January 25, 2022

Bubbly Conditions for Nickel
The metals needed for the electric vehicle (EV) battery market are on fire right now, as are other industrial metals like tin and aluminum. Other key metals, including copper and steel, are hanging tough as hopes for revived infrastructure demand in China increase. The main story right now is nickel, which appears to be in the early stages of a speculative bubble. In the portfolio, we just added a new position in our favorite gold-tracking fund.

Feature Story: Gold – Plenty of Fear but Short Interest is Too Low

You know things are going well for gold when the metal manages to squeeze out not one but two(!) consecutive weeks of gains. Yet that’s exactly what happened last week as the safety trade returned in the face of melting equity prices.

Gold is up 2% since January 7, while gold mining stocks are up by an average of 5% since then (and up 10% at one point last week). These are the best performances for the yellow metal and mining stocks since November, which is all the more impressive when you consider that stocks are down 8% so far this month.

Accounting for gold’s newfound popularity is a flight-to-safety mentality that hasn’t been seen since 2020. Indeed, each of gold’s previous rallies of the past year has been the result of either falling bond yields, a weaker dollar or short covering. Broad equity market pullbacks in 2021 typically saw gold prices decline in sympathy with stocks.

This time around, however, there has been a definite shift of character in the gold market as investors seem to be genuinely worried over the corporate profit outlook, particularly as it concerns inflation (which is beginning to erode margins for some companies while drastically increasing costs for consumers).

Underscoring this uncomfortable realization was last week’s performance, which saw stocks post their worst week since the early days of the pandemic. The week was punctuated by a disappointing earnings report from mega-cap Netflix, which rattled participants.

And as the latest earnings season continues, “new earnings reports are also revealing that inflation continues to cause companies’ costs to rise, hurting their profit margins,” observed Jack Denton in Barron’s last week. “That isn’t exactly helping the stock prices of companies that haven’t reported yet,” he added.

Clearly, gold is benefiting from growing worries on the financial market front. But gold’s bullish case is also being bolstered by the recent action in the U.S. Treasury bond market (which competes with non-yielding gold). The yield on the 10-year Treasury note fell 6% over a 3-day period last week. And while this hardly constitutes the end of the meteoric upside run of Treasury yields, an increasing number of bond market analysts believe yields may have peaked on a short-term basis as safe-haven demand for T-bonds increases in the face of a weakening equity market.

Certainly, lower bond yields would further help the bullish case for gold, but I would hasten to add that falling rates aren’t essential for gold prices to move higher. Arguably the most important supporting variable for the gold bulls (behind worries about inflation’s—and Covid’s—impact on the economy) is the U.S. dollar outlook.

The dollar index (USD) showed signs of faltering last week, breaking decisively below the widely-watched 50-day moving average for the first time since last September. And while it’s too soon to tell, it’s just possible we may have seen the peak of the rising dollar trend for a while.

Even dollar strength doesn’t typically impede gold prices from rising when investors are being driven mainly by fear (especially since the greenback often strengthens during a liquidation market as investors are mainly interested in raising cash). Nonetheless, a falling dollar index would further increase gold’s upside potential since it would imply that inflation is becoming an even bigger problem.

From strictly a technical standpoint, I’ve noticed a growing number of gold analysts and traders are keying in on the $1,880 an ounce level for gold. The consensus seems to be that a breakout above this level would essentially constitute a reversal of a 15-month downward trend. Given the apparent psychological significance of this level, a breakout above $1,880 could end up becoming a self-fulfilling prophecy for the bulls (at least temporarily) as it would likely attract “run the stops” for short sellers while triggering buy signals for the trend-following algorithmic trading crowd.

For these reasons, I think we should keep a close eye on $1,880. If this level is exceeded on the upside, it would for us serve as a potential profit-taking point (rather than an entry signal).

What to Do Now
With several of gold’s supporting factors back in play, I’ve recently moved our favorite gold-tracking fun, the GraniteShares Gold Trust (BAR), back to a buy. Participants purchased a half position in BAR on January 19 using the 17.75 level as the initial stop-loss. As with our previous trade in BAR, I’m recommending a fairly tight stop since a violation of this level would imply a total reversal in buying interest (hence a “head fake” situation). BUY A HALF

New Recommendations & Current Portfolio

Silver’s Bottoming Process Continues
While last week was good for gold, it was even better for silver. The white metal finished with a gain of 6% for its best week since early May 2021.

