Which way for small cap commodity stocks in 2023?
“…Demand for oil and gas remains robust. Gold is on the up. The electric vehicles market is making demand for battery metals even more urgent. Coal, for those investors who want to go there, is strong. And there is the tantalising prospect of a resurgent China…”
Companies to consider include : #ANGS #BEY #BLOE #CHAR #CGO #CORO #ECO #EEE #EOG #FRG #GUN #IOG #JAN #LBE #LEX #LND #NTOG #PALM #POW #UJO #VAST
The markets have rallied somewhat so far this year, signs that inflationary pressures may be easing sparking hopes that central banks will have more scope to limit interest rate rises.
But these fragile ‘green shoots’ may be rooted as much in sentiment as hard analysis: after the rigours of 2022 many investors are desperate for signs of good news, pushing stock prices up, it seems, through the sheer power of will. Sure enough, there are indications that the energy crisis, which its attendant inflationary pressures, is being weathered as well as might have been hoped. But the uncomfortable fact remains that the benign market environment fostered by central banks over the past few years is being dismantled. We are transitioning from a world of quantitative easing to one of tightening, in which central banks are no longer willing or able to underwrite benign conditions for investors.
The truth is we just don’t know how 2023 will unfold. But as in 2022, the natural resources sector seems to offer opportunities to secure returns running against the grain of the wider market. Commodities investors experienced mixed fortunes, of course. Last year oil and gas stocks surged but metal traders were frustrated. The long term narrative is well known: ‘future-facing commodities’ like copper, nickel, cobalt and lithium are urgently needed for the ongoing transition to a greener economy. But 2022 was a poor year on the markets for miners, particularly for speculative small caps. Metals remain a cyclical trade, highly sensitive to downward turns in the economy cycle.
There are early signs, however, that 2023 could be a better year for all commodities investors. Here we take a look at the natural resources stories that have emerged over the past few weeks, and attempt to shine some light on a complex picture.
The return of China
One important new element in the mix is China’s ‘re-opening’ after civil unrest last autumn forced President Xi Jinping to begin loosening Beijing’s rigorous zero-Covid restrictions. China’s vast economy has come to exert an influence on the commodities market somewhat like that of the moon on the tides of the sea. Massive public and private investment in Chinese infrastructure has played a huge role in shaping global trade and commodities demand since the turn of the millennia, keeping the world economy motoring as the West struggled to move back into to gear after the banking crisis.
Since Xi began to ease pandemic measures last November the prices of industrial metals have surged as traders wager that a reinvigorated China will again work its magic, supercharging global demand for raw materials. Bullish developments reported over the past few months include new support for the country’s massive property sector, the restocking of its steel mills, the resumption of vast renewable energy projects, and sharply rising consumer demand for electric vehicles. Global commodity prices have responded. Tin, zinc, copper and other base metals are up more than 20pc since November, tin rocketing almost 80pc to $32,262 per tonne, and copper rallying by a tenth through January to $9,329 per tonne. Iron ore prices have hit $130 a tonne.
The re-opening has also injected new life into the oil price, which had been drifting down from the stratospheric heights reached in the wake of Russian’s invasion. According to the International Energy Authority (IEA) Chinese oil demand, which fell last year for the first time since 1990, kicked back suddenly in November, rising 470,000 b/d in the space of a month. The IEA estimates global oil demand will rise to an all-time high of 101.7mn barrels a day this year on the back of China’s return. Jeff Currie, the influential head of commodities research at Goldman Sachs, indicated in a recent note that Chinese demand could add $5 to the price of oil, while hedge fund energy trader Pierre Andurand suggests oil prices could return to the heights of $140 they reached shortly after the outbreak of the Ukraine war. Andurand estimates Chinese-led global consumption could rise by as much as four million barrels a day this year compared with an average annual growth of just over one million.
Investors scarcely need reminding to treat all this speculation with caution. The strength of China’s recovery – which comes amid growing political tensions with the West – is uncertain. This month’s economic data will give some indication of how deeply rooted it might be. David Lubin, head of emerging markets economics at Citi, observes that the boom in metals prices ‘reflects a confidence in the market that this year’s acceleration in China’s growth rate will cast the same benign shadow over the global economy as earlier big recoveries have done.’ But he notes that the big Chinese economic recoveries of the past decade or so have been stimulus-driven and investment-led, focused on supporting activity in infrastructure and real estate. This year’s growth, however, will be more the natural consequence of the economy re-emerging from lockdown, led by consumers rather than massive state investment. The amount of each renminbi of spending that boosts other countries’ exports is likely to be lower, or as Lubin puts it: ‘More Chinese households going to restaurants and theme parks will have a lot less impact on other countries than more Chinese high-speed trains or apartment buildings would.’
