November 23, 2021

Rare Earths Lift Off
Driven by strong demand in the magnet market, prices for rare earths like neodymium and praseodymium have skyrocketed and achieved a position of relative strength among the metals in November. Lithium, meanwhile, is also still a strong performer along with nickel, thanks to growing electric vehicle (EV) battery demand and tight supplies. Rising “green technology” demand has further served to fuel the bull market in both metals.

Feature Story: Is Inflation Fully Priced into the Metals Market?

What happens when a financial market theme becomes so widely embraced by investors that almost no one questions it, and to do so is considered heretical?

Well, the contrarian principle informs us that when too many participants make bets based on the same underlying premise, it tends to backfire. For instance, if investors are overly optimistic or pessimistic, it can evoke a trend reversal since there’s not enough balance on both sides to sustain it.

Or to put it in the words of the famous market pundit, Joe Granville, “The obvious is obviously wrong!”

Last year, it was clear that inflation would be a problem going forward based on the massive amounts of federal stimulus and diminished production related to Covid lockdowns. What was surprising was the fact that many analysts dismissed the inflation threat posed by increased money creation and lower production (the basic ingredients of inflation).

By the beginning of 2021, everyone could see that inflation was in fact a real danger. Yet even then many pundits, including the Federal Reserve Chair, dismissed the threat as “transitory.” Now even those observers have changed their tune in recent months and the term “transitory inflation” has been replaced with a belief that inflation is here to stay for a while.

To illustrate just how ubiquitous inflation talk has become, take a look at the Google Trends graph below which shows interest in the word “inflation” as an internet search term. As you can see, inflation has been an increasingly hot topic in recent months and this trend shows no sign of abating.

Now that inflation has become the prevailing narrative in mainstream financial media, it’s time to ask a pertinent question: Have future inflation expectations already been fully priced into industrial metals prices (e.g. steel and aluminum)?

That question is even more imperative to ask when considering the steady strength in the U.S. dollar index (USD). The dollar’s rising value is a headwind for higher industrial metal prices—at least in the near term—and this has been made clear by the recent performance of two key manufacturing metals: aluminum is down 16% from this year’s high, while steel prices have lost an incredible 30%!

Most investors define inflation as the yearly percentage change of the Consumer Price Index (CPI), which gives an outsize importance to the prices that consumers pay for goods and services like food, transportation and medical care.

But in simple terms, inflation can be defined as “too much money chasing too few goods.” Put another way, inflation is what happens when the demand for goods and services exceeds the demand for money. Inflation is also typically characterized by persistently rising prices, wages and interest rates.

Looking at only retail prices, there’s no denying that rising living costs are a major issue right now. The 18-month U.S. national gasoline price average is $3.42/gallon, according to GasBuddy.com, the highest level since 2014 (but still under the $3.93 average price in 2012).

Food prices are also on the rise, with meat prices in particular “seriously out of hand” in the words of a recent Money magazine article. According to the Bureau of Labor Statistics, overall meat prices in October were up nearly 15% from the previous month, while bacon and beef are up 20% from a year ago.

However, the nominal rate of interest isn’t rising while the real rate of interest (defined as the difference between the nominal interest rate and the inflation rate) is actually negative (currently -1.10%). This tells us that the inflation we’re now experiencing isn’t classical inflation. Rather, it’s simply a case of rising commodity prices due to a combination of high central bank money printing and government spending levels, coupled with supply-chain problems.

If inflation was completely out of control, we should be seeing a weaker dollar. Instead, we find that the U.S. dollar index is showing some strength. Indeed, the stronger dollar tells us that the demand for money is still high enough to counteract some of those inflationary pressures and is also serving to keep inflation from spiraling out of control.

Another question that should be asked is whether it’s possible something could happen to (unexpectedly) reverse the trend of higher consumer prices. If so, it doesn’t take much imagination to guess what the catalyst might be, i.e. China’s debt crisis.

