By John Forwood, CIO at Lowell Resources Funds Management
As a result of rapidly evolving dynamics in resources and broader markets, we are seeing a changing of the guard of investors in commodities and resource equities. New investor classes have emerged or re-emerged, while some traditional sources of finance have dried up or been redirected.
Resources market drivers
The resources equities market is a function of two factors:
a. The outlook for the underlying commodities
b. Equity markets
The former is in large part driven by Chinese demand, while the latter is dominated by the US equity market, which is in turn beholden to the Federal Reserve. When these two key factors are working in sync, the resources equities market booms. The forecasts for many commodities are currently unusually bullish, both in the short term, due to China ‘reopening’, and in the long term due to numerous factors but primarily underinvestment and electrification/decarbonisation.
Commodities also respond to lower US interest rates, as they are priced in US dollars, and “de-dollarisation” boosts nominal prices.
However, the outlook for US equity markets is more clouded. It seems that the “bad news is good news” theme is an overriding factor i.e. if the US economy is decelerating, the market believes that the Fed will slow or reverse its interest rate hikes, and that will be good for Wall Street.
The new classes of investors
In terms of new investors in the upstream resources sector, car companies are one of the most remarkable. Many would have never thought they’d see Maserati investing in a development-stage mining company, but in 2022 Stellantis (owner of the Fiat, Chrysler, Peugeot, Maserati, and Jeep brands) invested AU$76 million in Vulcan Energy, which plans to produce lithium brines in the Rhine valley.
Similarly in early 2023, General Motors announced a US$650 million investment in Lithium Americas Corp to help it develop Nevada’s Thacker Pass lithium mining project, which holds enough of the battery metal to build one million electric vehicles annually. Many fossil fuel companies, and coal companies in particular, appear to be avoiding investing in their own businesses. This is in equal parts driven by shareholder antipathy as much as government restrictions. Instead, they are diversifying into new sectors.
Major producers such as Yancoal and Teck have both stated publicly that they are looking to invest the windfall profits from current sky-high coal prices into other areas, such as renewable energy. Of perhaps higher priority for these companies are efforts to find opportunities to deploy capital into copper projects, which is the metal universally regarded as among those which will be in the greatest demand due to decarbonisation and electrification.
In a similar vein, oil and gas companies have looked to deploy capital into battery minerals projects. An example is Australian oil producer Buru Energy entering into a base metal exploration joint venture with long-time metals explorer Sipa Resources.
Then there are western governments. After years of neglect and often active stymieing of mining projects in their own countries, governments in the US and Europe in particular have compiled lists of “critical minerals” and are now providing funding to help “reshore” their primary production.
For example, President Joe Biden’s Bipartisan Infrastructure Law has promised funding to seven mineral projects such as the $114 million grant towards project construction and execution costs for as Talon Metals’ nickel and copper processing facility in North Dakota.
Similarly in Europe, the EU€17.5 billion “Just Transition Fund” has classified the Cinovec lithium mining project in the Czech Republic as a “strategic project”. And in Australia the former Morrison Government approved a AU$1.25 billion loan through the Critical Minerals Facility to Iluka Resources, to develop Australia’s first integrated rare earths refinery in Western Australia.
In the gold sector, central banks have re-emerged as one of the largest investor groups. In 2022, central banks bought the most gold since 1967, according to the World Gold Council. China’s central bank has been a large buyer, notable not only for the volumes purchased but also for the fact that it has disclosed its actions. This may form a part of a “de-dollarisation” trend.
Who’s not investing?
North American investors appear to be shunning the resources sector. The world’s largest market for resources stocks Canada (including the TSX, TSXV and CSE) has seen the junior resources sector there largely deserted. Figure 1 from Crescat Capital demonstrates that trade has all but dried up on the TSXV, home to over 2,000 listed resource companies.
By contrast, on the ASX there have been over 150 resource company listings in the past two years. A recent Bank of America Fund Manager Survey indicated in December 2022 that professional investors were most underweight commodities relative to bonds since April 2009.
Probably the most important sector which has reduced its investment in resources is the resource companies themselves. Despite record free cashflows, capital investment by commodity producers is at more than 20 year lows in real terms (see Figure 2 from the Australian Reserve Bank re Australian resources investment).
Producers, perhaps in response to investor dissatisfaction with their profligate capital investing in the 2000s, have instead been paying special dividends and conducting share buy-backs. This severe underinvestment is the major factor which is expected to drive widespread forecast commodity shortages in everything from natural gas to nickel and copper.
Where are they investing?
In a gross sense, over the past decade, capital has been directed into technology stocks (such as Google and Tesla) and away from commodities.
In 2021, the top ten US market cap tech stocks collectively reached a ratio of 56 per cent enterprise value to US GDP, 87 per cent higher than the ratio was at the peak of the 2000 “Tech Bubble”. While this investor focus has shifted since the start of the US Fed rate hiking cycle, there remains historically high valuations in the tech sector, especially in relation to the (now high-yielding) resources market.
As indicated above, in the resources sector, capital has been redirected from fossil fuels into battery minerals. As shown in Figure 3 from Austex, gold and iron ore lost out to rare earths, lithium, uranium and copper as to which commodities ASX-listed resources companies were focused on. Attention on fossil fuels remains largely unchanged, perhaps reflecting a balance between record profits and investor aversion.
The resources market remains undervalued on a number of metrics and relativities, despite record profitability from the large players.
Nevertheless, different investor classes have begun to emerge to take advantage of strong structural outlook for many commodities due to long term underinvestment. We wait for North American appetite to re-ignite the resource equities market, which can be a strong and violent driver.