Silver also broke out above a much-heralded seven-month downtrend line (below), which many traders excitedly viewed as the start of a new bull market for the metal. The assumption here is that with this key trend line finally broken, most of the overhead supply that has plagued the metal in recent months has been absorbed to justify another major rally leg for silver.

Of course, it’s usually not this simple when it comes to the cyclical precious metals market. More often than not, an upside breakout from a downward trend line ends up being a “head fake” signal, with prices retreating back under the trend line (at least long enough to shake out the Johnny-come-latelies). I think we should be prepared for this possible scenario to play out in the short term.

But it’s always possible that the silver “bugs” are right this time and that last week’s trendline break will facilitate another short-covering rally. To gain some additional insight into this possibility, let’s examine the latest data showing the combined Comex silver short positions for money managers.

Money managers tend to be on the correct side of the trends in silver, but they also tend to be overextended at tops and bottoms in the silver price. That is, they’re typically wrong at the extremes. As gold and silver analytics firm Sunshine Profits has observed, “Money managers tend to be most bullish just prior to significant price tops and most bearish before significant price bottoms.”

An example of that can be seen in the above graph, which shows that while managed money accounts were indeed correctly bearish on silver during last year’s July-to-September decline, they were overly bearish when silver prices bottomed in early October and ended up missing a good part of the subsequent October-to-November rally.

This graph also illustrates that money managers are currently neutral on silver, as they have been backing off of short positions in the metal, but haven’t returned to the low short positions that were seen near the early December silver price bottom.

So, it would appear that there isn’t quite the necessary short interest among money managers to justify a sustained short-covering silver rally. For this reason, I’m recommending that we stick to our long position in gold and wait for a better entry point in the white metal—one where the psychological backdrop for silver justifies taking on the additional risk.

From a longer-term perspective, however, it’s clear that silver’s bottoming process is continuing with the metal’s price having recently established a classic “double bottom” in October through December. And when silver is finally able to extend its recent gains and put some distance between current levels (around $24 per ounce) and the downtrend line shown above, we’ll be able to say that the bottoming process is over and a new silver bull has finally begun.

What to Do Now
I’m not currently recommending any new position in the iShares Silver Trust (SLV), our preferred silver-tracking vehicle. As previously noted, I’d like to see some additional firming up of the silver price before feeling comfortable enough to jump in again with both feet. WAIT

Copper Supplies Remain Tight
While some industrial metals pulled back a bit late last week as stock prices careened on growth concerns, the economically-sensitive copper held its own. High-grade copper futures prices advanced 3% for the week as supplies remained tight and high demand persists.

Optimism from top consumer China persists, with one major Chinese firm (Amer International) announcing a major expansion in its copper wire rod capacity to meet green energy targets.

On the economic front, China recently cut its benchmark mortgage rates for the first time in nearly two years to help assuage the bleeding in its real estate sector. The move is also designed to lift consumer activity, which has been dwindling of late. Traders were confident that the dovish moves of China’s bank regulators would also filter down into the metals market by increasing construction-related demand for the red metal.

Meanwhile, on the supply front, China’s refined copper production fell 6.1% in December but in 2021 was up by 7.4% to a record of 10.5 million tons, according to Trading Economics. Elsewhere, Barrick Gold (GOLD), the world’s second-largest gold mining company, reported that its preliminary copper production for 2021 was 9% lower than a year earlier, feeding concerns that the tight supply situation for copper will persist into 2022.

Further fanning the flames of copper’s growing supply deficit is a report by the International Copper Study Group (ICSG), which found that while global copper mine production increased by 2.6% over the first 10 months of 2021, government-imposed restrictions related to Covid and sustained rates of infection have continued to constrain mine output in a number of countries heading into 2022.

Significantly, ICSG noted that global refined copper balances in the first 10 months of last year showed an apparent deficit of about 295,000 tons, while copper balance adjusted for changes in Chinese bonded stocks indicated a market deficit of around 438,000 tons.

