The article below is an excerpt from our Q4 2022 commentary.
Commodity prices rebounded in Q4. Natural resource-related equities were firm.
Investors came back into commodity-related markets, hoping that the worst of Central Bank tightening was in the past, combined with economic data that refused to confirm recessionary fears.
The energy-heavy Goldman Sachs Commodity index returned 3.4% in Q4. Reflecting the significant rebound in base metal prices, the metal and agricultural heavy Rogers International Commodity index rose 4.6%. After experiencing some weakness in Q3, natural resource-related stocks showed significant strength in Q4. The energy-heavy S&P North American Natural Resource Stock index rose 17.9%. The S&P Global Natural Resource Index, which has more metal and agricultural exposure, also increased by 18%. In contrast, US equity markets, as measured by the S&P 500 index, rose 7.1%, and global equity markets, as measured by the MSCI All World Index, rose 9.9%. For 2022, commodities and their related stocks significantly outperformed general stock markets. The Goldman Sachs Commodity Index, on a total return basis, returned 25.9%, The Rogers International Commodity index returned 19.8%, the S&P North American Natural Resource stock index returned 33.2%, and the S&P Global Natural Resource index returned 10.2%. In comparison, US equities, as measured by the S&P 500 Index, fell 18.5%, and global stocks, as measured by the MSCI All World Index, fell 17.8%.
Oil Markets
After pulling back a significant 25% in Q3, oil prices stabilized in Q4. West Texas Intermediate crude prices rose 1%. Brent prices were slightly better, rising 2.5%.
Although prices stabilized, investor psychology toward oil remains firmly bearish. Investors remain convinced that an imminent global recession brought on by aggressive Fed tightening is inevitable. The pronounced weakness in 2023 oil demand is consensus opinion.
The gap widens between the “paper” markets and the underlying physical market. In the paper oil markets, speculators have liquidated 125,000 futures contracts on the New York Mercantile Exchange since oil prices peaked back in the first week of March, pushing the oil price down by over $ 50 per barrel or almost 40%. In contrast, reflecting the strength in global oil demand, global OECD inventories, adjusted for SPR releases, have fallen by another 180 mm barrels—a clear sign of continued market tightness. Now that SPR releases are scheduled to stop (except for another 35 mm barrels related to funding the 2021 Infrastructure and Jobs Act), we believe the deficit between demand and supply and the resulting tightness will be quickly reflected in the oil price.
In this letter’s Oil section, we will show that investors are again completely ignoring underlying data. Other than a short-lived period of Chinese demand weakness experienced last summer in one of China’s aggressive COVID-related lockdowns, global oil demand continues to surprise the upside. We have significantly passed through 2019 highs in demand. Global inventories, including SPR inventory withdrawals, continue their steep declines and have fallen considerably below their 2007 lows. With lifting all COVID-related restrictions in China, we believe that Chinese oil demand, which now looks to have declined by 800,000 b/d in 2022 versus 2021, could rebound significantly in 2023 and be a driving factor in pushing oil markets into continued deficit.
On the supply side, we will again discuss recent developments in the US shales. After over a decade of phenomenal growth, the US shales continue to expand. The importance of the shales on the global oil balance cannot be overstated. Total non-OPEC supply growth in 2022 should approach 1.9 mm barrels per day, but few people comment on the breakdown of this supply. 80% of the 1.9 mm b/d of growth (1.5 mm b/d) comes from unconventional sources; 1.2 mm b/d from the US shales, 0.16 mm b/d from the Canadian oil sands, and 0.15 mm b/d from biofuels. But what people may miss is that almost 100% of the 1.2 mm/d of US shale growth comes from the Permian Basin. In past letters, we extensively discussed how the other extensive shale basins—the Bakken and the Eagle Ford- peaked and were now in decline and how the Permian only had several years of production growth left. However, more evidence emerged that the Permian is nearing a production peak, possibly in 2024. Drilling productivity increases in the Permian have weakened considerably over the last two years—to the extent that several E&P analysts have commented on the trends. As our readers know, our research tells us that most of the productivity increases over the last decade have come from companies “high-grading” their drilling activity. Declining productivity strongly suggest that companies are running out of tier-one drilling inventory—a classic sign of field exhaustion and a precursor of future production declines. Please read this letter’s introduction to learn more. We are reaching a point where we believe almost all non-OPEC oil supply growth will come from just six counties in the Permian basin. Understanding trends in these counties will be vital to understanding the direction of oil prices.
