February 8, 2022

Weakening Dollar Boosts Base Metals
Industrial metals got another boost last week when the U.S. dollar index suddenly and swiftly reversed a prior rally. Gold barely budged, but a recent development in the stock market suggests the yellow metal could soon get another buying bid. In the white metals, silver slept but palladium is on the rise once again.

In the portfolio, we recently added a new position in our favorite commodity-tracking fund and have initiated four additional new buys in various industrial and precious metal plays.

Feature Story: How Hot is Too Hot for Industrial Metals?

Just when you thought the industrial metals market couldn’t get any hotter, the weakening dollar could boost metal prices even more.

After a temporary surge in flight-to-safety demand for dollars during January’s stock market rout, last week brought an equally sudden plunge in the U.S. dollar index (USD). Last week’s sharp drop in the dollar’s value put USD below its key 50-day line for the second time in less than a month.

This is a potentially critical development for commodities in general, but particularly for the more inflation-sensitive metals like aluminum and copper, which tend to move inversely to the dollar. As Briefing.com analyst Brett Manning recently observed, the fact that commodities like oil have been trending higher in the last few months when the dollar was strengthening makes it “somewhat disturbing to contemplate” how commodities might perform if the dollar continues to weaken.

In other words, a weaker dollar could easily propel commodities prices (including metals) to far greater heights than anything we’ve seen in the past year.

Aside from the dollar’s recent weakness, the 10-year Treasury Yield Index (TNX) surged almost 6% last Friday and reached a two-year high of 1.93%. This is yet another sign that last year’s inflation trend is still very much in force.

While higher bond yields can definitely coexist with an industrial metals bull market, it’s widely assumed that non-yielding gold will be negatively impacted by rising yields. And while this is typically true as long as inflation isn’t spinning out of control, there have been times in the past when gold and Treasury yields have risen in tandem.

A few months ago, I pointed out that gold had one of its strongest historical performances during the period from roughly 1977 through 1980, which incidentally is when the U.S. inflation rate reached one of its highest levels in decades. During those years, gold prices gained a solid 400%. Yet the U.S. 10-year Treasury yield was also steadily rising at that time, gaining 86% during the same 3-year period.

The lesson here is that when inflation is “red hot” and increasing at an ever-accelerating pace, investors at some point lose their excessive focus on yield and begin to worry about maintaining the value of their money. That’s when gold finally comes into its own and safety-related demand explodes while investors recognize the asset protection it affords.

On a related note, while the 10-year Treasury yield was last seen at 1.93%, the latest aggregate yield for the 30 stocks in the Dow Jones Industrial Average was 1.97%. For the first time since just prior to the 2020 stock market crash, the 10-year yield is very close to exceeding the Dow 30 yield. This is significant, for if bond yields eclipse stock yields, it will give the bond market a competitive advantage over equities among yield-oriented investors. And that could mean increasing headwinds for stocks, in turn boosting gold’s profile as a safe alternative to risk assets (as is typically the case in such instances).

From a near-term technical perspective, gold hasn’t yet flashed a new buy signal after last month’s “whipsaw” rally failure. Accordingly, I recommend that we wait before entering our preferred gold ETF, the GraniteShares Gold Trust (BAR), again.

What to Do Now
With inflation likely to persist at least through the first half of 2022, not only industrial metals but commodities in general should generally 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 show relative strength. Traders recently purchased a conservative position in DBC using a level slightly under 21 as the initial stop-loss on a closing basis. I suggest raising the stop to slightly under 21.50 (closing basis). HOLD

New Recommendations & Current Portfolio

Silver Sleeps While Palladium Awakens
Silver has been surprisingly somnambulant in the face of a weakening dollar and rising inflation pressures. In fact, the white metal has barely budged from the lower end of its six-month trading range and isn’t that much above its 1-year low price of $21.50 an ounce from September.

The word “surprising” definitely applies to silver since the white metal typically responds more quickly to downside moves in the dollar index than its sister metal, gold. But this isn’t necessarily a death knell for silver as one of its fellow white metals, palladium, has recently arisen from the ashes to take flight.

Palladium futures are up over 55% from the December low in just the last six weeks—and up 25% since the start of this year. The precious metal also just posted its best monthly performance (in January) of the last 14 years.

