Natural Resources Market Commentary (GRA): Oil, Natural Gas, Precious Metals, Copper, Agriculture


Goehring & Rozencwajg Associates 2Q17 Market Commentary, July 21, 2017

Market Commentary

  • S&P North American Natural Resource Sector Index, which has a high weighting to North American oil and gas stocks, declined 7.2% during the second quarter (down 11.2% for the year)
  • Reflecting the relative outperformance of mining versus energy this year, S&P Global Natural Resource Index, with its much higher mining and agricultural weightings, continued to outperform its North American peer
    • Only declined 1% in 2Q17; up 2.5% for the full year
    • For the year, S&P 500 is up a robust 7.5%
  • Although investing in energy over the last six months has been painful, believe that global oil market balances have rapidly tightened
    • Present weakness in energy and energy-related equities represents a huge buying opportunity for those investors with small energy exposure
  • Outside of energy, base metals were mixed. Aluminum, zinc, and nickel were down between 2% and 6% during the quarter. Standout was copper which rose by ~2% during the same period
    • Last year, almost every metals analysts thought the global copper market would be in structural surplus for years to come. Recent data has now forced many of these copper analysts to change their stances
  • Precious metals were weak overall during the quarter – gold fell less than 1% and silver fell by almost 10% during the quarter
    • After showing pronounced strength in 1Q, physical accumulation of gold by western investors, turned negative in 2Q
    • Physical gold accumulation by both China and India soared in 2Q
    • Believe that history is now repeating itself and that if Fed continues to raise rates and ultimately shrinks its balance sheet, USD will continue to weaken
    • Fed has raised rates twice so far this year and the dollar has now declined over 7%
  • After years of a grinding bear market, global grain markets appear to be showing signs of life. Huge speculative short positions ran into adverse weather conditions which has finally stirred investor interest
    • Wheat prices were particularly strong. Record low wheat plantings in the US combined with extremely dry European weather has produced a surge in wheat prices of 20% during 2Q and 25% for the year
    • Global grain demand remains incredibly strong
    • Ultimately believe that depressed grain prices combined with low valuations in many agricultural stocks has created the potential for an explosive move in grain prices that has made investments in the agricultural industry attractive

