By Avinash Kalkerpersad and Arnold van Graan.
While no two cycles are the same, the one thing that stands out in this cycle is the sheer volatility. There have been massive moves daily, not just weekly, or monthly, which leaves analysts confused as to whether we are up or down. Another thing that stands out is the breakdown in several long-term metrics that are usually tracked.
There are certain factors that drive the metal price, but over the last few months, these seem to have fallen by the wayside. What is reflected in the market and on the ticker boards are not necessarily a reflection of what is happening in the fundamentals, which is challenging.
So, what is really driving this market? What are the factors one should look at to really understand where this is going and what will the new norms look like? This is quite challenging, but the cycle has been good to the sector with most resources going up sharply, gold being the standard – and that is key. It is the breakdown of fundamentals and the volatility that are the real challenges in this sector.
Gold has seen a 100% return, year-to-date compared to the All Share Index at -1%. The resource sector is up 18% which includes platinum, up by 13%. This indicates good performance. On a one-year basis, resources are up 34%, platinum is up 100%, gold is up by 140% and the All Share Index is up only 4%. Looking at it on a five-year basis is where the excitement around gold really is, with it being projected to go up by 580%, platinum up to 250% and resources in general up 75% compared to the All-Share index going up only 12%. This is the wonder of resources and mining. When you think it is down and out, you get a bull market. The uniqueness of this sector is that a big reset can occur and make up everything you have lost in the past few years within a few months.
The direction of this rally will be determined by two things – one being the outcome of Covid-19 and whether we will peak or see the second round of infections, the other being how much money central banks and governments will invest into the financial systems to boost the economy. These will be key drivers of commodity prices and their trajectory, gold included.
There are two important drivers of demand, one being China and the other being stimulus, and these are interlinked. Most of the metals produced both in Africa are consumed in China. The resource sector is greatly affected by the Chinese economy. With a strong rebound in China after the damage from their lockdown, it is net positive for the rest of us.
There are a lot of goods that are manufactured in China, which ends up being exported and consumed elsewhere. Close to 65% of PGMs are consumed in China. This is important for the PGM sector.
We are in a familiar situation which we saw at the end of the global financial crisis in 2008. A good way to get the economy going again is to get people to spend money and that comes down to stimulus and QE and the like. It will not only push money into the system but also revitalise it.
Approximately 70% of all PGMs produced go into the auto industry and the bulk of that goes directly into China. There was a decline in global vehicle sales pre-Covid-19 which raised questions around the long-term future of the industry. A major disruptor in the industry remains electric-powered vehicles and the impact it will have. This is made more relevant with Tesla’s increasing share prices. We need to answer the question of post-Covid-19 recovery and the future of electric vehicles. They go hand-in-hand. The recovery of the auto sector will depend on stimulus measures. We predict a strong recovery in global vehicle sales on the back of stimulus and continued growth out of the global auto sector.
There is an increasing need for private transport to avoid using public transport considering Covid-19. This is a positive for the auto sector in terms of a rebound. There is still the threat of electric vehicles on the horizon and we believe it is not a near threat – not within the next five years, at least. The transition to electric vehicles will be a long-term theme.
Pre-Covid-19, the PGM market looked good and prices were starting to increase due to a potential shortage of metal, because the industry had been under-capitalised. We have not built enough mines to sustain long-term demands. With the hard lockdown, we will see 15% of 2020’s production taken offline.
This is a positive, as you are losing supply when there is no demand. The shortages pre-Covid-19 will push through and continue. Platinum tends to be in oversupply, whereas palladium and rhodium will be in deep deficits for the foreseeable future. Our view is that we will see the substitution of palladium with platinum. If we look at it from a basket perspective, we do see these shortages.
Ultimately, we will be discussing the impacts of Covid-19 on the industry for much longer than it will be trending in the news. The ramp-up post-Covid-19 is deliberately slow with mining companies focusing on the health and safety of workers and not production. As a result, most mines only reached a somewhat steady state towards the end of July. Underground mines sit at 80% production levels due to social distancing, which results in delays and challenges getting some members back to work. There is always a risk of Covid-19 impacting production on the mines.
Since the 90s there has been a big push to expand offshore. This continued and we saw disinvestment by major listed produces, like Anglo Gold who recently sold their last operations in South Africa. In our research, we found that in the gold sector companies went offshore due to weak papers. But they did not have the buying power to purchase the best assets and ended up buying lower-tier assets in new jurisdictions, different from the mining methods they were used to. The sector spent a lot of money buying lower-tier assets but was not the best at running them, which resulted in a lot of value destruction in the process. While companies are becoming more prudent in their offshore expansions, we are not seeing major deals as we have in the past.
South African companies have become better international operators, not just in mining, but in other sectors too. A cautionary warning to offshore expansion would be to have a thorough understanding of the new jurisdiction, its legislature, its people and ensure you buy the best quality assets – not just buying assets for the sake of buying an asset offshore. This will be key.