April 26, 2022

While there are still plenty of reasons for remaining bullish on the intermediate- and long-term outlook for metals and other commodities, the strengthening U.S. dollar is providing a near-term headwind for metal prices.

The greenback’s latest strength has also performed the valuable service of helping to cool off what was becoming a seriously overheated market condition in several major industrial metals.

However, until the dollar weakens, I’m recommending that participants maintain a mostly defensive stance.

The Dollar is King for Now

The broad metals market took a hit last week as traders reacted to a series of global growth obstacles. Almost no segment of the financial market was unscathed by the selling rout, which was driven by several factors.

You’ve no doubt heard me say that gold is the ultimate safe-haven asset. And while I still believe that to be true from a longer-term perspective, the U.S. dollar often supplants gold as the “ultimate” safe haven from a short-term perspective—especially when there’s a degree of panic in the market and participants are trying to raise cash for fear of tumbling asset prices. And that looks to be the case right now.

Currencies aren’t my specialty, so I typically avoid discussing them. But since the currency market is essential to understanding what’s happening right now in the metals, I believe this subject must be addressed. But let’s first take a look at the latest headlines.

Recent selling pressure is being widely blamed on the Federal Reserve’s stated intention of raising its benchmark rate by half a percent in May, implying that investors are “finally” beginning to factor in the potential impacts of a tighter policy on equities. But a half-point rate increase almost certainly won’t put a dent in the inflationary trend, which is building momentum. For that reason, I don’t believe rate hike fears are the main catalyst of the recent selling.

A more likely reason is intensifying concerns about accelerating inflation itself. Indeed, the Consumer Price Index (CPI) and Producer Price Index (PPI) provide ample justification for this worry. For March, both showed significant increases in inflation, with the CPI jumping 8.5% from a year ago while the PPI soared 11%.

Commenting on the jump, Briefing.com stated that while CPI and PPI prints aren’t as bad as those seen in the late 1970s, “the current inflation readings are at treacherous altitudes that haven’t been visited in the case of CPI since the early 1980s.”

Moreover, with the war between Ukraine and Russia persisting, and with China strenuously pursuing a zero-tolerance policy on Covid with more lockdowns, supply-chain troubles are likely to fuel even more inflation in the coming months. (As an aside, the U.S. state of Georgia’s recent supply chain emergency declaration is a “heads-up” of sorts for what may occur in other states if the problem persists overseas.)

While supply-related woes are no doubt feeding the inflationary trend, I also tend to believe that monetary factors are the main reason for it. That is, the “too much money” part of the classic inflation definition is likely the main determinant of rising commodity prices. And with many nations having been on a rampant money printing and fiscal spending spree these last two years, there has been no shortage of fuel for higher asset prices.

One of the best ways of viewing the global inflation problem is through the lens of the FX market. The following chart combines the leading foreign currency ETFs and offers a bird’s-eye view of what most currencies—including the euro (black line), the yen (gold line) and the yuan (blue line)—are doing right now. As you can see, they’re all reflecting the worldwide inflationary phenomenon, as the world’s leading currencies are losing value.

The notable exception, however, is the U.S. dollar index (USD), which is the lone standout in an otherwise weak global currency market. Last week, the dollar index hit its highest level since the height of the early 2020 Covid crisis. The strength was evidently the result of global investors liquidating equities and bonds (with bond yields rising further), then turning to the greenback as a temporary haven until, presumably, the selling pressure subsides.

Another potential catalyst for the USD rally is the Fed’s stated commitment to tightening its money policy in the coming months, which is widely expected to further strengthen the dollar. “But,” you may be wondering, “aren’t rising yields typically bad news for non-yielding gold?”

While the answer is sometimes “yes,” this isn’t likely to be one of those times. As Deutsche Bank’s head of credit strategy, Jim Reid, told Barron’s last week, the bond market’s prediction of future inflation isn’t always useful. Reid bases his calculations for real interest rates on the CPI which, as we saw above, is at a 40-year high. Reid says based on his calculation, real yields (inflation-adjusted Treasury yields) are still “deeply” negative, which should bode well for the intermediate-term gold outlook.

