals and miners for security and value in a broad market that is overvalued and volatile. And while this setup makes good sense to me, I have been very heartened in the last week to get some significant validation that generalists are indeed starting to get interested in metals.

 The Wall Street Journal started the support with an article titled Supply Crunch Looms in Commodities Markets. It started like this:

A prolonged period of underinvestment by commodity producers is setting the stage for large price increases in raw-materials markets, say bullish investors who focus on the metals and energy industries. Prices of copper, nickel and aluminum could soar past prior records — more than 40% above current levels — in the coming years, say the portfolio managers. Such a development would likely transform markets marked in recent years by soft prices and tepid investor interest.

The Wall Street Journal matters in the investing space, so simply for this article to appear is significant.

Then I chatted with executives at the Metals Investor Forum who have been marketing their stories around North America and several commented that they had secured meetings with generalist fund managers for the first time in years. At those meetings, these generalist investors commonly said they for the first time in many years were looking to commodities, metals and miners in particular, for value and diversification. That, my friends, is music to my ears. When generalist investors who managed billions of dollars get interested in metals – a drop of interest makes a huge difference.

This chart is a touch dated but I love its message:

 

 

In the booming gold market of 2009-2011, generalists had roughly 7% allocation to precious metals. Today that’s down to about 1%. When generalists just rotate a few percent of their portfolios towards gold and miners, it makes an immense impact on our small sector.

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