Analysts attribute the white metal’s powerful rally to concerns over supply availability in Russia in the face of the escalating Ukraine crisis. But an equally likely explanation for palladium’s strength is its use in the automobile supply chain. With global auto demand on the upswing, the auto-catalyst metal (used in gas-powered and hybrid autos) is also in high demand right now.

However, to date there has been no disruption to palladium production or exports, according to Reuters. Moreover, part of the reason behind palladium’s rally is like short-covering activity linked to a heavily net-short position among non-commercial accounts earlier this year.

The threat of exports from Russia being hindered if Russia invades Ukraine is nonetheless a key concern for the palladium outlook going forward. Additionally, the U.S. and European Union (EU) are considering additional sanctions on Russia’s largest banks and are also debating whether to levy restrictions on Russia’s ability to convert rubles to dollars. Fundamentally, this provides a bullish backdrop for palladium that could keep prices elevated in the coming months.

In view of the above factors, I’m recommending a new position in one of our favorite white metal tracking ETFs.

What to Do Now
Traders can purchase a conservative position in the Aberdeen Standard Physical Palladium Shares ETF (PALL), using an initial stop-loss slightly below 195 on a closing basis. BUY A HALF

Copper on the Comeback Trail
Copper prices have rebounded from a six-week low of $4.28 last month and have been mostly buoyant so far in February.

The weaker dollar and strong factory activity in Europe have bolstered the red metal’s prospects, even as local markets in China are closed for the nation’s Lunar New Year’s celebrations (ending on February 15).

Other supporting factors for copper include the latest Purchasing Managers’ Index (PMI) data which reveal that factory activity has increased strongly in the U.K., the Eurozone, Russia and Japan. Moreover, supply-chain bottlenecks are easing and production and order books have improved, giving copper a new supporting bid.

Additionally, Trading Economics reports “improvements in business confidence across European factories,” which suggests higher copper demand in the coming months.

Meanwhile, Goldman Sachs’ chief commodity strategist, Jeff Currie, recently told podcast host Grant Williams that “copper is the new oil.” Currie said copper’s conductive characteristics are “necessary in almost every major facet of the energy transition,” which in turn will support copper demand for years to come. Currie also expanded on his recent assertion that another commodity market “super boom” is likely underway.

What to Do Now
In view of copper’s improving near-term fundamentals, participants who wish to have some exposure to the metal can purchase a conservative position in Teck Resources (TECK). The company plans to start up its Quebrada Blanca Phase 2 project in Chile during the second half of this year, which will double its consolidated copper production by 2023. When the company reports fourth-quarter earnings on February 23, analysts expect revenue growth of 81% and per-share earnings growth of 415%. Further, high double-digit top line and triple-digit bottom line growth are forecast for Q1 and Q2 2022. I suggest using a stop-loss slightly under 31 on a closing basis for this trade. BUY A HALF

Steel Supported By Supply Restrictions
Steel rebar prices continue to rally after bottoming at CNY 4,140 per ton on November 30. Steel has gained over 15% since then and prices are at the highest level since late October in the face of restricted supplies, rising input costs and increasing global demand.

Steel manufacturing in top producer China is likely to be lower in the first quarter due to factory maintenance, plus Lunar New Year holiday-related business closures. What’s more, the Chinese government’s recent initiative to limit pollution during the Beijing Winter Olympics is weighing on production.

The prices of steelmaking components iron ore and nickel are also increasing, while top iron ore exporter Australia faces supply disruptions due to a recent surge in coronavirus cases, as well as weather-related woes and labor shortages at some major iron ore mines.

On the demand front, China’s central bank lowered mortgage lending benchmark rates in an effort to prop its beleaguered real estate sector and rejuvenate manufacturing. Chinese authorities also indicated they could increase investments in the property and infrastructure sectors. Bank analysts believe that China still has room for additional easing in the first half of this year.

China’s People’s Bank has also said that it fully intends to support the economy. There are also indications that construction and infrastructure spending will increase in the second quarter, which bodes well for steel demand.

