A Bifurcated Metals Market
For metal investors, it has been a classic tale of two markets. On the precious metals side of the market, disappointment still reigns as gold remains stuck in neutral and the white metals (led by palladium) are still in the dumps. On the industrial side of the market, however, metals like aluminum and molybdenum—as well as battery metals like lithium and nickel—are fairly strong.
It’s not hard to figure out what accounts for the disparity; the strong dollar is holding back precious metals while strong industrial application demand is keeping some of the key base metals afloat. Case in point are the latest inflation headlines.
Last week it was revealed that the producer price index (PPI) for November rose nearly 10%, the largest advance in the PPI’s history. The news shocked investors and provided a much-needed jolt to the industrial segment of the metals market. Consumer prices, meanwhile, rose 7% for the largest year-over-year increase since 1982 in a sign that inflationary pressures are still a factor for the economy despite the relatively stronger dollar.
Gold and silver are clearly more dollar-sensitive than the industrial metals, hence the reason why they can remain moribund while base metals like aluminum are strong. The combination of higher demand for the latter metal (mainly for its use in increasingly popular “green” technologies like electric vehicles), plus diminished supply from top producer China, accounts for the base metal’s bullishness.
Aluminum in particular has come into the Wall Street spotlight after major producer Alcoa’s (AA) recent announcement that it will close 146,000 tons of aluminum smelting capacity at its Wenatchee Works plant in Washington as part of its five-year review of operating assets. The move should further reduce supply in what is already a market faced with low inventories globally.
Specifically, the latest data show that LME warehouse inventories for aluminum near a 14-year low of 882,800 tons. Demand in China, meanwhile, continues to improve following the easing of energy consumption curbs, according to industry reports.
The sanguine expectations that a growing number of analysts have for aluminum and other industrial metals (like molybdenum and cobalt) is further supported by a bullish commodities outlook in general. This was highlighted by the respected market statistician Jason Goepfert, who observed that the Bloomberg Commodity Spot Index recently jumped 50% over the past two years—something it has never done during a secular commodity bear market.
Goepfert further noted that the recent gains aren’t being driven by a single commodity or two, but are “exceptionally broad-based.” As it turns out, among the hard assets tracked by the S&P GSCI Commodity Spot Indexes, all are showing positive 3-year rolling returns, a feat that hasn’t occurred in 17 years!
The implication of this signal, according to Goepfert? Commodity prices—including industrial metals like copper—continued higher for nearly four more years.
While this should be good news for gold and silver, it still doesn’t explain why the U.S. dollar index remains stubbornly strong in the face of rising inflation pressures. What we do know is that for gold to rally on a sustained basis, the dollar must weaken substantially.
On that score, LPL chief strategist Ryan Detrick has observed that “when gold outperforms the U.S. dollar is when true gold bull markets take place.” Below is the chart comparing the strength of the gold price relative to the U.S. dollar index (USD). A series of higher highs and lows in this ratio is required to confirm that gold has truly broken out and is in the firm hands of the buyers. Obviously, we’re not there yet.
In light of the bifurcated metals market environment, I recommend that we continue to focus mainly on the outperforming base metals while steering clear of the underperforming precious metals (notably platinum and palladium). Silver looks like it may be bottoming, FYI, so we may soon have another entry point in our favorite silver-tracking ETF. As for gold, we should ideally see improvement in the gold/dollar ratio before getting our next buy signal.
Updates
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. BUY A HALF
Earlier this month 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. I also suggest raising the stop-loss on the remaining position in this stock to slightly under 6.00 (near the 50-day line). HOLD A HALF
MP Materials (MP) operates the largest rare earth mineral mines in the Western Hemisphere, currently accounting for around 15% of total global supply, with a focus on Neodymium-Praseodymium (NdPr)—a crucial input used for making rare-earth magnets used in many of those devices. MP opened Wall Street’s eyes to the oft-overlooked industry in Q3, boasting estimate-beating revenue that soared 143% from a year ago and 36% sequentially, while net earnings nearly tripled, prompting at least two major institutions to recommend the company. Management also reported generating a “significant” amount of cash from operations, which will be used to advance its Stage II and Stage III plans to restore the full rare earth supply chain to the U.S. (Most of the rare earth concentrates MP produces are sold to China through an intermediary, but its plans will allow it to bypass the middleman and fully process and sell NdPr straight to end users.) Most recently, MP got a boost when it was revealed that automaker General Motors (GM) has contracted with the firm to supply magnets for building motors for more than a dozen GM models. Traders recently purchased a conservative position in MP using a level slightly under 37.15 (50-day line) as the initial stop-loss on a closing basis. Let’s maintain this stop for now. Traders also booked some profit after the recent 14% rally (per the rules of our trading discipline). HOLD A HALF
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 can do some nibbling here, using a level slightly under 8.50 (intraday) as the initial stop-loss. BUY A HALF
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 can do some nibbling around current levels, using a level slightly under 12 as the initial stop-loss on a closing basis. BUY A HALF
New Positions
After underperforming the sector for much of 2021, Harmony Gold Mining (HMY) is now in a position of relative strength compared with gold, the benchmark PHLX Gold/Silver Index (XAU) and the broad market S&P 500 Index. Harmony is a world-class gold producer operating in South Africa and in Papua New Guinea, one of the world’s premier new copper-gold regions, and is also South Africa’s largest gold miner. In its fiscal Q1 2022 report, the company reported gold production of 413,714 ounces, representing a 32% increase from a year ago thanks to higher gold grades and metric tons milled. Moreover, management guided for 2022 gold production to be in line with, or above, last year’s production of 1.54 million ounces, with a midpoint forecast of 1.58 million ounces. Harmony is also focused on de-leveraging its balance sheet going forward, and the market has been rewarding the firm’s recent de-risking measures. Traders can purchase a conservative position in HMY using a level slightly under 3.75 (the 50-day line) as the initial stop-loss on a closing basis. BUY A HALF
Portfolio
| Stock | Price Bought | Date Bought | Price 12/21/21 | Profit | Rating |
| Alcoa (AA) | 52.25 | 12/16/21 | 55.67 | 7% | Buy a Half |
| Lynas Corp. (LYSCF) | 5.85 | 11/16/21 | 6.41 | 10% | Hold a Half |
| MP Materials (MP) | 42 | 12/7/21 | 43 | 3% | Hold a Half |
| Sigma Lithium Resources (SGML) | 10.15 | 12/14/21 | 10 | -3% | Buy a Half |
| United States Copper Fund (CPER) | - | - | - | - | Sold |
| Vale S.A. (VALE) | 13.50 | 12/14/21 | 14 | 3% | Buy a Half |
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%.