What lasting impacts do you see coming out of the Russia-Ukraine conflict, as well as China’s continued lockdowns, and how all this is affecting commodities?
Several things have happened because of the Russia-Ukraine conflict. We’ve seen a very significant decline in supplies from Russia. The situation might get even worse. Why? Well, you’re looking at more robust sanctions being directed at Russia by the European Union, and I think at the same time, we have a situation where it’s becoming increasingly risky to get involved in any way. And we’re out of the UK, looking at restrictions for insurance on shipping. There is an environment developing where it’s going to be increasingly difficult to finance inventories to ensure cargoes and, as such, supplies from Russia are unlikely to fully return anytime soon.
The impact has been on oil and natural gas, but I think very important to look at the distillate market where, globally, we’re seeing a very tight petroleum product market. Natural gas supplies haven’t been there to the extent they have, prior to this conflict. And on the margin, it meant that there was some substitution, which you normally wouldn’t see for natural gas or for petroleum products.
OPEC have just agreed to a 685,000-barrels-per-day increase over the next few months. There really isn’t the processing power, or the refining capacity, to improve the situation very quickly. We’ve seen significant shutdowns of refining capacity. I think, at one point, a peak of two million barrels because of COVID-19, and that hasn’t really returned. And that could be attributed to everything from ESG, to regulation, to basically unwillingness on the part of the owners of these refining assets to put in capital, given the environment.
And that resulted in but extremely high spreads or crack spreads, between what you pay for the feed and what you’re seeing at the gas station. Of course, in the U.S., that’s translating into very high gasoline prices.
The other factor is fertilizers. We’re seeing a big shock – everything from urea or nitrogen and potash, of course – as Ukraine and Russia are big suppliers of those inputs. And, at the same time, they are big suppliers of the grain. Import issues in Ukraine have already had a massive impact on grain prices.
So you’re going to have a shortage. And that, of course, is translating into inflation, and food inflation around the world. In the U.S., we had inflation at 8.6% which was a 40-year high.
Markets are increasingly pricing in a very aggressive federal reserve. Now we’re even talking 75 basis point hikes, we’re looking at 3.6% fed funds rate, at the end of this year. The implications here, for the economy, are I think quite clear. You have that interest rate track so great that there’s a risk of a significant slowdown, possibly even leading to a recession.
And that’s bad enough, but we have a situation in China that is not making this much better. There’s the Chinese Zero-COVID policy, where we’re seeing maybe the worst of the mobility impairment which has caused massive port congestion. Much of Asia is a lot further behind than North America is. And that means that the offset you would have from those sources of demand aren’t occurring to the same extent that they have previously.
We do think there’s going to be a correction across the commodity space. Though we would say, not a rout, and I’m excluding energy here. We still believe that there is a lack of capital investment and demand should be okay, but all bets are off. Everything from copper to zinc, to aluminium, to silver, platinum, and palladium, all will, as a consequence, migrate lower.
We’re looking for gold to be below US$1,800, by year-end. Certainly, I think we’ll be well into the US$1,700s as 2023 unfolds. I think for the next few quarters, the Fed must make sure that the market believes that it wants to tame inflation. But I think, once it turns over, I suspect they may not work too hard to hit the 2% inflation target.
For the next few quarters, the Fed must make sure that the market believes that it wants to tame inflation
Do you see demand projections going through the roof for battery metals?
Well, you know, if not down in absolute terms, certainly the rate of change will be a lot less. There are constraints, and the microchip shortage continues to be an issue. So you add higher interest rates, higher lease rates for cars, higher financing, and all this results in somewhat higher unemployment.
So, you have a higher fuel, food, and higher mortgage costs for particularly new buyers. The U.S. is a little different because many people have the 30-year fixed mortgages. But in countries like Canada, where you must reset, particularly for new buyers, it’s going to get potentially more expensive. So, there will be real impacts I think, on the demand. And that ultimately means prices.
The attention with gold seems to have dropped off, at least from the investors that we’re talking to. Does it still hold that safe haven value?
Gold to some has been a disappointment because we haven’t seen these absolute performances that some have hoped for. We’ve peaked at US$2,070 this year. I don’t want to be disparaging to anybody, but when I compare gold’s relative performance to, let’s say, the cryptocurrencies that were touted as the answer for everything, I think it’s quite apparent which is a better preserver of wealth. Gold, year-to-date, has outperformed vast majority of other assets.
I still think gold is a good hedge against inflation. When you look at the 90th percentile of the cost curve for gold versus its price over time, they track very well. And why is that? Well, gold is really a function of labour and energy. You have to extract it from the ground.
Gold helps balance out a portfolio because it has a negative correlation to a lot of most equity markets, over time. It doesn’t always happen tick for tick. Sometimes you have an issue when risk assets are trading down, like they did recently. And sometimes people sell gold because it’s the most stable thing they can get to cover margin calls. You might not want to use an equity that fails 75%, and sell it in a fire sale, in order to satisfy a margin call. Gold is relatively stable.
Real rates are going to move higher, but there’s probably going to be a lot more ambiguity in six months to a year from now, where the Fed is going to try to balance two of its major goals of full employment versus inflation control. If inflation gets out of control, the cost benefit is going to very much be skewed to a disaster, especially for people on the lower side of income distribution – if they can’t afford food, if they can’t afford fuel. So I think central banks around the world have no choice right now, but to do and say what exactly what they’re doing.
Silver ultimately responds negatively to higher interest rates for now. It’s quasi-monetary and industrial, and 60% of silver demand is industrial demand. But its environmental component is growing, and will probably be in very tight market environment for the next little while.
I know there are a lot of people around the world that love silver and they think there is a scarcity. I think there is enough silver out there, and some from vaults will make its way into the broader market, when interest rates continue to be higher.