What to Do Now
Gerdau SA (GGB) is the largest producer of long steel in America, with steel mills in the U.S. Canada, Mexico and throughout South America and specializing in long steel and specialty steel products. In the third quarter, Gerdau saw its revenue grow 75% from a year ago to $3.8 billion, while per-share earnings of 59 cents beat the consensus by a whopping 55%. For the upcoming Q4 report, analysts expect Gerdau to post top- and bottom-line increases of 57% and 240%, respectively. The next earnings report is expected to be out on February 22. Traders can purchase a conservative position in GGB using a level slightly under 5 (closing basis) as the initial stop-loss. BUY A HALF

As previously discussed, prices for steel making coal are on the rise, which is partly attributable to the improved outlook for steel production and consumption globally. A beneficiary of higher coal prices is Natural Resource Partners (NRP), which 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. In the third quarter, the company reported revenues of $57 million that were 90% higher from a year ago. Per-share earnings of $1.10, meanwhile, beat consensus expectations by 28 cents. Management said it sees steel demand “remaining strong” going forward, as global economic recovery is “more than offsetting” Covid-related challenges. The company also said it remains committed to finding alternative revenue sources across its large portfolio of land, mineral and timber assets. Participants last week purchased a conservative position in NRP using a level slightly under 31 as the initial stop-loss on a closing basis. After the recent 10% rally, I recommended selling a half and raising the stop on the remaining position. I now suggest raising it further to slightly under 33.75 (closing basis). HOLD A HALF

Aluminum Poised To Make New Highs
Aluminum prices remain near record levels (up 50% in the past year!), thanks to strong industrial demand, but also to supply-squeezing plant closures in China and Europe due to rising energy costs.

Aluminum prices are currently trading around $3,075 per ton, not far below a 13-year high of $3,200 which was last October. Solid demand, tight supply and high energy prices are the fundamentals supporting the recent rally.

On the energy front, electricity costs in Europe are still rising despite a recent pullback in natural gas and coal prices. This has convinced smelters, including Norsk Hydro and Alcoa (AA), to cut production of the metal.

Meanwhile, from a supply perspective, stockpiles of aluminum in LME warehouses have dropped to less than 850,000 tons. This represents the lowest level in 15 years, according to FactSet.

Additionally, the recent escalation between the U.S. and Russia over Ukraine has increased the likelihood of sanctions against Russian aluminum producers. As the New York Times recently noted, U.S. sanctions against Russia in 2018 caused a temporary surge in global aluminum prices (the sanctions were lifted in December of that year).

Consequently, aluminum prices are expected to remain buoyant for most of 2022 as a tight global supply condition (the metal is expected to post a 2.2 million-ton deficit this year) is likely to continue.

What to Do Now
We were recently stopped out of our trading position in Alcoa (AA) due to last month’s “whipsaw” volatility event. The strength in the stock since then has prompted me to return AA to a buy, which means a conservative trading position in the stock is warranted. Fundamentally, Alcoa easily beat expectations in Q4 in reporting a 40% increase in sales and earnings-per-share of $2.50 (a 59-cent beat). The company generated revenue of $12.2 billion for the full year, up 31% from a year ago and the highest since 2018, while recording its highest ever annual net income and per-share earnings of $2.26. Going forward, the company sees higher aluminum prices as a major tailwind and plans to continue its strategy of reducing debt and pension obligations while increasing shareholder returns, recently initiating a new $500 million share repurchase program. Wall Street, meanwhile, sees revenue growth of 14% in Q1 and per-share earnings growth of around 200%. I suggest using a level slightly under 59 (closing basis) as the initial stop-loss for this trading position. BUY A HALF

Nickel Price Pulls Back
Previously we discussed that traders feared tight supplies on the London Metal Exchange (LME) had driven up prices to unsustainably high levels. I observed, “Given the vertical ascent of the metal in recent weeks, that worry would seem to be at least somewhat justified.”

Nickel has since pulled back to “correct” some of the ebullient sentiment behind its extraordinary run-up. After a 6% decline from last month’s highest price in 10 years, nickel has settled at a somewhat more reasonable—though still lofty—level of $23,390 a ton.

Technical considerations aside, nickel is being supported by strong auto-related demand (particularly electric vehicles), but also energy-related demand. Robert Wetherbee, CEO of Allegheny Technologies (ATI), noted in a recent earnings call that his company’s oil and gas sales were driven by the final shipment of nickel alloy materials for large pipeline projects off the coast of Brazil. He predicted that nickel alloy markets will tighten in 2022 as more offshore pipeline projects are sourced, further noting that nickel scrap prices are rising “near prime levels.”