That said, if the dollar index continues to run away on the upside, there could be some corresponding downside pressure for gold and the other metals in the very near term. For this reason, I believe we should regard “king” dollar as being in the driver’s seat for now. This also means we’ll need watch the dollar index for clues as to when the short-term environment for the metals has become more favorable from a buyer’s perspective.

What to Do Now
South Africa’s Gold Fields (GFI) is one of the world’s largest gold miners with total attributable annual gold-equivalent production of over two million ounces and attributable gold-equivalent mineral reserves of 52 million ounces, providing the firm with plenty of exposure to rising prices. After purchasing GFI on February 17, I recently recommended taking 50% profit and raising the stop-loss on the remaining position after the stock’s impressive rally into early March. However, we were stopped out of the remainder of our trading position in GFI last week when the 14.30 level was violated on a closing basis. SOLD

With inflation likely to persist, not only industrial metals but commodities in general should outperform. One way of playing the bullish trend in natural resources is the Invesco DB Commodity Index Tracking Fund (DBC), an actively traded index ETF which is based on several major commodity futures contracts ranging from metals (including gold, silver and copper) to grains (including corn, wheat and soybeans) to energy products (including oil and natural gas). A combination of strong global demand for farm commodities, exceptionally volatile weather in many food growing regions around the globe and rising input costs (i.e. fuel and fertilizer) should contribute to rising hard asset prices in the months ahead. Additionally, crude oil prices are expected to remain elevated in the coming year, and for that reason, I expect DBC—which is heavily skewed toward the energy sector—to continue to outperform. Traders recently purchased a conservative position in DBC using a level slightly under 21.50 as the stop-loss on a closing basis. After the 21% rally since our initial entry, I previously suggested taking 50% profit in this position. I also suggest raising the stop at slightly under 25.80 (closing basis) on the remaining position. HOLD A HALF

New Recommendations & Current Portfolio

Silver Seasonality Is Weak
Silver took one of the bigger hits among the precious metals, falling 8% from its latest high and ending the week at its lowest level since late February. As we talked about in the last update, silver continues to be eclipsed by gold’s safe-haven demand with little speculative interest being shown in recent months for the white metal.

Kitco senior analyst Jim Wycoff put it best when he said, “The safe-haven metals need a fresh fundamental spark to heighten investor and trader concern.” Moreover, the strengthening U.S. dollar isn’t doing silver’s short-term technical profile any favors.

Additionally, silver’s seasonal factors aren’t in the metal’s favor right now. SentimenTrader’s Jay Kaeppel informs us that historically, between the dates April 18 and June 20, silver has a tendency to trend lower. In fact, the May-June period is the worst two-month period for silver the entire year, with June being the single worst month based strictly on seasonal considerations.

Of course, seasonal patterns can be easily eclipsed by a strong commodity market and inflationary environment—which is currently the case—which means we must be careful not to read too much into the seasonal factor. Nonetheless, it’s another piece of anecdotal evidence that provides an explanation as to why silver can’t seem to get any traction right now.

Also, as mentioned above, the dollar will likely need to weaken considerably before silver is ready to commence its next sustained rally. For now then, no new silver ETF purchases are recommended.

What to Do Now
SSR Mining (SSRM), formerly Silver Standard Resources, operates Argentina’s largest commercial silver project (Puna) and also produces gold, zinc, lead and tin. SSR also boasts a pipeline of high-quality development and exploration assets in the U.S., Turkey, Mexico, Peru and Canada. The company recently guided for its combined properties to produce around 740,000 gold-equivalent ounces annually through 2024. In last year’s fourth quarter, SSR posted revenue of $408 million, which was 10% higher than the year-ago quarter and 5% above analyst expectations. For gold, the company also delivered Q4 production of 211,717 gold-equivalent ounces at an all-in sustaining cost of $961 an ounce (well under the current $1,950 gold price). Management emphasized that SSR’s excellent cost profile ensures strong free cash flow and capital returns going forward. In view of the stock’s excellent relative strength profile, participants purchased a conservative position in SSRM on April 12 using a level slightly under 21 as the initial stop-loss on a closing basis. BUY A HALF

Global Copper Production Faces Threats
The dominant theme in the copper industry today could be characterized as “strong demand meets shrinking supply,” which of course is a classic bull market theme.

