February 15, 2022

Turnaround Time for Gold and Steel
The last few months have been a tale of two markets for the metals. Base metals like copper, tin and aluminum have outperformed, while steel and precious metals like gold, silver and platinum have underperformed.

That dynamic is in the process of changing, however, as gold has begun another attempt at turning around after last month’s disappointing drop. Gold futures prices were up for seven straight sessions, and as of this writing the metal is just $10 below its former high of $1,867 an ounce from November 17.

Helping gold’s cause is a combination of higher levels of fear among investors as highlighted by elevated levels in the CBOE Volatility Index (VIX), Wall Street’s favorite fear gauge. Recent weakness in the U.S. dollar index has also helped attract safe-haven interest in gold.

What’s most intriguing about gold from a technical aspect is the fact that, despite not making much net progress since November, the metal’s price has established a series of three higher lows over the last four-and-a-half months. Normally, that would be enough by itself to qualify as the start of an intermediate-term upward trend. The only thing that has held back gold from achieving this goal is the lack of a higher high since the November peak at $1,867.

It’s looking more and more, though, like this time gold will follow through and reach a new high to complete its turnaround from the late-September bottom. Consider, for instance, that gold’s latest rally has been supported by corresponding rallies in platinum and palladium—confirming moves in other key precious metals that let us know that this is more than just short covering activity in gold.

Additionally, gold is beginning to show sustained relative strength versus the S&P 500 Index (SPX). This is a key consideration since prolonged periods of gold outperforming equities tends to attract money managers to gold’s capital preservation (and capital gains) potential. As I’ve noted before, gold’s relationship versus the SPX is one of the most important indicators for determining whether or not an intermediate- or long-term bull market has begun for the metal.

The key to using this indicator, however, is how long gold continues outperforming the stock market. To be exact, gold’s best intermediate-to-long-term performances occur when the gold versus SPX ratio (above) is trending higher for at least three months. To date, the outperformance has only lasted around six weeks—halfway there—but if my take on gold’s “fear factor” being unusually strong is correct, then we should see this indicator confirming the start of a new interim bull market by the end of March.

On a short-term basis, gold is very close to confirming another trading signal for the bulls. A decisive breakout above $1,867 would be enough for me to return to a buy on my favorite gold-tracking ETF (stay tuned). For now, I recommend that we content ourselves with our trading position in the palladium ETF discussed below.

Turning to the steel market, that metal is also showing signs of being in turnaround mode as evidenced by the 15% gain in benchmark rebar prices since late November. Top U.S. steel producer Nucor (NUE) told the Wall Street Journal that steel market weakness is only temporary and mainly the result of Covid-related supply chain disruptions, which the firm expects to diminish in the coming months as steelmakers increase production to fill high demand.

Nucor’s CEO, Leon Topalian, told WSJ that the demand picture across every end market for the company’s steel remains “very robust.”

Management also said in a recent conference call that 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 that Nucor would experience another year of “strong profitability.”

This is encouraging news and adds to the increasingly bullish fundamental backdrop for steel, which, unfortunately, hasn’t yet translated into strong upside moves for most actively traded steel stocks. That looks to change soon, though, which means we’ll likely have some new buying opportunities in our favorite steel companies soon.

Note: In the portfolio, we have no new additions this week.

Updates
Traders recently purchased a conservative position in the Aberdeen Standard Physical Palladium Shares ETF (PALL), using an initial stop-loss slightly below 195 on a closing basis. Let’s maintain this stop for now. BUY A HALF

Earlier this month we bought a new trading position in Alcoa (AA) based on its technical and fundamental strength. 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%. Last week, I recommended that we book a quarter profit in Alcoa after the stock’s 10% rally. We also raised the stop-loss on the remaining position to slightly under 65 on a closing basis. HOLD

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 recently bought a conservative position in GGB using a level slightly under 5 (closing basis) as the initial stop-loss. Let’s maintain this stop for now. BUY A HALF

With inflation likely to persist at least through the first half of 2022, not only industrial metals but commodities 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 21.50 as the stop-loss on a closing basis. Maintain this stop for now. HOLD

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 a conservative position in this tin-tracking vehicle. I also recently recommended taking a 50% profit in this position after January’s big rally. Last week, I further suggested raising the stop-loss on the remaining position to slightly under 125 on a closing basis. HOLD A HALF

Prices for steel making coal are on the rise, due in part 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 month 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 34.50 (closing basis). HOLD A HALF

In view of copper’s improving near-term fundamentals, participants who wish to have some exposure to the metal purchased a conservative position in Teck Resources (TECK) earlier this month. 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 raising the stop-loss to slightly under 32 on a closing basis for this trade. 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%. Traders 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. Last week I recommended raising the stop-loss to slightly under 16 on a closing basis. Vale has given us 30% profit since December, but the stock is now starting to run up into what could prove to be strong overhead supply/resistance beginning at 18 and extending to 22. Moreover, the nickel market (which Vale partly represents) is admittedly becoming a bit overheated and could therefore exert a negative spillover impact on Vale and other nickel-related stocks. HOLD A HALF

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%.