China’s largest real estate operator, Evergrande, creates nearly 4 million jobs each year. As many analysts have pointed out, should it collapse, it could create a crisis similar in magnitude to the Lehman Brothers collapse in the U.S. some 14 years ago. But the problem doesn’t stop with Evergrande. According to Liz Brumer-Smith of Motley Fool:

“Since 2013, China has used a unique system of local government financing vehicles (LGFVs) to help stimulate economic growth through infrastructure improvements. China doesn’t reveal much about its financial vulnerability, but estimates from Goldman Sachs show outstanding debts for LGFVs could be well over $8 trillion today and make up around 52% of the country’s GDP. Many of these LGFVs are considered risky and ‘weak,’ meaning in the event of collapse, far more than Evergrande’s indebtedness could be at risk.”

The growing fear of a China-led global crisis is likely one of the major catalysts behind the recent gold price rally, and this worry will likely provide a persistent supporting bid for gold in the coming weeks and months. But for the metals that depends more on manufacturing demand (like copper and steel), and the fear of a China crisis is already having a negative impact, as shown by recent price declines.

The weight of the evidence discussed here suggests that inflation has likely already been priced into the industrial metals market, at least from a 3-to-6-month perspective. Iron ore prices (which tend to lead benchmark steel prices) are especially telling us that metals price inflation has likely run its course for now. And until the dollar reverses its rising trend, inflation isn’t likely to be a major near-term driver for the metals.

What to Do Now
With our favorite gold-tracking ETF, the GraniteShares Gold Trust (BAR), showing signs of life last month, I recommended doing some nibbling in the event gold prices surge ahead in the coming weeks on mounting inflation fears. To that end, participants purchased a conservative position in BAR on October 13 using a level slightly under 17.35 as the initial stop-loss (intraday basis). I recommend raising the stop-loss to slightly under 17.75 in light of the recent rally. I also suggest taking partial profits if BAR reaches 19 (the June peak and a potential resistance level) in the coming days. HOLD

New Recommendations & Current Portfolio

Silver Remains Rangebound
Silver prices continue to tread water around the $25-an-ounce level, which is its highest price in almost four months. Silver made no new headway last week, declining modestly but remaining above its 25-day and 50-day trend lines.

There seems to be a consensus among market analysts that silver is being supported by worries that inflation will spiral out of control. And while global inflation rates are hitting their highest levels in 10 years (due to rising input costs and supply chain disruptions), the strong U.S. dollar is undermining inflation pressures for silver to a certain extent.

The net result of these conflicting factors has been a lateral trading range for silver between roughly the $22 and $26 levels over the last few months. Because of this, I’ve recommended that we remain content with our exposure to gold without taking on extra risk by purchasing a stake in a trendless silver market. I’m going to stand pat with that recommendation for now (though admittedly the silver market outlook could shift in the bulls’ favor if the dollar weakens).

On the demand side, silver stands to benefit from the increased embracement of “green” technology, including EVs and solar panels. Therefore, the green tech outlook will likely counteract at least some of silver’s headwinds from a strong dollar.

What to Do Now
I’m not currently recommending any new position in the iShares Silver Trust (SLV), our preferred silver-tracking vehicle. Although silver did close decisively above the 50-day moving average (which was needed to confirm a reversal of the intermediate-term downward trend in SLV), I’m going to play it conservative for now and stand pat with our gold ETF trading position. As previously noted, I’d like to see some additional firming up of the silver price before feeling comfortable enough to jump in again with both feet. WAIT

China’s Copper Supply Situation Tightens
Sometimes there’s a disparity between physical copper market fundamentals and the near-term performance of the leading copper mining stocks. Now appears to be one of those times.

Copper premiums in China have spiked to record highs over an administrative issue over value-added tax (VAT) on imports. The VAT issue is adding to an already tight supply situation as copper inventories in top consumer China are at their lowest levels in a decade.

The premium for physical copper over Shanghai Futures Exchange prices surged to 2,200 yuan ($344) a ton late last week, according to Reuters. This is an astounding 80% increase from the recent 7-year peak and the highest daily assessment since at least 2012.