A series of production problems have lately hit the industry, including, most recently, top producer Chile’s government recommending that Anglo American’s (AAUKF) Los Bronces copper project not be granted an extension permit for a planned $3 billion mining project. The company is seeking to extend the life of the mine through 2036, but environmental activists believe the project would adversely impact a local glacier.

Elsewhere, No. 2 copper miner Peru has declared a state of emergency as protests have resulted in the country halting 20% of its copper production. Civil unrest has also spread to the Las Bambas mine, Peru’s fourth-largest copper mine and the world’s ninth-largest, according to Mining.com.

Meanwhile, Glencore’s (GLNCY) Antapaccay, Peru’s sixth-largest copper mine, has also been the target of demonstrators lately. The disruptions are projected to have a palpable impact on global copper supplies for 2022.

In the near term, however, copper inventories have risen from multi-year lows and partly account for the softer prices of the last two weeks. Providing additional short-term downward pressure on copper are the ongoing lockdowns in China, which are having a discernibly negative effect on commodity consumption in general.

What to Do Now
In view of copper’s strong near-term fundamentals (inventories are near record lows while global demand remains high), we added Teck Resources (TECK) on February 8. After Teck’s recent 11% rally, I suggested booking 50% profit and recommend raising the stop-loss on the remainder of this trading position to slightly under 38 on a closing basis. This stop was triggered last week, knocking us out of the rest of our position and putting our copper portfolio back into a full cash position. SOLD

China Threatens to Curb Steel Output
After hitting a multi-month peak of $158 last month, iron ore prices have stabilized and have shown resilience in the wake of China’s announced intention to cut steel production for the rest of 2022.

China’s state planner said it would continue to reduce steel output in the coming months, even as the country’s steelmaking hub Tangshan was hit earlier this month with another series of Covid-related lockdowns.

The country’s plan to curb crude steel output this year is based on the assessment of the state planner, National Development and Reform Commission, that carbon emissions need to be more strictly controlled.

Industry analysts have widely interpreted the announcement as having a bullish long-term implication for steel and iron ore prices, but headwinds pertaining to China’s lockdowns are leaving unanswered questions about how much the policies will affect China’s domestic steel consumption.

Additionally, the scope and timing of China’s previously announced stimulus measures to reinvigorate the domestic economy are in question. “Chinese authorities are walking a tight rope as they try to stimulate growth without endangering price stability,” as a Reuters editorial put it.

The consensus among steel industry members seems to be that China’s growth will remain sluggish until around the third quarter this year, at which time an economic rebound is expected.

As for benchmark steel rebar, prices are up nearly 20% since last November, so a short-term pullback is certainty possible—especially if the dollar continues to strengthen. However, prevailing fundamentals support higher steel prices in the coming months.

What to Do Now
Natural Resource Partners (NRP) is a master limited partnership engaged in owning and managing a diversified portfolio of mineral reserve properties, including coal and other natural resources (mainly gas and timber). Approximately 65% of the firm’s coal royalty revenues and around 45% of coal royalty sales volumes were derived from metallurgical coal in the latest quarter, making the stock a good proxy for steel demand. Management is sanguine about the year-ahead outlook, with plans to generate even more “robust” free cash flow in the coming months while paying down debt and solidifying its capital structure. The company also recently declared a 45-cent per share quarterly dividend (4% yield). Participants recently purchased a conservative position in NRP, and after a 10% rally, I recommended selling a half and raising the stop on the remaining position to slightly under 34.50. I now suggest raising the stop a bit higher to slightly under 40.80 (closing basis) where the 50-day line comes into play. HOLD A HALF