Uncertainty about the nature and strength of the Chinese recovery has prompted fund managers to warn about the durability of the current rally in Chinese equities, which have surged 20pc in the past few weeks, the country’s tech stocks staging a $700bn rally since their low in October 2021. In a recent global survey one in five managers said Chinese stocks had become the market’s ‘most crowded trade’.
Supply shocks and the rise and rise of electric vehicles
Though the Chinese recovery, with all its imponderables, is the clearest indication of a turn in the tide for commodities, there are other promising signals. Beyond the impact of demand from China, copper prices are rising in response to supply pressures, most visibly ongoing labour disputes in Peru, which, along with Chile and China, accounts for almost half of world supply. The National Society of Mining, Petroleum and Energy estimates nearly third of the country’s copper supply – about 11pc of the world’s mined total – is at risk as shutdowns continue. There is also a supply crunch in Chile, where water and labour shortages forced production cuts last year. The IEA estimates that demand for copper, a key input for electricity grids, electric vehicles and heat pumps, will increase by almost 40pc to 33 million tonnes a year by 2040.
Supply pressures for copper and other metals are particularly acute in the fast moving electric vehicles market, which continues to gather momentum, though somewhat obscured by the beating growth stocks like Tesla took last year, which dragged down several batter metal funds by 30pc through 2022. But with demand surging, particularly in China, data company Sustainalytics predicts the global electric vehicle market will grow from $287bn in 2021 to $1.31tn in 2028. That makes the shortage of battery metals such as lithium, cobalt and nickel particularly pressing, opening investment opportunities.
Lithium stocks stood strong through 2022 as battery-grade lithium chemical prices continued to rise (up ten-fold in the in the past two years to $75,000 a tonne.) Caution is required here too: the lithium market crashed between 2018 and 2020, prices plunging from $25,000 per tonne to below $6,000 when cuts to subsidies for electric vehicles led to oversupply. But Albemarle, the world’s largest lithium producer, is ramping up supply aggressively, expecting high prices for this most vital of battery metals to persist for years as electric vehicle sales accelerate. Producers are responding to demand from carmakers, with about 40 lithium projects under development underway across the world, a 166pc increase in the past three years. Lithium analysts do, however, believe prices should stay high because of the lower grades under development at most new projects.
Gold glimmering again
Another metal recording strong gains has little to do with electric vehicles or the energy transition: gold. The price of the precious metal slid through much of 2022 as interest rates rose, falling from a record high last March of above $2,000 to just above $1,600 per troy ounce in November. Gold, which produces no yield, becomes less attractive when interest rates climb. But huge demand from central banks, and renewed interest from retail investors, have powered a rally since November, prices rising almost a fifth to $1,928 per troy ounce.
The World Gold Council reported the highest rate of central bank purchases since the exchange rate crises of 1967, attributed by analysts to a desire to diversify reserves away from the dollar after the US froze Russia’s reserves denominated in the currency. Central bank purchases of gold hit 417 tonnes in the final three months of the year, roughly 12 times higher than the same quarter a year ago. As prices edged up retail investors followed, once again turning to the yellow metal as a hedge against inflation. UBS has raised its year-end target for gold to $2,100 per troy ounce, up from $1,850 previously. The rally has been further underlined by consolidation among the big gold miners, Newmont, the world’s biggest miner launching a $17bn bid to buy Australian rival Newcrest.
Continued demand for fossil fuels
Beyond metals, oil and gas seem set for another strong year. The slowdown in gas prices indicates that Europe is doing a decent job of containing the energy crisis. Cuts to Russian gas exports in retaliation for western support for Ukraine drove the European benchmark price above €300 a megawatt hour in August, more than 10 times its normal level. In the past few months it has fallen back to about €50, still high by historic standards but far more manageable, not least for consumers. Energy trader Pierre Andurand says that while he expects oil to go higher again this year (as noted above) his fund has closed out all its positions in natural gas markets in the belief that last year’s price surge to record levels is unlikely to be repeated as Europe continues to adapt to life without Russian gas.