And finally, as an aside, you may recall the copper theft trend of the 2006-2008 period when metals prices were soaring during the market’s last major inflationary runup. Well, the copper bandits are back!

In a sign that copper’s bull market is becoming increasingly recognized by the general public, several cities across the U.S. have recently reported an uptick in copper theft as the trend seems to be picking up in local news reports. Among the most popular items being stolen are copper windings, wire and scrap. The overall theft rate is still below that of 2008, however, and hasn’t yet commanded the same level of attention it did at that time.

If the previous copper theft trend is any indication, we should have a good anecdotal indication of when the current copper bull is peaking once the thefts begin making mainstream news headlines again.

What to Do Now
Freeport-McMoRan Copper & Gold (FCX) is back on our radar after the stock’s latest show of relative strength. Not only is FCX manifesting strength versus the copper price, it has even begun to strengthen relative to the broad market S&P 500 Index. Based on the fundamental outlook for copper mentioned above, FCX could prove to be a top performer among the most actively traded copper producers. In its latest financial quarter, Freeport topped earnings estimates but missed revenue estimates, as copper prices rose while weaker gold prices weighed on sales. Net income soared to $1.4 million from $329 million in last year’s Q3, while revenue increased 58% to just over $6 billion. Consolidated copper sales were up 22% in the quarter, while gold sales jumped 72%. Averaged realized prices for copper were higher, while realized gold prices were lower from the year-ago quarter. Looking ahead, management said “the outlook for the copper market is extraordinarily positive,” and expects higher full-year sales for the metal. Traders recently purchased a half position in FCX using a level slightly under 37 (closing basis) as the initial stop-loss. I recommend raising the stop to slightly under 40 (closing basis) after its latest rally. BUY A HALF

Steel Sentiment Improves on China Outlook
Shanghai steel futures rose to their highest since late October in January on rising demand hopes.

In particular, a return of confidence that there will be more infrastructure projects in China has accounted for the positive sentiment shift for steel. The improvement in sentiment came after the People’s Bank unexpectedly cut interest rates on medium-term loans last week. Additionally, the central bank implied that additional pro-growth measures would likely follow.

Also, reports circulated that steel supplies in China remain limited, in part due to reduced production following manufacturing plant maintenance in the first quarter. The Chinese Lunar New Year holiday and the upcoming Beijing Winter Olympics, plus a rally in nickel prices (a key ingredient for stainless steel), are providing additional strength for the steel market.

According to Fastmarkets, limited supplies continue to boost heavy plate prices, with coil offer prices from China either unchanged or slightly up from the previous week.

Further adding to the tight supply situation, severe weather and busy railways have reportedly delayed shipments from Russia’s Black Sea port of Novorossiysk, said Fastmarkets.

What to Do Now
Grinrod Shipping Holdings (GRIN) is an international shipping company focused on minerals, ores, coal and other commodities. Traders recently purchased a half position in GRIN using a level slightly under 15.60 as the initial stop-loss (intraday basis). This stop was violated last week on a closing basis, forcing us out of our trading position. SOLD

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 to slightly under 32.50 (closing basis). Let’s maintain this stop for now. HOLD A HALF

Aluminum Deficit Persists
Aluminum prices exceeded $3,000 per ton in January, the highest levels since last October. Driving the rising trend are dwindling inventories and expectations of large deficits as energy crises in Europe and Asia persist and smelters reduce production.

Aluminum Dunkerque Industries France, Europe’s largest aluminum smelter, is set to reduce production by 15%, according to Trading Economics, while the second-largest producer, Alcoa Corp. (AA), will stop aluminum output for two years at Europe’s second-largest aluminum plant in Spain (as previously reported).

Stocks of aluminum in LME approved warehouses have declined over 50% since the middle of March. By all accounts, the aluminum industry simply can’t manufacture enough as everything from cans to windows to gutters are months behind schedule.

Meanwhile, a ban on Indonesia exports of thermal coal has caused a rally in metallurgical coal prices, which is widely expected to increase aluminum smelting down in top producers China and India.