Nucor (NUE) is a leading steel company with a massive market share in North American structural, cold finish and bar steels. Management said it was “overwhelmingly positive” for 2022 based on pent-up demand, predicting the end use market would remain strong for steel and steel products and expecting another year of “strong profitability.” Shareholder returns remain another focus going forward (returns averaged 55% of net income last year), and Nucor just hiked its quarterly dividend by a healthy 24% (1.3% yield) with plans to repurchase additional shares in 2022. For Q1, analysts see sales and per-share earnings jumping 50% and 132%, respectively. Participants recently purchased a conservative position in NUE using a level slightly under 134 as the initial stop-loss. After last week’s 11% rally in this stock, I suggest taking 50% profit and raising the stop on the remaining position to slightly under 154.50 (closing basis) at the 25-day line. HOLD A HALF

Peabody Energy (BTU) is the world’s largest private sector coal company, engaged in the mining and distribution of steelmaking and thermal coal. Participants on March 22 bought a conservative position in BTU using a level slightly under 19.75 as the initial stop-loss (closing basis). After the 19% rally from our initial entry point, we sold half the position on March 29 and raised the stop on the remaining position. Last week I suggested raising the stop further to slightly under the 25 level (closing basis) where the 25-day line comes into play, and by week’s end we were stopped out of the remainder of our trading position in BTU as selling pressure swept the broad energy sector. SOLD

Uranium Takes a Needed Rest
Uranium took a well-deserved breather last week, falling to $62 per pound after hitting an 11-year high of almost $65 on April 13. The pullback in the energy metal market was a sympathy move with other energy commodity prices as higher rate expectations and global growth worries shook traders’ nerves.

As Trading Economics pointed out, however, uranium prices remain 40% higher than prices that prevailed before Russia’s invasion of Ukraine. The possibility of a ban on Russian uranium (a bill proposing this has been put forward in both the U.S. House and Senate) is also acting as a support for the market and should help put the brakes on additional selling pressure in the market.

Another supporting factor is the U.K.’s recently announced intention to build eight nuclear reactors by 2030, with a goal of tripling its current nuclear energy output to supply 25% of the U.K.’s energy demand by 2050.

What to Do Now
Uranium and uranium miners were in the doldrums for several months after prices peaked last fall, as the industry fell out of favor on Wall Street along with the overall alternative energy group. But the energy metal is attracting new interest among investors in the wake of Russia’s invasion of Ukraine, while prices for uranium have lately firmed up. Consequently, the most actively traded uranium fund—the Global X Uranium ETF (URA)—recently provided us with another attractive entry point after correcting almost 40% between November and January. Participants subsequently purchased a conservative position in URA on March 1, using an initial stop-loss slightly under the 20 level. After the 13% rally in URA from our initial entry point, I recommended locking in 50% profit on the remaining position in late March. After the latest show of relative weakness in the uranium group, I now suggest exiting the remaining position in URA. SELL

Not Enough Lithium to Go Around
According to a leading lithium market expert, the battery metal is set to replace semiconductors as the next major supply-chain setback for the automobile industry.

Metals industry analyst Joe Lowry, known as “Mr. Lithium,” was recently interviewed by Bloomberg and predicted that lithium demand will continue to outstrip supply for at least the next two years. He added that while he believes the lithium market will someday be in oversupply, “it won’t be in this decade.”

Lowry went on to point out that while a battery factory can be built inside of two years, it typically takes up to a decade to get a lithium project up and running. He added that “metal supply scarcity poses a more immediate challenge to automakers,” and that battery prices are expected to rise slightly this year, reversing a series of declines. “That will delay the point at which [electric vehicles] achieve price parity with combustion engine cars, potentially by as much as two years, to 2026,” he said.

Tesla CEO Elon Musk further drew attention to the worldwide lithium supply crunch numerous times in the company’s latest earnings call. “I’d certainly encourage entrepreneurs out there who are looking for opportunities to get into the lithium business,” he said last week. “We think we’re going to need to help the industry on this front.”