Mining.com has noted, moreover, that the nickel market is showing increasing signs of stress. Stockpiles held by the LME have reportedly extended their decline, with the last increase coming in October. Mining.com said buyers are paying a “massive premium” for immediately deliverable futures, adding that:

“The key cash three-month spread…notched new highs [last week]. Contracts for immediate delivery are trading at a $508-a-ton premium to those in three months, the highest such premium since a historic squeeze in 2007.”

Market observers believe that while the short squeeze in nickel prices in January was focused on near-dated contracts, it has recently spread through the curve. This suggests the market is “pricing in tighter nickel supplies for longer, amid strong demand from stainless steel producers and battery manufacturers,” according to Mining.com.

What to Do Now
Vale S.A. (VALE) is one of the world’s largest iron ore and nickel miners, as well as a diversified producer of other industrial and precious metals. Earlier this year, the company garnered attention when management announced an ambitious plan to reach 400 million tons of iron ore production by 2022, which, if realized, would be a 33% increase from 2020’s total production. More recently, though, Vale has shifted its focus on so-called “green” metals in an effort to diversify and generate higher shareholder returns. Vale recently guided for copper production to increase to a midpoint of around 345,000 tons per year, led by the firm’s Salobo 3 expansion copper project, while nickel production is expected to reach around 185,000 tons per year. Additionally, Vale’s outlook received a boost from the recently passed $1 trillion infrastructure spending bill, which would dramatically expand fiscal spending for roads, water pipes, EV charging stations and other infrastructure, in turn necessitating higher industrial metal production volumes. Analysts, meanwhile, expect Vale’s revenue for full-year 2021 to increase 34% while per-share earnings improve 85%. From a technical standpoint, VALE is coming off a 1-year low near 12 but appears to be bottoming out. Any improvement in the iron ore, copper and nickel prices from here should provide a boost to the stock. Traders who didn’t mind the China-related volatility risk did some nibbling around 14 in December, using a level slightly under 12 as the initial stop-loss on a closing basis. After the recent 14% rally, I suggested taking 50% profits and raising the stop to slightly under 13 (closing basis). I now recommend raising the stop to slightly under 14.35 (closing basis) where the 50-day line comes into play. HOLD A HALF

Tin Marches Higher
Tin prices have increased 11% since the start of 2022 and were last seen around $43,000 per ton after reaching a fresh record high in late January. The story with tin continues to be a market driven by tight inventories and supply bottlenecks.

Tin inventories at LME warehouses were recently 2,059 tons, which is above last November’s record low of 887 tons, well under the 2020 average of 5,000 tons.

As previously mentioned, measures to curb the coronavirus in Myanmar the world’s number six tin producer) have resulted in widespread shipment delays, in turn cutting tin concentrate shipments to top producer China by roughly half. (China relied on Myanmar for more than 90% of its tin concentrate imports in 2020.)

Elsewhere, the world’s third-largest refined tin producer, Malaysia Smelting Group (MSG), which had temporarily suspended contract deliveries since last June based on a major virus outbreak, has lifted “force majeure” as of late December due to an improvement in its Covid situation and is accepting tin ore orders from customers for smelting.

According to the Malaysia Star newspaper, MSG “is on track for a more meaningful recovery growth in 2022, supported by improved production output and better cost savings from the full utilization of its new eco-friendly plant,” adding that the full utilization of the new plant and the lifting of its force majeure came at the ideal time after tin prices recently hit a record high and gained 100% from last year’s levels.

MSG expects tin ore production to reach 12 tons per day in 2022, slightly above last year’s 11.5 tons and well above the pre-pandemic 2019 level of 8.6 tons per day, according to The Edge Markets.

The International Tin Association (ITA), in a recent report, said solder accounted for almost half of global tin use in 2020 (the latest year for which data is available), followed by chemicals at 17% and tinplate at 12%, then lead-acid batteries at 7%.

What to Do Now
I recently placed the iPath Series B Bloomberg Tin Subindex Total Return ETN (JJT) on a buy after the improvement in the tin price after a brief stumble in December. Keep in mind this is an exchange-traded note (ETN), not a traditional ETF, which is an unsecured debt note that trades more like a bond than a stock. Earlier last month, I recommended buying conservative position in this tin-tracking vehicle. I also suggested using an initial stop-loss slightly under the 115 level on an intraday basis for this trading position. I also recently recommended taking a 50% profit in this position after January’s big rally. I further suggest raising the stop-loss on the remaining position to slightly under 121 (the current location of the 50-day moving average) after the recent rally. HOLD 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 February 22, 2022.