The new year brought with it a new sense of investor optimism and purpose. Global equities were trading near all-time highs, and commodity sensitive metrics like Industrial Production, Fixed Asset Investment and the Manufacturing PMI were moving in the right direction. This optimism proved resilient in the early stages of the COVID-19 as the virus spread from Hubei province but appeared to be coming under control, and TOR Mining Capital was planning its public listing.
The past three months have proven this optimism to be misplaced. The global economy has dropped into a recession that will be as severe, if not more than the 2009 Global Financial Crisis. Fortunately, severity is one of few parallels. The root cause of the GFC was a huge, unaddressed expansion and misallocation of credit, the structural effects of which continue to stifle economic growth today. While COVID-19 has created more pervasive economic disruption through curtailing movement of workers, consumers and goods and services, there is an end point to the crisis if a vaccine is developed and widely distributed (an upside scenario is that this occurs rapidly). On the downside, prolonged shutdowns can reduce the productive capacity of the economy – capacity that can take some time to bring back. How likely or soon this might happen remains unclear and, sadly, further disruption within and between economies is almost certain before this point is reached.
The near-term threat posed by coronavirus has prompted a collective fiscal stimulus from governments around the world, focussed on supporting the incomes of millions of newly unemployed and moderating the impact of widespread business closures. Public infrastructure spending – the doyen of recession-busting packages of the past – is rightfully taking a back seat until control over the human cost can be established. Until then, the focus of government economic policy must be on managing the unintended consequences of preserving public health.
Commodity exporting countries face a series of challenges that will shape their own domestic economic policy responses. One of the limited benefits of restrictive civil liberties in many countries appears to have been the levers in place to contain the domestic spread of the virus. However, this can be offset in economic terms by the impact of falling prices, and revenue and capital outflows. Even prior to COVID-19, the collective impact of countries in financial distress such as Argentina and Turkey served as a greater drag on global growth than changes in US momentum. Capital flight from emerging markets has accelerated during the crisis, with US$83bn leaving emerging markets since the crisis started – the largest capital outflow ever recorded. This highlights the paramount importance of global coordination to maintain economic and financial stability.
Energy commodities, particularly oil, have experienced significant declines over the past month as the COVID-19 disruption married with Saudi-Russian price competition driving the price of Brent Crude down 53% in the month of March to reach US$23/bbl, a 17-year low. At least a tenth of global oil production is uneconomic at these prices and this proportion will increase as prices tumble further. Many US shale producers, facing breakeven prices in excess of US$45/bbl, will be forced to shut down production, especially in light of history being made of negative -US$37/bbl.
Industrial metal prices have also fallen over the last month. Copper is down 20%, nickel down 13% and zinc down 14%. The permanency of these declines will be tied to the duration of the crisis. A lot of metals are building surpluses due to demand weakness and supply growth. Previously strong physical fundamentals are being eroded with commodity exchange inventories growing rapidly. Copper has been supported by a future supply shortage outlook for a long time. Now that shortage narrative is changing. Surprisingly, the precious metals are also tanking. Big month declines for palladium (-38%), platinum (-35%) and silver (-30%). Only the classic ‘safe haven’ gold is doing ok, but still lost ground with a 6% price decline in the past month.
The fear is that this inventory overhang will extend the downturn and cap any price recovery.
The impact of COVID-19 on supply and production operations may partially offset downward pressure on commodity prices. Mines are typically in remote locations characterised by FIFO operations. This makes them highly vulnerable to a transportable and highly contagious virus like COVID-19. Efforts to contain the virus by restricting the flow of labour and transport will inevitably have a production impact, particularly for those commodities where supply is highly concentrated in a particular region and where transportation is a big part of the value chain like the bulk commodities.
Fears of reduced supplies of key commodities are growing due to measures to contain the virus at key mine operations across the globe. Several of the world’s biggest mining groups have announced delays to production and development projects because of travel and other restrictions imposed in response to the global pandemic.
We’ve seen that dynamic play out in Peru recently where production has come to a halt after the government declared a state of emergency. Bear in mind that Peru produces 12% of the world’s copper. Removing supply on this scale is likely to have a price impact.
Supply developments aside, the main challenge for commodities is lack of investor confidence. Until we see an end to panic selling in the markets, it’s hard to build a strong case for a commodity market recovery.
TOR Mining Capital will continually monitor the markets, however, as the ramifications of this unprecedented virus plays out, this could mean several years before liquid value can be delivered from the portfolio.