Conventional oil production peaked in the non-OPEC world in 2006 and today sits almost three million barrels below that level. Including OPEC, conventional oil production peaked in 2015 and sits 4 mm barrels lower today. Twenty years ago, a colossal interest developed around the concept of Peak Oil and Hubbert’s theories. Since then, interest has switched from peaking supply to peaking demand. We believe US shale oil production is nearing its peak. Given how dismal conventional oil discoveries have been over the last 20 years, we think it’s time to bring back the subject of peak oil. If you attended our recent investor day, we continuously stressed that this decade would be the “Decade of Shortages.” Hubbert’s peak is a perfect example of what we believe this decade will bring.
Natural Gas
Natural gas pulled back massively. The primary reasons were a significantly warmer-than normal fall in the US and Europe and a late start to the North American natural gas withdrawal season. US natural gas prices fell 34% in Q4, while European and Asian prices fell 55% and 35%, respectively.
Weather is always a huge factor in the short term. Short-term weather trends produce spasms of price weakness, leading to substantial buying opportunities. We believe the significant price pullback experienced in Q4 today presents investors with another very opportunistic buying opportunity. We are confident that the global natural gas market remains in structural deficit and that the US gas supply, driven over the last decades by considerable expansions in the Marcellus and Hayneville fields, may be ending. When the global markets swung from “structural surplus” to “structural deficit,” international gas prices surged tenfold (from $6 per MMBtu to $70 per MMBtu) in just over 12 months. A high probability exists that a move of similar magnitude could happen in the North American gas market in the next 12 months. The Natural Gas section of this letter updates the bullish fundamentals we believe are now fully embedded in the North American natural gas market---bullish fundamentals that short-term bearish weather factors have obscured.
Coal Markets
After experiencing a substantial upward price move in the first three months of 2022, global coal markets pulled back in Q4. Central Appalachian and Illinois prices in the US were flat and down 15%, respectively. Thermal seaborne coal also pulled back in Q4. Thermal coal shipped from Richards Bay, South Africa (the API 2 and API 4 markets) fell by approximately 30%. Thermal coal shipped out of Newcastle, Australia, fell by 7%. Coal was a commodity price leader in 2022-- an exciting outcome given that coal entered 2022 as the world’s most hated commodity by far. Even after the Q4 pullback, Central Appalachian coal prices advanced 125%, Illinois basin prices grew 280%, and Australian thermal coal prices advanced 140% for the year. Given the structural tightness in global natural gas markets, we believe global thermal coal prices will continue to rise. We believe radical underinvestment in global coal projects combined with continued energy demand growth means that coal demand will likely continue to set new all-time highs in the next several years. Coal-related equities have been the market leaders in the three great commodity bull markets over the last 120 years (1929-1945, 1970-1980, and 2000-2010). It looks like history is repeating itself.
Base Metals
After experiencing pronounced weakness in Q3, base metals prices staged a significant rebound in Q4, with nickel in the lead based on continued worries over future Russian supply. For the quarter, nickel advanced by 40%, copper increased by 11%, aluminum by 10%, and lead and zinc by 20% and 4%, respectively. Base metals-related equities were also strong. Copper equities, as measured by the COPX ETF, rose 27%, and larger-capitalization base metals equities, as measured by the XBM ETF, rose 20%.
In our essay, “The Coming Shortage in Base Metals,” (found on page 26 of Q4 2022 Commentary) we highlighted how exchange-traded inventories of the six primary base metals—copper, aluminum, nickel, lead, zinc, and tin— now trade at levels last seen in 2005 and 2006. Given the underlying demand strength, driven by China, India, and renewables, along with the severe problems that have crept into the world copper mine supply, copper remains our favorite base metals investment.
