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This week we have recorded an interview with one of the leading experts in the global coal markets, Matt Warder, exclusively for premium subscribers. In this interview, we discussed the current landscape and outlook for the sector, delving into the thesis of the main companies in the model portfolio sector.
Next week, we will feature a new investment analysis article covering a special situation in the oil & gas sector.
Weekly macro summary
There have also been quite a few interesting events to analyze, and below I list the most noteworthy news. Let's get started:
The slow economic drip and worsening data continue, with weak retail sales figures being the most recent example. This is yet another step on the ladder that inevitably leads to rate cuts in the USA: the CBO estimates that the fiscal deficit will be $1.9T this year, $400B more than expected in February (6.9% of GDP) due to increased spending on items like student debt forgiveness and foreign aid (Ukraine and Israel). The most likely path for the coming months is a continued increase in liquidity proxies, which is especially relevant for the markets.
Despite Thursday's slight correction, the indices remain at highs, and renewed liquidity will only add more fuel to the movement. In Europe, this trend is progressing even faster, with the second consecutive (slightly surprising) rate cut by the Swiss Central Bank, which seems to set the path for the ECB. In reality, Europe will have no choice but to correct course given the rapid deterioration of conditions we are witnessing: on Friday, the catastrophic PMI reports (52.6 for services and 45.6 for manufacturing) confirmed the grimness of the situation.
Last month, Chinese copper exports reached a record high due to low domestic demand, prompting traders to seek international markets to offload their inventories. In May, exports of unrefined copper and related products doubled compared to the previous year, surpassing the previous record set in 2012. This trend has been observed in other commodity markets dominated by China, such as aluminum and animal feed, due to a weak economy and deflationary conditions.
Chinese factories refrained from paying high prices when the global copper market hit an all-time high a month ago. Although prices have since dropped, domestic consumption remains low. Chinese smelters have started reducing refined copper production due to a global shortage of raw materials.
Currently, macroeconomic weakness and demand concerns dominate headlines and impact many commodities, including copper. However, it's essential to think beyond the immediate situation: how long can a crisis last? Will the economy recover afterward? If we believe it will (otherwise, holding stock market exposure might not be the best idea), the following chart summarizes the thesis: building a mine takes time and involves significant operational headaches. This is relevant if we understand that supply is relatively inelastic to price signals, so a market imbalance situation is not resolved quickly, leading to (more or less) prolonged periods of extraordinary returns.
Goldman Sachs recently shared a very interesting table analyzing which commodities would be the best hedge to face different inflationary shocks, which can arise from demand issues, supply problems, or geopolitical tensions. We can see that in the case of a positive demand shock (the least likely), industrial metals and oil would perform particularly well; in the case of a supply shock (very likely), oil and, to a lesser extent, gold would benefit the most; and finally, in the event of increased geopolitical tension, gold would be the reference asset.
It is projected that India will add 15.4 gigawatts of new coal power capacity by March 2025, the highest amount in nine years, in response to the growing demand for electricity. Although New Delhi has ambitious clean energy targets, rapid economic growth and heat waves have maintained reliance on coal, which generates 75% of the country's electricity. Over the past decade, India has added more than 100 gigawatts of renewable energy capacity, but the lack of sufficient energy storage has hindered the expansion of green electricity.
Last year, India planned to add nearly 90 gigawatts of coal capacity by 2032, increasing a previous forecast by more than half. Currently, it has 28.5 gigawatts under construction and plans to award more than 50 gigawatts over the next three years.
In almost all projections for major fossil fuels, there is a fairly widespread consensus on the increase in their consumption in developing economies in the coming years, which will combine a growing middle class with robust economic growth. The following chart is very illustrative of this trend, and we see how countries like India, Indonesia, and Pakistan, with high growth rates and positive demographics, consume (per capita) a minuscule amount of energy compared to Western economies or even China; my bet is that this situation will change, and energy security will take center stage, pushing environmental considerations to the background. With this outlook, any projection that implies a net-zero scenario for the coming decades is a mere chimera.
The oil inventory declines we've been warning about for weeks have already begun. Although the figures in the EIA's weekly report still show some surprising discrepancies, they now reflect declines in all categories: -2.547Mb of crude oil, +0.307Mb in Cushing, -2.28Mb of gasoline, and -1.726Mb of distillates. The trend in implied demand is also positive and is approaching the upper end of the range for the past five years, which is logical in a world that is economically progressing despite the evident slowdown in American growth. The U.S. Energy Information Administration, in contrast to the IEA, has raised its demand growth forecasts for 2024 (+1.1Mb/d) and 2025 (+1.5Mb/d), as well as its price expectations ($87/b by the end of the year). Some investment banks, such as Goldman Sachs, are more optimistic and expect growth of +1.25Mb/d in 2024, anchored in robust demand for aviation fuel and petrochemical products.
With Saudi Arabia's increased domestic consumption during the summer season (largely using oil for electricity generation), the kingdom's crude exports have sharply declined, tightening the physical market once again and bolstering fundamentals.
We can observe a complete turnaround in physical timespreads, showing a V-shaped recovery, reaching levels similar to March and April, when significant oil inventory draws in Q1 supported prices near $90/bbl. If, as it appears, the coming months see inventory trends similar to the beginning of the year, an equivalent price pattern is entirely plausible.
To counteract this possibility, the Biden administration, deeply engaged in an election campaign, is prepared (and indeed, if all goes as expected, likely to do so) to release more oil from the strategic reserve this summer, aiming to keep prices as low as possible for citizens.
To add the final touch, it is becoming increasingly clear that nobody wants EVs. The infrastructure does not allow for a massive rollout (and it won't) of this technology. It is technically impossible right now, and therefore its adoption will not be exponential unless car usage is restricted. In Germany, we have already seen how electric car registration numbers are rapidly deteriorating. In May 2024, the Federal Motor Transport Authority (KBA) registered only 29,708 electric vehicles, a 30.6% decrease compared to the previous year. Additionally, CO2 emissions from new German cars increased by 3.3%, indicating a setback in the transition to green mobility.
In contrast, gasoline and diesel cars saw increases in their registrations. In May, 89,498 gasoline cars were registered (+2.1%) and 44,893 diesel cars (+3.2%). Hybrid cars also represented a significant portion, with 71,451 new registrations (30.2%), including 14,038 plug-in hybrids.
In the natural gas sector, whose fundamentals are increasingly improving, current prices are already becoming attractive to many producers, which will ultimately put pressure on the underlying market unless accompanied by a significant demand surge. The paradigm will change definitively and permanently at the end of this year, when a large amount of new LNG export capacity is expected to come online, continuing to increase in 2025.
Model Portfolio
After three frustrating weeks for the model portfolio, we now enter the seasonally best period for commodities:
The summer driving season is just around the corner, and as we have seen in the previous section, the outlook for oil is excellent.
Seasonality for coal, especially metallurgical coal, also enters a positive period for several reasons, as Matt Warder explained in great detail in this week's video.
Let's go for more.
The model portfolio's return is +14.72% YTD compared to +13.93% for the S&P500, and +51.59% versus +35.31% for the S&P500 since inception (September 2022).
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