Also last week, Mexico officially nationalized its lithium industry by declaring it to be a “strategic mineral” within the right of the state to control all exploration, exploitation and use of the metal. Industry analysts expect tensions between the U.S. and Mexico over the move, which they say violate the United States-Mexico-Canada Agreement (USMCA).

Meanwhile, according to the Mexican Association of Mining Engineers, Mexico has also discovered lithium-containing clays within the country, which could make it the first nation ever to produce and commercialize lithium from clays.

What to Do Now
Sigma Lithium (SGML) is a Canadian company that develops, through its subsidiary Sigma Mineracao S.A., hard rock lithium deposits in the Americas. Sigma’s properties are located in Brazil’s Minas Gerais State in the municipalities of Aracuai and Itinga, and the company holds nearly 30 mineral rights in four properties spread over 120 miles, including nine past-producing lithium mines. The firm is focused on producing battery-grade lithium concentrate from its Grota do Cirilo property—the largest lithium hard rock deposit in the Americas—to support the booming electric vehicle (EV) industry. Analysts expect Sigma will begin generating revenue by the end of 2022 as its lithium production commences at half scale, bringing the company one step closer to its goal of being the world’s largest low-cost lithium producer. Additionally, Bank of America recently picked Sigma as one of its top “scarcity plays” in the face of a tight supply backdrop in the global lithium battery space. Participants on March 22 bought a conservative position in SGML using an initial stop-loss slightly under 10.50 (closing basis). Last month, I suggested taking 50% profit in this stock after it rallied 14% from our initial entry point. I also recommend raising the stop-loss in the remaining position to slightly under 15 (closing basis). HOLD A HALF

Titanium Remains Elevated
European civil and military plane maker Airbus has defended its decision to continue importing its titanium supplies from Russia.

Imports from Russia make up 50% of Airbus’s titanium supplies, directly or through key suppliers, according to Reuters. And with global supply chains in disarray, prices for titanium and titanium-based alloy mill shapes have risen 6% since November and remain elevated (see chart below).

Airbus CEO Guillaume Faury told investors at the company’s recent annual general meeting, “We don’t think sanctions on imports will be appropriate,” adding that sanctions would have only a minimal impact on Russia but much bigger consequences on other countries and the industry itself. “So we think the no-sanction policy actually is the most meaningful one,” he said.

Titanium is widely used in the aerospace industry for constructing landing gears due to its strength and resistance to corrosion. It’s also used to attach the carbon-fiber outer shell of the Airbus A350 aircraft since it doesn’t expand as much as other metals due to temperature changes, according to Bloomberg.

What to Do Now
Kronos Worldwide (KRO) is a leader in the production of titanium dioxide pigments, the world’s primary pigment for providing whiteness, brightness and opacity (used in two-thirds of all pigments). In Q4, the company reported net income that was 220% higher from a year ago (28 cents per share) on revenue of $496 million that was up 20%, driven by higher titanium dioxide prices. Titanium dioxide segment profit was 55% higher for full-year 2021 and a whopping 143% higher for Q4. Going forward, analysts see sales rising 9% and earnings soaring 31% for 2022, which will likely prove conservative. A 5% dividend yield ties a bow on this package. Participants recently purchased a conservative position in KRO using a stop-loss slightly under 14.75 on a closing basis. I now recommend raising the stop to slightly under 15.10 where the 50-day line comes into play. BUY A HALF

Current Portfolio

Buy
means purchase a position at or around current prices.
Buy a Quarter/Half means allocate less of your portfolio to a position than you normally would (due to risk factors).
Hold means maintain existing position; don’t add to it by buying more, but don’t sell.
Sell means to liquidate the entire (or remaining) position.
Sell a Quarter/Half means take partial profits, either 25% or 50%.

The next Sector Xpress Gold & Metals Advisor issue will be published on May 10, 2022.