Potentially adding more fuel to the fire is the decision by China’s customs regulators that it will temporarily stop issuing VAT invoices (reportedly to defer tax revenue into 2022). Analysts believe this could result in even tighter copper inventories.

Moreover, a recent spate of strong economic data out of the U.S., along with the passage of a major infrastructure bill, has given industry observers reasons for believing that copper demand will increase going forward.

An additional positive for the copper market is a recent remark from top miner BHP’s Chief Commercial Officer, Vandita Pant, which boosted sentiment. Pant stated that the global markets will need double the copper in the next 30 years “to facilitate a decarbonized world.”

Collectively, these factors suggest that copper prices could remain buoyant even while copper mining stock prices come down from recent highs (in an apparent profit-taking move among investors). For this reason, I’ve made some adjustments to our copper market portfolio, as discussed below.

Traders can purchase a conservative position in the United States Copper Index Fund (CPER) using a level slightly under 25.60 (the nearest pivotal low) as the initial stop-loss on an intraday basis. BUY A HALF

What to Do Now
We were stopped out of our trading position in Taseko Mines (TGB) after the stop-loss at slightly under 2 was violated last week on an intraday basis. SOLD

We were stopped out of our trading position in Teck Resources (TECK) after the stop-loss at slightly under 26 was violated last week. SOLD

A Weak Near-Term Steel Outlook
Steel futures prices are 25% below their May 11 record high, also plunging to their lowest levels since February 2020 last week. A combination of weaker demand globally and supply-chain bottlenecks contributed to the drop.

To begin with, steel use from top consumer China has drastically diminished as the nation’s real estate sector is facing major problems. Real estate-related construction accounts for around 40% of China’s overall steel consumption, and the Evergrande crisis has cut into this demand.

China’s real estate market has significantly contracted since May, with the latest data showing new construction starts falling 33% from a year ago in October. Meanwhile, overall investment by developers in projects decreased over 5%, according to Trading Economics.

China’s automobile market is also another key piece of the demand equation, and mainland auto sales fell for a sixth straight month in October. The weak showing was blamed on the continued global semiconductor shortage, but also on lower demand.

Also noteworthy is that top producer ArcelorMittal SA estimates China’s steel demand will contract slightly for full-year 2021. However, the company also estimates that demand outside China will increase 12% to 13%, led by the U.S., based on continued post-pandemic economic recovery.

Industry analysts also estimate that supply-chain difficulties, while hampering steel use to some extent this year, could result in pent-up demand for 2022.

While steel’s intermediate-term supply/demand picture looks promising, the near-term outlook is decidedly less sanguine. After steel prices in the U.S. soared to record levels earlier this year, foreign mills could afford to pay a 25% tariff and still profit. Since then, however, steel imports have surged and hot-rolled prices have fallen accordingly. The following graph illustrates the extent of the price decline in the fourth quarter, down almost 30% in just over a month.

According to industry intelligence provider, The Fabricator, “One-third of the service center and manufacturing executives polled last month said they are sitting on the sidelines waiting to see how prices play out before committing to purchases for inventory.”

Thus, the market remains in a state of limbo for now with the persistently strong dollar also serving as a near-term headwind. I accordingly recommend that we hold off on making any new commitments in steel-tracking ETFs and stocks for now.

What to Do Now
We were stopped out of our conservative trading position in Alliance Resource Partners (ARLP), a metallurgical coal mining complex operator, after our stop-loss slightly under 10.50 was violated on a closing basis. SOLD

Ryerson Holding (RYI) is a value-added distributor and processor of industrial metals, including stainless steel, aluminum, carbon and alloys. Most of its customers operate in the metals fabrication with exposure to electric vehicles, e-commerce logistics, automation and other industries. Aside from being an indirect play on the steel industry, Ryerson is also an infrastructure spending play. The company posted revenue of $1.6 billion in Q3, a 90% increase compared to the comparable 2020 quarter and up 14% sequentially. Per-share earnings of $3.25, meanwhile, beat the consensus by $1.50. Also in the third quarter, Ryerson achieved a record gross margin of 23% and announced a quarterly cash dividend increase to 9 cents per share. Investors purchased a conservative position in RYI on November 2, using a level slightly under 23 as the initial stop-loss on a closing basis. I recommend raising the stop to slightly under 24 after the latest rally (50-day moving average). BUY A HALF

Battery Demand Boosts Nickel
Strong battery market demand has kept nickel prices buoyant in recent months. Nickel futures have ranged between roughly $19,000 and $20,000 in the past month and are within reach of a 10-year high.