2022 was a visceral reminder that the world still depends on fossil fuels for 80pc of its energy: the UK relies on gas for 40pc of domestic electricity. The inexorable move towards for renewables does not preclude continuing demand for fossil fuels: the IEA itself estimates oil demand will rise from 95 million barrels a day (Mb/d) in 2021 to 102 Mb/d by 2030. The persistence of hydrocarbons was highlighted again earlier this month when BP retreated on its commitment to cut fossil fuel output by 40pc by 2030, as CEO Bernard Looney had very publicly pledged in 2020. The energy giant now plans to cut oil and gas production by about 25pc, and will spend $8bn more on its traditional business than it had planned.
Looney is concerned about falling too far behind US peers Exxon and Chevron, which have recorded huge profits by prioritising fossil fuels. And though the current liberal US administration succeeded in pushing a raft of significant green programme through its Inflation Reduction Act, President Biden used his State of the Union address to call on producers to drill more wells, acknowledging that ‘We’re still going to need oil and gas for a while … at least another decade.’ The Energy Information Administration’s annual energy outlook forecast that oil and gas will still be the main sources of US energy consumption by mid-century, anticipating US hydrocarbons production will grow through to 2050, with gas production up almost 24pc.
There is another fossil fuel – the natural resource that dare not speak its name: coal. Despite high-profile UN agreements to ‘phase down’ coal usage it is still used to produce more than one-third of the world’s electricity, and remains the primary source of power in fast-growing economies such as India, China and Indonesia. And last year IEA figures show consumption rose 1.2pc to reach a record high. The squeeze on Russian gas supply forced an increase even in Europe, which aims to cut emissions by 55 per cent by 2030. Profits at the world’s 20 biggest coal miners tripled last year to more than $97bn, with Glencore earning $13.2bn in the 12 months to June 2022. Shares in the mining giant rose 40pc through 2022, and are trading at near record levels. Elsewhere Whitehaven Coal is up some 200pc, and Peabody Energy 150pc.
A complex story, then. But one with definite highlights for commodities investors. Demand for oil and gas remains robust. Gold is on the up. The electric vehicles market is making demand for battery metals even more urgent. Coal, for those investors who want to go there, is strong. And there is the tantalising prospect of a resurgent China. As noted, China’s recovery is uncertain, and it might have counterproductive effects: robust Asian demand could push up global inflation, adding to uncertainty over the outlook for monetary policy in the US and Europe. Only time will tell. But 2023 has so far emitted intriguing signals for smart investors willing to explore opportunities while exercising due caution.
Small caps to watch
A few weeks ago we picked out a few natural resources small caps to look out for this year. To recap, our mining companies feature highlighted the following companies focused on resources referenced in this article:
Chaarat Gold Holdings (AIM:CGH): gold, silver, copper and zinc in central Asia.
Contango Holdings (LON:CGO): a coking coal project in Zimbabwe.
Empire Metals (AIM:EEE): gold and copper prospects in Western Australia.
Firering Strategic Minerals (AIM:FRG): lithium, nickel, columbite-tantalite, tantalum and niobium in the Côte d’Ivoire.
Jangada Mines (AIM:JAN): vanadium battery metals in South America.
Landore Resources (AIM:LND): a Canadian gold resource also prospective for nickel, copper, cobalt and other battery metals.
Lexington Gold (AIM:LEX): gold mines in the US.
Panther Metals plc (LON:PALM): gold, copper, nickel and Platinum Group Metals (PGM) prospects in Canada and Australia.
Power Metal Resources (AIM:POW): international gold, nickel, copper and uranium prospects.
Vast Resources (AIM:VAST): mines in Romania, Tajikistan, and Zimbabwe.
88 Energy (AIM: 88E): exploring Alaska’s largely North Shore.
Angus Energy (AIM:ANGS): a cluster of producing oil and gas fields across southern England.
Barryroe Offshore Energy (LON:BEY): seeking to test a major oil and gas discovery in the Celtic Sea.
Block Energy (AIM:BLOE): exploratory and producing assets in the country of Georgia.
Chariot (AIM CHAR): exploring a significant gas discovery offshore Morocco.
Coro Energy (AIM:CORO): hydrocarbons and renewables prospects in Vietnam, the Phillipines and Indonesia.
Eco (Atlantic) Oil & Gas (AIM:ECO:) Atlantic margin basins offshore Guyana, Namibia and South Africa.
Europa Oil & Gas (AIM:EOG): developing the North Sea Serenity field.
IOG (AIM:IOG): Saturn Banks infrastructure in the Southern North Sea.
Longboat Energy (LON:LBE): interests in the Norweigan North Sea.
Nostra Terra Oil and Gas (AIM:NTOG): producing assets in three Texas basins.
Union Jack Oil (AIM:UJO): interest in the UK’s high performing Wressle licence.