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OVERVIEW
Resource markets are still very much looking for direction, with very few catalysts at present to inspire confidence in the near-term. Volatility continues to reign supreme, driven by war, inflation and China covid concerns – these concerns aren’t going away anytime soon.
The US dollar has also been a contributing factor, with its surge in value coinciding with the US Federal Reserve’s belated attempts to try and contain inflation via the blunt implement of monetary policy, specifically interest rate hikes.
The surge in the US currency to two-decade highs can be seen in a comparison of its performance to other major currencies. This is important because it effectively makes commodity prices, which are priced in US$, more expensive in terms of those other currencies.
Gold
This is important with respect to gold, because despite the inflationary environment that is typically highly supportive of gold, the yellow metal has fallen in value in US$ terms due to the strong dollar. Since gold is priced in dollars, the two assets have historically shared an inverse relationship, with one falling when the other rises, and vice versa.
However, it’s not just about the US$ price of gold. To get a better overview of gold’s overall performance as a hedge, it is useful to track gold in terms of other major currencies. For example our A$, as this is the price that is most relevant to our domestic producers. As the graphic shows, over the last 10 years the A$ gold price has significantly outpaced the US$ gold price. This strong uptrend in the A$ gold price is reinforced by the 50-year chart.
The key takeaway in all of this is that despite current uncertainty in the domestic gold sector, the A$ gold price is trading close to an all-time high. This will help insulate our gold producers from the inflationary cost environment in the market today.
In terms of the first sector in the resource space that might turn and begin to recover, I would be betting on gold. We can conceivably see the price stabilising and recovering as the US dollar approaches a peak. This could well see gold recovering and outperforming the industrial metals sector during the remainder of 2022 or into early 2023.
Industrial Commodities and Energy
Despite growth concerns, there are still a multitude of factors that are helping to limit the downside with respect to commodity prices. Ongoing supply-side problems related to covid, the Ukraine war, rising industry costs and declining grades, along with funding taps being turned off, are all helping to provide support for commodity prices.
If prices fall too much further, we will be faced with instances of miners shuttering production due to falling margins. Remember, this boom has been unlike previous booms, where previously miners have boosted production incentivised by high prices. This time around, miners have learnt the mistakes of the past, thus maintaining a significant degree of supply-side discipline.
A great example is the oil sector, where both OPEC and US shale production is now effectively capped. OPEC production is now 1M bbls per day below target.
Markets are effectively grappling with a near-term downturn within the context of a medium to longer-term bull market in commodities.
The move to renewable and cleaner energy that was initiated during the post-covid recover era, has not gone away. There is still massive investment required to facilitate the supply of key commodities to make renewable energy and EVs a reality. For most commodities we are looking at the need for a 10 to 15-fold increase in production, if it can be achieved, over the next couple of decades. This is in an environment of growing ESG factors, which will hamper the rate of project commissioning.
For copper alone, eight projects the size of Escondida are needed over the next eight years. But Escondida took nine years to commission from first discovery. If capacity utilization and recycling in the copper industry remain at their current 10-year global average, there’s going to be an annual supply shortfall of around 10 million metric tons by 2035. This is equivalent to 20% of the demand projected to be required for a 2050 net-zero world.
The current market downturn, with associated project funding restrictions, will only exacerbate the eventual recovery, making the price reaction even more explosive across all commodities, not just copper.