Industry members report “forced” spot buying due to hoarding of supplies ahead of what many expect will be another year of tight supplies and rising demand for the metal.

Production has declined since October after the Philippines (a top producer) entered its rainy season, curtailing production at some mining areas. Additionally, a power-rationing policy in some areas of the Philippines has impacted nickel production this fall.

According to SMM News, the smelting costs at ferronickel plants remain high amid increasing electricity prices, and those price increases have been passed down to the nickel ore end of the market. However, nickel ore prices are expected to remain stable, according to industry sources.

Further supporting a bullish intermediate-term outlook for nickel prices are LME warehouse inventories that have been depleted by 130,000 tons in the year to date. Combined exchange warehouse stocks, meanwhile, declined to around 144,000 tons, down 46% from the start of 2021.

What to Do Now
One way to have some exposure to nickel is through owning shares of Haynes International (HAYN), a leading developer and manufacturer of technically advanced nickel- and cobalt-based alloys used in corrosion-resistant and high-temperature applications (including aerospace, chemical processing, industrial gas turbines and other industries). Haynes’ stock price tends to track nickel prices (albeit loosely), but the firm is also involved with other metals, including chromium, molybdenum, tungsten, aluminum and titanium). In the fiscal fourth quarter, Haynes reported that revenue was up 8% sequentially and 19% from a year ago, while net income was $2.6 million, up substantially from a net loss of $5.7 million in last year’s Q4. Profitability is expanding and gross margin is exceeding pre-pandemic levels, prompting management to call for “significant growth” in volume and revenue in the coming year based on an increasing backlog and accelerating commercial build rate schedules in the aerospace industry. Wall Street expects 34% sales growth in fiscal Q1 2022 and 25% growth in Q2. A 2% dividend yield ties a nice bow on this package. Investors can purchase a conservative position in HAYN using an initial stop-loss slightly below the 41.35 level on a closing basis. BUY A HALF

Tin Hits Record High Amid Covid Threat
Shanghai tin prices recently hit record highs in the face of supply disruptions caused by China closing a port with Myanmar in response to a Covid outbreak.

China, the world’s top refined tin producer, relies on Myanmar for 82% of its tin concentrate imports. However, repeated pandemic-related disruptions this year have created problems with the tin supply chain.

Tin inventories in both LME and Shanghai warehouses have been hovering near multi-year lows levels, while tin prices have reached multi-year highs. (Tin is up 90% since the start of 2021, based on a trading contract that tracks the benchmark market for this metal.)

According to analysts at Jinrui Futures, several downstream soldering manufacturers are bullish on fourth-quarter tin demand, with consumption from the photovoltaic sector expected to be particularly strong.

What to Do Now
With tin remaining in a position of strength, I recently placed Alphamin Resources (AFMJF) on a buy. Mauritius-based Alphamin explores and develops mineral properties and is a low-cost producer of tin concentrate from its high-grade deposit, Mpama North, part of the Bisie Tin Project in the Democratic Republic of Congo. (Mpama North is the world’s highest-grade tin resource—about four times higher than most other operating tin mines in the world—allowing Alphamin to produce 3% of tin produced globally.) Alphamin also mines and sells tin from its North Kivu mine, producing nearly 10,000 tons of tin annually. While Alphamin is recognized as a promising tin producer, it flies largely under the radar among mining stock analysts right now. Total revenues for 2021 are projected to be around $310 million, up 66% from a year ago. Participants purchased conservative position in AFMJF on October 7 using a level slightly under 58 cents as the initial stop-loss. I also previously suggested taking a bit of profit earlier this month after the stock’s 21% rally and raising the stop to slightly under 65 cents. I now suggest further raising the stop to slightly under 72 cents (near the 50-day line). HOLD

Lithium Stays Strong on EV Outlook
2021 has been stellar for lithium, thanks to rising electric vehicle (EV) use and clean-energy demand. Prices have more than doubled this year, and a key lithium price index is up 225% in the year to date, according to data from Benchmark Mineral Intelligence. Lithium carbonate prices, meanwhile, have increased by more than 320% since the start of 2021.