Global Oil Markets

  • Disconnect between fundamentals and market perceptions in today’s global oil market is the greatest we have ever seen
  • Global oil market has undergone one of the largest improvements in the fundamentals ever recorded. However, the market sentiment has remained unanimously bearish
  • With recent data all coming in positive, we are more bullish now than when we first wrote back in January
  • YTD through June 30th, WTI has declined by 12%. Following the oil price, energy-related securities were down anywhere between 7% and 14% for the quarter, leaving their YTD performance down approximately 20-25%
  • Predict that inventories would continue to normalize relative to long-term averages throughout 2017 and would work off most of their excess by the end of the year
  • Last time inventories stood at these “normalized” levels, crude oil prices were over $100/bbl and continue to believe there is strong likelihood we can reach similar price levels again in 2018
  • Since the US makes up over 50% of total OECD inventories, direction of US inventories is of critical importance and the most recent data continues to paint a very bullish picture
    • Since the end of February, US core petroleum inventories have declined by an incredible 63 million barrels
    • This occurred during a period that normally sees core inventories draw by only 1.5 million barrels, implying the oil market in the US alone was undersupplied by nearly 500,000bpd
  • At the end of 2006, OPEC believed that global oil markets were oversupplied despite the fact that inventory behavior at the time suggested otherwise – but few market participants took notice
    • OPEC cut production into an already-tight market in November 2006, inventories drew down sharply over the next 12 months, and prices advanced relentlessly throughout 2007 and 2008
    • 10-year average change in US core petroleum inventories over the first 27 weeks of the year is a build of 16 million barrels; back in 2007, inventories were largely flat by the 27th week, implying a market that was 100,000bpd undersupplied; by comparison, inventories have drawn by nearly 20 mmbpd through the 27th week this year
  • Pace of recent draws suggests the oil market is substantially tighter today than it was in the period preceding oil’s rally to $145/bbl by summer of 2008
  • This has been the most important market for us to be involved with since we began managing natural resources investments in 1991
  • Looking into 2018, expect further significant tightening in global crude oil markets
    • IEA is currently projecting global demand to average 99.3 mmbpd while non-OPEC supply is expected to grow by very strong 1.4mmbpd to average 59.7mmbpd
    • OPEC NGLs are expected to average 6.9mmbpd, leaving the call on OPEC crude at 32.7mmbpd for the full year
    • Our base case for March 2018 meeting in Vienna is that it will remain at today’s elevated rate of 32.5mmbpd – the oil market will be in deficit next year by 200,000bpd for the full year
      • This would reduce OECD inventories by another 70 million barrels next year
    • This would put OECD inventory cover at 43 days, or the lowest level since the IEA data began in 1990
  • Several headlines recently calling for the death of crude oil as electric cars will all but replace internal combustion engine
    • World will run out of copper long before we are able to replace even a fraction of world’s automotive fleet with electric vehicles
    • At present, global oil demand is incredibly robust: in the US, set an all-time record in both gasoline and jet fuel demand during 2Q
    • Globally, demand jumped by 1.5 mmbpd y-o-y during the 2Q and this growth is expected to persist into the second half and through most of next year
  • Back in 2001, China’s real GDP reached $1,900/person. The average Chinese citizen in 2001 consumed 1.4bbl of oil over the course of the full year. Total vehicle sales in 2001 averaged 2.2 vehicles per 1000 Chinese citizens, while the airlines carried ~57 out of every 1000 Chinese citizens
    • In many respects, 2001 was a typical year for Chinese per capita oil demand growth – +0.02bbl/person/year, in line with prior 25 year-average of +0.03bbl/person/year
    • By 2008, real GDP reached $3,800 per capita. Average Chinese citizen consumed 2.2bbl of oil per year. 9 vehicles were sold per thousand citizens. Total passengers carried by airlines increased from 57 per 1,000 Chinese citizens to nearly 100 – most analysts still did not appreciate the seismic shift that had taken place
    • By 2017, real GDP is expected to reach $7,377/person. Oil demand has continued relentless growth and expected to reach 3.2 bbl/person this year. Vehicle sales have nearly tripled since 2008 and now surpass the US on an absolute basis by nearly 60%. Total airline passengers carried is expected to reach 414 out of every 1,000 Chinese citizens
  • Another factor that has gone unnoticed by many is that Indonesia, Vietnam, the Philippines and Thailand are all experiencing the same phenomenon. The wild card, however, going forward will be India
    • India per capita GDP stands at $1,973/person (same level as China in 2001). Average Indian consumes 1.2 barrels of oil per year (same as China in 2001)
    • There is some evidence to suggest that India is further along its growth trajectory than we had believed. For example, vehicle sales are expected to reach 2.8 vehicles per thousand Indian citizens, which is higher than China was in 2001. Similarly, total airline passengers carried is expected to hit 90 out of every 1,000 Indian citizens this year
    • Next year, Indian oil demand is expected to grow by 300,000bpd just as it has since 2016, making it the second largest source of global demand after China
    • Since 2016, per capita oil demand has grown at nearly 0.7bbl/person/year, suggesting to us that India has already entered its inflection point
  • If we were to use China as a guide, we should expect to see Indian oil consumption growth reach approximately 0.12 bbl/person/year over the next several years which, given India’s population of 1.4 billion people, would equate to an annual demand growth approaching 500,000bbl/d every year
    • However, IEA in its medium term report projects that Indian demand will grow by only slightly more than half the rate until 2022
    • Instead, we are on the verge of entering the next stage of rapidly accelerating growth
  • IEA is projecting non-OPEC oil supply growth outside of the US to grow by 700,000bbl/d next year and we think these figures are far too optimistic
    • Large energy-service company in a recent presentation stated that given curtailment of capital spending by oil companies globally, there is actually risk that non-OPEC supply outside the US contracts by several hundred thousand bbls/d each year for the next several years
    • We believe shales will continue to grow robustly but that they will not be enough to meet global demand going forward. Between Jan and May, total US production grew by 572,000bbl/d; however, since then, production growth has slowed dramatically to only 55,000bbl/d