What to Do Now
Among the most actively U.S.-traded aluminum stocks, Alcoa (AA) has not only outperformed the industry lately but is also in a relative strength position versus the broad equity market as reflected in the benchmark S&P 500 Index (as discussed in last week’s trade alert). From an earnings standpoint, Alcoa set a record for quarterly net income in Q3, prompting management to initiate a quarterly cash dividend (10 cents per common share). Revenue was up by a solid 32% from a year ago and well ahead of Wall Street’s estimates, driven by higher aluminum prices and higher premiums for value-added products. Liquidity isn’t an issue, either, as Alcoa had a cash balance of nearly $1.5 billion at quarter’s end, with no substantial debt maturities until 2027. Moreover, the company just launched a half-billion-dollar stock buyback plan. All these factors prompted a major institution to give Alcoa a “conviction buy” rating, the upgrade was also due to Alcoa’s efforts at decarbonizing its portfolio while supporting the “green transition.” Accordingly, I recommended on December 16 that participants purchase a conservative position in AA, using a level slightly under 45 as an initial protective stop. On December 22, I recommended taking half profits in AA after the latest 17% rally. I further suggest raising the stop-loss on the remaining position to slightly under 55 (intraday). HOLD A HALF

Is Nickel in a Speculative Bubble?
Like lithium, the nickel market is being heavily driven by demand for the metal’s use in the battery electric vehicle market. However, nickel’s heavy use in stainless steel manufacturing is also a reason for the increased demand, with both factors pushing nickel to its highest price in more than a decade.

Given the extraordinary upside run in nickel prices in the past year, traders are increasingly becoming worried that a speculative bubble may be forming. Traders fear tight supplies on the London Metal Exchange (LME) have driven up prices to unsustainably high levels, according to Mining.com. Given the vertical ascent of the metal in recent weeks (see chart below), that worry would seem to be at least somewhat justified.

Mining.com further noted that “Demand for nearby delivery of LME nickel has created a hefty premium for the cash over the three-month contract which hit a 13-year peak of $495 a ton [last] Tuesday.” This was an eye-popping 112% higher than what it was at the end of December, further supporting bubble concerns.

Sources also reported that market participants are worried about nickel inventory availability from LME warehouses, which have declined 65% since last April.

Yet there seems to be no shortage of nickel supplies shipping to top consumer China, which currently dominates the EV market. Last year, for instance, China’s refined nickel imports nearly doubled, with EV production in China increasing 150%.

Meanwhile, BNP Paribas analyst David Wilson is forecasting total nickel demand of around 3 million tons globally for 2022. If realized, this would amount to a 6% gain from the prior year. However, he also predicts a supply surplus of 29,000 tons after a deficit of 76,600 tons last year.

Assuming supplies increase this year as predicted, nickel’s runaway price rally could reverse once speculators become widely aware of the shifting supply dynamic. Accordingly, we’ll need to tread very carefully in the nickel market in the coming months.

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 don’t mind the China-related volatility risk did some recent nibbling around current levels, using a level slightly under 12 as the initial stop-loss on a closing basis. After the recent 10% 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 13.60 (closing basis) where the 50-day line comes into play. HOLD A HALF

Expanding Battery Market Driving Lithium Demand
Lithium carbonate prices rallied in the second half of January, with high battery-related demand and supply difficulties remaining in the driver’s seat in the New Year.

Prices are up over 25% so far this year from steadily increasing demand from lithium-ion battery makers, particularly for their use in the white-hot electric vehicle (EV) market. Global electric vehicle sales are estimated to have increased by 160% during 2021, according to Trading Economics, while deliveries in China are expected to double in 2022 to over five million sales.

A constant refrain among battery makers is the scarcity of supply as they scramble to secure contracts and supplies wherever available. Environmental worries are keeping new lithium mines from being opened, a problem that was punctuated last week when Rio Tinto (LLC) had its exploration license suspended by the Serbian government in the face of environmental quality concerns surrounding the project (which would have been worth $2.4 billion, with an estimated lithium production for some one million EV batteries).