What’s more, the recently passed U.S. infrastructure bill has earmarked nearly $8 billion for a nationwide network of EV chargers—a move that many expect will accelerate the adoption of EVs. This should further boost lithium demand in the coming years, which is expected to reach a million metric tons by 2025 and two million metric tons by 2030, according to S&P Global Platts.

Lithium supplies remain tight, which is serving to further exacerbate price increases. Lithium carbonate prices in China have just hit their highest levels ever on supply tightness and increasing automotive and battery-related demand.

Elsewhere, latest Wall Street analyst reports point to a continued bull market for the key battery metal. Fitch Solutions has increased its forecasts for lithium carbonate prices for the next five years in anticipation of higher EV sales and lithium battery use for portable electronic devices.

Analysts at Bank of America predict that EV battery supplies will be “sold out” by 2025 based on continued lithium supply problems. BofA further expects global battery shortages to increase heading into the period between 2026 to 2030 due to a continued global rise in EV demand, reflecting an “incrementally bullish” outlook for the industry.

What to Do Now
Livent Corp. (LTHM) is the largest U.S. lithium-only miner, providing a range of lithium-based products and serving the EV, chemical, aerospace and pharmaceutical industries. Revenue and earnings projections for Livent are strongly optimistic for the next several years, with analysts expecting top-line growth of 34% this year and around 20% next year, while earnings are projected to grow at an even faster pace. For Q3, Livent reported estimate-beating revenue of $104 million, an increase of 43% from a year ago. Management also increased full-year 2021 guidance ranges for both revenue (from a previous $380 million midpoint estimate to a $400 million midpoint estimate) and EBITDA (from $62 million to $70 million). The company also provided an update on its near-term capacity expansions, with the 5,000 metric ton hydroxide addition in Bessemer City and initial lithium carbonate expansion of 10,000 metric tons in Argentina expected to reach commercial production by the third quarter of 2022 and the first quarter of 2023, respectively. Additionally, its phase two carbonate expansion for an additional 10,000 metric tons is scheduled to be in commercial production by the end of 2023. Participants on October 13 bought a conservative position in LTHM using a level slightly under 22.25 as the initial stop-loss. After rallying 21% since then, I recommend taking some profit in LTHM and raising the stop-loss on the remaining position to slightly under 28 (near the 25-day trend line). HOLD

Magnet Market Elevates Rare Earths
Neodymium prices are up 68% for the year to date and up 150% from a year ago, driven by strong demand in the magnet and laser markets. Praseodymium prices, meanwhile, are up 185% from a year ago driven by demand from the magnet and colorant markets.

According to industry estimates, the global permanent magnet market is expected to grow from $34 billion in 2021 to $54 billion by 2026, for a compound annual growth rate of 10%. Neodymium in particular will be a key element of this market.

The neodymium market is benefiting from a number of trends, including the expanding growth of miniaturization in the electronics industry. For this reason, neodymium-based magnets are highly utilized as permanent magnets owing to the metal’s strong magnetic properties (in fact the strongest permanent magnet available today with maximum energy products).

Additionally, the exponential growth of cloud computing and related developments has resulted in the growing demand for data centers to store enormous amount of data. Data center demand for HDD computer storage means higher usage for permanent magnets. Neodymium and praseodymium magnets are also used in air conditioners, home appliances, cooling fan motors in computers, fans, microwaves and other electronic applications.