North American Natural Gas

  • Henry Hub natural gas prices were weak during 2Q, as milder than normal weather decreased demand while US production grew for the first time in 2 years
  • Gas demand remains strong but our concerns about growing gas supply have already appeared. Total inventories built by 837Bcf during the quarter which was slightly less than average historical build of 908Bcf over the same period
  • Sabine Pass continued to increase its throughput and reached 1.7Bcf/d in April, a five-fold increase compared with last year as its ramping up continued
  • Between January and April, US gas production grew by nearly 1bcf/d – largest 3-month growth rate since 2015. This occurred with a US rig count that stands 43% lower than it did over the same period in 2015
    • After peaking at an incredible 10.5bcf/d in 2011, Haynesville spent the last 6 years declining by over 40%. Beginning in March of this year, basin started to grow again
  • Maintain our neutral view toward natural gas markets due to the potential for a large supply response

Precious Metals

  • Gold was down slightly during the 2Q while silver, rattled by the Fed’s talk of rising rates and shrinking balance sheets, declined by over 9%
  • Western investors have recently reversed their 1Q physical gold accumulation. 12 physical gold ETFs that we track liquidated 225 tonnes of gold in the final months of 2016
  • However, offsetting the weakness in western demand, we have seen explosion in both Indian and Chinese physical demand
  • Lingering Indian distrust surrounding paper currency after last year’s forced note exchange program combined with a financial system that has re-liquified and an excellent start to the Indian monsoon season has re-stimulated Indian gold demand
  • In China, premiums for physical gold continue to move higher, indicating that demand remains extremely robust
  • With the USD now beginning to show considerable weakness, believe that western investors will soon resume accumulating physical gold
  • We are bearish on USD and believe that gold is cheap on our models

Copper Market

  • Copper analytic community has been incorrect in their projections of Chinese copper demand
  • If China wants to grow out of the “middle-income” trap that has stranded many an emerging economy, the amount of copper invested in its economy will have to almost double from its present levels. Now seems that many analysts are recognizing this fact and as a result are raising their long-term Chinese copper growth assumptions
  • Even with these revisions, believe that most analysts are still significantly underestimating global copper demand. Few analysts have made any comments regarding what’s presently occurring in India
    • Emerging evidence is now confirming that India is indeed approaching its period of rapid growth in electric consumption which is the largest driver of copper consummation
    • India has an incredibly low level of copper installed in its economic infrastructure at present. Our models calculate that today India has only 15 pounds of copper per person invested in its economic infrastructure vs China which has 175 pounds per person
    • Indian demand alone will add nearly 400,000 tonnes of incremental world copper demand in the next several years
  • Meanwhile, global mine supply has now stopped growing. Most of new supply in Peru and Kazakhstan has now come on line and models tell us that global copper mine production growth will experience a rapid slowdown beginning in 2017 and lasting until the beginning of the next decade

Agricultural Markets

  • Wheat prices were very strong during 2Q, advancing by nearly 20% on concerns over the condition of crop resulting from excessive heat in the Midwestern US and lack of rain in Europe
  • Soy and corn prices were more subdued, declining by 0.40% and rallying by 1.72% respectively
  • Global agricultural markets remain in a very interesting state. Global grain demand remains extremely strong, as developing countries continue to increase their protein consumption
    • As a country hits a certain level of per capita GDP, they switch from a starch-based diet to a meat-based diet. Since raising livestock is up to 7x as grain-intensive as subsisting on a plant-based diet alone, the impact on the grain markets is immense
  • Robust demand trends were masked last year by record crop yields in nearly every growing region globally
    • Yields in the US shattered prior records as growing conditions were nothing short of perfect
    • It would be almost impossible to recreate last year’s perfect global conditions and there is a high likelihood that global grain inventories would be drawn down more sharply than anticipated this year
  • As recently as April, speculators were incredibly bearish regarding the grain markets. Net exposure of speculative wheat traders reported by the CFTC hit an all-time net short level at the end of April. Soy and corn speculators did not hit all-time net speculative length but both were at multi-year net short extremes
    • Price action since then is likely the result of speculators covering their short positions in the face of less-than-perfect growing conditions
  • Have become slightly more bullish regarding the global agricultural markets as it now seems that 2017/2018 yields will fall below records set last year

Image Source: EIA, Goehring & Rozencwajg Associates


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