In the Copper section of this letter, (found on page 35 of Q4 2022 Commentary) we discuss the continued unexpected strength in demand and the growing supply problems. Chile supplies 25% of the world’s copper mine supply. Its 2022 copper production has unexpectedly fallen almost 6% versus 2021. Back in the Q1 2021 letter, our introductory essay, “The Problems with Copper Supply,” discussed the operating history of the Escondida copper mine in Chile—by far the world’s largest —which is an excellent example of the enormous problems that are creeping into the world’s copper mining industry. We update what’s happening at Escondida over the two years since and what we believe it means for global copper mine supply from now on.
Agricultural
Grain prices were mixed, and fertilizer prices showed pronounced weakness in Q4. Urea prices slumped 27%, and phosphate and potash fell 18% and 16%, respectively. Q4 was dominated by worries that higher fertilizer prices in the first half of 2022 significantly impacted demand. Nutrien, the world’s largest fertilizer producer, on its Q3 conference call, cut its guidance for potash sales this year on disappointing sales volume. Nutrien said high fertilizer prices and dry North American soil conditions that hindered field fertilizer application significantly impacted demand.
As a result of the worst drought conditions in over 20 years in Argentina, the world’s third largest soybean producer and the largest exporter of soybean meal and oil, soybean prices advanced 11%. Corn prices in Q4 were flat, and wheat prices fell 14% on news that farmers have significantly boosted their fall wheat plantings.
We believe grain markets will be highly susceptible to any possible black swan events shortly as tightness in the global grain market persists. The recent 175% surge in US egg prices, in response to a tight egg supply and an unexpected “avian bird flu” outbreak, provides an excellent example of a black swan event that could very well grip various agricultural markets as we progress through 2023.
Precious Metals
Precious metals prices finally broke eight months of persistent price weakness and exhibited strength in Q4. After peaking in March, both gold and silver have spent the last eight months declining in response to aggressive monetary tightening by the US Federal Reserve.
Responding to a Fed-Funds rate that has surged to 4.5%, up from zero at the beginning of 2022, gold prices pulled back 20% and silver 35% from their March peaks. Silver prices bottomed in mid-October, and gold prices in early November. In Q4, gold prices rose 10%, and silver prices rose 26%. Gold and silver equities followed the prices of both metals upward. Gold equities, as measured by the GDX ETF, rallied 21%, and silver equities rose 17%, as measured by the SIL ETF.
We believe the two-and-a-half years of price correction in gold and silver prices, which saw gold price fall back 20% and silver prices 40%, has now run its course. After flashing a solid sell signal in the summer of 2020 triggered by silver’s furious “catch-up” rally to gold in March to August 2020, we significantly reduced our precious metals equity exposure; however, we believe more evidence has emerged that both gold and silver prices have made their lows in this cycle. Our analysis suggests investors may benefit from increased exposure to precious metals.
Uranium
Uranium markets were quiet in Q4. Spot uranium prices hardly moved, starting and ending the quarter at approximately $48 per pound. Even though uranium markets were calm, new positive momentum keeps building in the nuclear power generation business. Even Oliver Stone, the famed liberal film director, delivered an impassionate speech at the World Economic Forum (Davos) on how, contrary to standard “green” dogma, nuclear power must be part of the solution to the world’s CO2 and climate change problems.
In the Uranium section of this letter, we talk about positive developments. We also discuss the latest news regarding “breakthroughs” surrounding nuclear fusion. On December 13th, a scientist at the Livermore National Laboratory announced they had achieved “fusion ignition”—that is, researchers and scientists were finally able to create a fusion reaction that resulted in a net energy gain. The announcement generated massive excitement; however, the challenges to producing and harnessing energy from a fusion reactor are so incredibly complex we believe that fusion as a power source remains as far away as ever.
Intrigued? We invite you to download or revisit our entire Q4 2022 research letter, available below.
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