What to Do Now
Lynas Corp. (LYSCF) is a rare earth mining company based in Australia and boasting one of the highest-grade rare earth mines in the world. Lynas is also the only producer of scale of separated rare earths outside of China, and it also operates the world’s largest single rare earth’s processing plant (in Malaysia). Among the rare earth oxides it produces are neodymium and praseodymium (NdPr), lanthanum, cerium and other mixed heavy rare earths. With the global rare earth supply chain being threatened by mining bans around the world, Lynas is poised to benefit from increasing demand for the key industrial elements it mines (particularly those used in magnets). Despite Covid-related production setbacks, the company reported strong demand from the magnet market and increased pricing for NdPr in the first quarter of fiscal 2022. Average selling prices across all product categories was more than double year-ago levels, while revenue of $122 million was the highest quarterly result on record for Lynas (up 40% from a year ago). The company also reported that its customers expect strong rare earth materials demand for magnets to continue and accelerate in 2022. Participants recently bought a conservative position in LYSCF using a level slightly under 5.25 (near the 50-day line) as the initial stop-loss on a closing basis. BUY A HALF

Another Fund Disrupts the Uranium Market
Uranium prices exceeded $48 per pound last week, their highest level since October. Prices are also nearing a decade high of $51, last seen in September.

Analysts remains sanguine on the intermediate-to-long-term outlook for uranium on the back of clean fuel mandates from governments worldwide. Energy producers are also expected to decrease coal use after the recent COP26 deal in Glasgow.

Elsewhere, Bloomberg is reporting that China plans at least 150 new reactors in the next 15 years, more than the rest of the world has built in the past 35. The cost is estimated as high as $440 billion. By the middle of this decade, China will surpass the U.S. as the world’s largest generator of nuclear power, said Bloomberg.

Also contributing to market strength was the news that Kazatomprom, the world’s largest uranium miner, announced its intention to launch its own uranium fund in Kazakhstan, which would involve purchasing physical uranium (thus further contributing to tightening supplies). This came on the heels of the Sprott Physical Uranium Fund’s late October announcement that it bought 300,000 pounds of uranium, three days after buying 500,000 pounds.

Meanwhile, the World Nuclear Association has forecast that uranium demand will reach 206 million pounds by 2030, while supplies are expected to decline by 50% at that time due to a shortage of new mines.

What to Do Now
One uranium player showing promise from an intermediate-term standpoint is Denison Mines (DNN), a Canada-based uranium exploration, development and production company. Denison’s flagship project at Wheeler River, which has two high-grade uranium deposits, Phoenix and Gryphon. Phoenix is believed to possess the lowest production costs of any undeveloped uranium deposit, with all-in sustaining costs of $8.90 per pound (compared with current prices of around $32) and operating costs of just $3.33 per pound. All-in sustaining costs for Gryphon, meanwhile, are also a below-market $22.82 per pound, with a combined 109 pounds of probable reserves and a 14-year mine life. Additionally, Denison recently agreed to acquire a 50% stake in the JCU Exploration Company from UEX Corp. JCU holds a portfolio of twelve uranium project joint venture interests in Canada, and the acquisition is expected to allow Denison to not only increase its indirect ownership of its flagship Wheeler River project, but also to expand its asset base to include additional important Canadian uranium development projects such as Millennium and Kiggavik. Denison is admittedly speculative, but with physical uranium supplies getting tighter thanks to the recent decision of the world’s largest uranium producer, Kazatomprom, to limit production in 2022 and 2023—and with the Sprott Physical Uranium Trust gobbling up uranium on the spot market—the stock looks to be in a good position to continue a turnaround that began last year. In Q3, Dennison reported total revenue of C$9.5 million (up 248% from a year ago) on earnings of 4 cents, beating the consensus by 5 cents. Investors purchased a conservative position in DNN last month with a level around 1.40 as the initial stop-loss. After the recent 15% rally, I also advised taking some profit and raising the stop on the remaining position to slightly under 1.50 on a closing basis. HOLD

Current 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%.

The next Sector Xpress Gold & Metals Advisor issue will be published on December 14, 2021.