Speaking of Rio Tinto, the company announced last month that it would purchase the Argentina-based Rincon lithium project for $825 million. (Rincon is one of the largest undeveloped lithium brine projects in the world, located in the heart of the lithium triangle in Salta Province.) Assuming the deal is approved, Rio would transition from being primarily an iron ore producer to a major player in the batter-grade lithium market.

Global lithium demand is expected to nearly triple by 2025, to 1.5 million metric tons, according to industry reports. S&P Global points out that lithium carbonate prices rose 413% last year, to $32,600, on primarily EV demand. S&P Global also believes the continued deficit that is forecast for this year will mean even higher prices in 2022.

Elsewhere in Europe, The Wall Street Journal reports that Europeans are reportedly purchasing EVs at a record pace (thanks in large part to “generous government incentives”). In doing so, they are pushing the continent to eclipse China as the world’s largest EV market, the WSJ said.

On that score, Swedish battery maker Northvolt recently announced the creation of a new lithium-ion battery cell, which is the first by a European company. Northvolt reportedly plans to ship the battery to EV makers starting later this year and said it has $30 billion in contracts from customers, including BMW, Volvo and Volkswagen.

What to Do Now
Sigma Lithium Resources (SGML) is a Canada-based, exploration-stage lithium developer with access to the largest hard rock lithium deposits in the Americas, located in its wholly owned Grota do Cirilo Project in Brazil. The company has been producing low carbon high purity lithium concentrate at an on-site demonstration pilot plant since 2018, with plans to reach near-term commercial stage production (initially in 2022) and eventually producing 220,000 tons annually of battery grade lithium concentrate. It’s admittedly a speculative play with sovereign and mining-related risks in Brazil. But with its substantial, high grade and low impurity resource, coupled with booming lithium carbonate and hydroxide prices, the risk appears justified. Accordingly, speculators who don’t mind the risk recently did some nibbling, and I recommended using a level slightly under 8.75 (intraday) as the initial stop-loss. After the latest 10% rally, I recommended earlier this month selling half this position and raising the stop-loss to slightly under 9.50 (intraday) near the 50-day line. Let’s maintain this stop for now. HOLD A HALF

Tin Continues Its Winning Ways
Tin futures were last seen around $43,000 per ton after reaching a fresh record high. The story with tin is the same with most of the other metals mentioned in this report, namely tight inventories and supply disruptions.

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, 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. The extended production downturn, however, has put a strain on the global tin supply situation that will likely take months to completely recover from.

On a related note, according to Cabot ETF analyst Kate Stalter, the iPath Series B Bloomberg Tin Subindex Total Return ETN (JJT), which recently gave us another buy signal, was one of last year’s top-five best performing ETFs. (Click here for Kate’s article.)

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. Last week, 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 now recommend taking 50% profit in this position after the 10% rally in the last couple of weeks. I also suggest raising the stop to slightly under 118.30 (the current location of the 50-day moving average) after the recent rally. SELL A HALF

Neodymium Prices Still Strong
Neodymium prices are up 14% for the year to date and over 150% from a year ago, driven by strong demand in the magnet and laser markets. Praseodymium prices, meanwhile, are up 185% from a year ago driven by demand from the magnet and colorant markets.

On the domestic front, the White House recently announced a plan to protect supply chains, develop a domestic lithium battery industry and begin to mine substantial quantities of rare earths—measures that should support neodymium and praseodymium prices going forward.

That said, the stock prices of rare earths producers have lately taken a hit in the face of broad equity market selling pressures. Accordingly, I’ve made a change to our lone rare earth-related trading position (below).

What to Do Now
In early December I suggested selling half our stake in Lynas Corp. (LYSCF), a rare earth mining company based in Australia and boasting one of the highest-grade rare earth mines in the world (including neodymium and praseodymium (NdPr), lanthanum, cerium and other mixed heavy rare earths). Participants previously bought a conservative position in LYSCF using a level slightly under 5.25 as the initial stop-loss on a closing basis. But after rallying 15% from our initial entry point, it was time to take some profit based on the rules of our technical trading discipline. We were stopped out of the remainder of our trading position in LYSCF last week after the stock violated our stop-loss at 7.25 on a closing basis. SOLD

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 8, 2022.