Commodities Outlook For Exposure to Mining Stocks

Joe Mazumdar weighs in on commodities such as gold, silver, copper, nickel, palladium, uranium and lithium

Joe Mazumdar | January 23, 2020 | SmallCapPower: Despite the potential for the continued strength in the broader U.S. equity markets to attract generalist investors, my commodity focus for mining equity exposure in the coming year is based on two central themes:

(The following is an excerpt from an article originally published on Exploration Insights on January 13, 2020)

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  • Gold and silver – precious metals that benefit from a weakening U.S. dollar accompanied by rising levels of negative-yielding debt and global uncertainty in a year of U.S. elections.
  • Copper, nickel, palladium and, less so, uranium and lithium – metals that may be positively impacted by global initiatives to reduce greenhouse gas emissions, which translate into the trend toward electric vehicles, more catalytic converters for vehicles using petroleum, and non-carbon based energy.

Except for gold and palladium, which is trading near its decade’s high, the majority of my chosen metal exposures are trading well below their peaks from the previous decade.

Interestingly, there can be a significant difference between the price levels of equities and the commodities underlying them. For example, although gold ended the year trading at ~80% of its decade’s high, the precious metal equities index (GDXJ) traded at ~9%, although not as low as the uranium equities (URA).

The underperformance of gold equities versus the gold price in 2019 is a reflection of a reduced flow of funds into the gold equity ETFs (GDX and GDXJ), which were down US$1.0 billion and US$0.6 billion, respectively. By sharp contrast, the gold ETF (GLD) received US$5.2 billion. That said, after the gold price reached US$1,550 per ounce during the summer, inflows for both the GDX and GDXJ began trending upwards, as generalist investors were slow to take notice.

Gold is the largest metal market I am focused on; therefore, it is also my most considerable exposure in the equity portfolio. The historical inverse relationship between the gold price and the U.S. dollar is well-known, and it’s been evident over most of the last decade. Gold reached a peak of US$1,890 per ounce in 2011 during a period of weakness of the trade-weighted U.S. dollar index (DXY), after which it began a downward spiral to a low of ~US$1,060 per ounce in 2015.

Even though the DXY has been gaining strength since the most recent period of vulnerability at the beginning of 2018, the gold price has also made headways, breaking past the US$1,500 per ounce mark during the summer of 2019. The resilience of the gold price in the past months could be attributed to concerns about weaker global growth rates, which underpinned a number of U.S. interest rate cuts. In addition, although the amount of global negative-yielding debt has fallen back from a peak of ~US$17 trillion, it is still at a high level. An excellent sign that the gold price is currently well-supported is its strength in multiple currencies, not just the greenback.

The average return for nine currencies was 18% during 2019, with the Australian dollar (AUD) gold price dominating over other gold producing nations like Canada (CAD), the US (USD), and South Africa (ZAR). As discussed a few times in the newsletter, the higher Australian gold price has supported many acquisitions in the Americas by Australian-listed producers.

As we are well aware, global geopolitical incidents can trigger spikes in the gold price. Since the beginning of 2020, the gold price has been trading up to ~US$1,600 per ounce as the markets absorb a couple of events that have generated market volatility and driven investors to safe-haven assets such as gold and the U.S. dollar:

  • the U.S. administration drone-strike killing of a prominent Iranian general in Iraq, and
  • the declaration by the North Korean dictator Kim Jong Un to end a moratorium on missile tests, while threatening to unveil a new strategic weapon.

Yet the impact of these geopolitical flashpoints can be ephemeral, so another sharp increase in the gold price beyond US$1,600 may require more market volatility than in 2019. An election year in the U.S. combined with an impeachment trial in the Senate may provide the necessary fuel. To be clear, I am not betting on World War III just to make a double on a junior gold mining stock.

I also continue to be bullish on silver, which is the higher-beta of the two precious metals. The gold-to-silver ratio reached its lowest point of the decade (32x) in early 2011 when gold was approaching its peak. Since then, it has been moving up, peaking at 94x in the middle of last year.

Since a fall in the ratio to the 60-70x level would be highly favorable to precious metal producers, I have added a mid-tier silver metal producer as a Top Pick. The stock has provided a 50-55% return so far on my January 2019 position. Another outperformer has been a royalty/streaming company that was up 53% in the portfolio in 2019. I also have four gold-focused explorers in the portfolio that currently have active drill programs.

The next major commodity theme that is driving my investments in the mining sector is the climate change movement. Whether you are a climate change denier or Greta Thunberg, we can’t ignore that there is a lot of capital being deployed for the reduction of emissions of greenhouse gases. Several global initiatives, including vehicle electrification, vehicle hybrids, and tighter emission standards, are having positive impacts on several commodities, including copper, nickel, and palladium.

The near-term tightening of emission standards combined with a reduction of diesel-fueled cars has led to a particularly strong demand for palladium, a metal that is critical for catalytic converters, hence its outperformance. But it is not easy to gain exposure to palladium without taking on the jurisdictional risk of Russia or South Africa. Norilsk Nickel, the Russian-based diversified miner, which has a market capitalization of ~US$50 billion and is well-exposed to palladium, nickel, and copper, is up ~60% in 2019 and trading at an all-time high on the Moscow exchange.

Regarding junior explorers, I had considered taking part in a private placement to raise funds for Palladium One Mining (TSXV:PDM) back in early November 2019, but I had issues with the grade and potential metallurgy of the Kaukua resource in Finland that dissuaded me. Despite my reluctance, I suggested to our subscribers that it would still be worth a punt as the share price could move up in a positive palladium price environment. I should have followed my own advice. Since then, the share price is up 230% from the oversubscribed private placement (C$0.06) based on retail investors’ demand for exposure to the metal.

My current copper exposure includes a junior explorer that is in my Top Picks list and whose share price has risen ~44% since early December. The other two copper juniors I hold are currently focused on overcoming permitting delays at their respective projects. With respect to nickel exposure, I took a position in an Australian-based explorer for a promising project it is pursuing in East Asia. Assay results from its active drill program are pending but may be available in January before the Vancouver mining conferences. The company’s CEO will also be presenting during my session at the Metals Investor Forum.

I have only one advanced explorer/developer in the lithium sector, and I am not planning on adding any others at the moment. The company’s experienced management team and the asset’s strategic location are factors supporting my decision to hold the stock.

I recently added a leveraged U.S.-based uranium play for its short-term exposure (first half of 2020) to a potential restriction of U3O8 imports into the U.S. by the current administration. Given the company’s hefty G&A burn rate of ~US$14 million per year, I am not keen on holding it much longer. Therefore, I will most likely seek another company to gain leverage and longer-term exposure to a potential turnaround in the uranium market.

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