Economic Resilience and Commodity Strength
By Clear Perspective Advisors on April 11, 2024
Energy and Metals Rally
Brent and WTI crude futures are at their highest levels since last October as supply constraints, tension in the Middle East and a strengthening economic outlook weigh on prices. It’s not just oil that has rallied to begin 2024: several commodities have hit recent highs amid a changing economic landscape. Gold is at an all-time high as investors gauge the Fed’s next move and conversations flare about inflation possibly reversing course. Gold is up 10% year-to-date, silver is at a three-year high, and not to mention cocoa, which is up 120% this year due to unfavorable weather conditions and disease in high production regions.
Beyond oil and gold, copper is at its highest level since June 2022, up nearly 15% in the last three months. Earlier this week, Bank of America upgraded Freeport-McMoRan (FCX) to a buy due to higher quality copper leverage, robust and rising free cash flow and exposure to gold revenue.[1] We own FCX as it is one of the world’s largest copper producers, which is a key component needed in energy transition, EVs and housing – three themes we have been highlighting and are positioned for.
The fluctuating Fed outlooks have brought increased uncertainty to markets, driving some investors to safe-haven assets like gold. Inflation has been sticky around 3%, but there is no doubting the great progress that has been made in bringing inflation down from 9% to 3%. With that said, there is still more work to do to bring inflation to the Fed’s 2% goal.
Chart 1: Commodities Have Outperformed the S&P 500 Thus Far in 2024[2]
Supply Constraints Push Oil Higher
Last week, OPEC+ opted to maintain its current production output, meaning the previous voluntary supply cuts of 2.2 million barrels per day will remain in place until at least the end of June. The decision was put in place last November, led by Saudi Arabia, as a way to support prices and stabilize the market. This is on top of the 3.66 million barrel per day cut agreed upon by the group in 2022, which is still in effect.
OPEC+ does not provide a target price level, but it is assumed a price closer to $90 is favored among the group. Brent crude has rallied from $73 a barrel in early December to over $90 a barrel as of last week. Higher demand going into the summer months may put pressure on prices and keep levels elevated.
Furthermore, Mexico released news last week stating its intentions to halt up to 436,000 barrels per day of crude exports over the coming months. Petroleos Mexicanos (Pemex) canceled contracts to supply Maya crude oil to the U.S., Europe and Asia as part of an effort to process more domestic oil at a new refinery ahead of the June 2 election.[3] This decision puts further pressure on already tight supply. J.P. Morgan strategist Natasha Kaneva said in late March that Brent crude could near $100 by September following Russian production cuts.[4]
U.S. Cancels Plans to Refill SPR
Tight supply and higher oil prices were also felt by the Biden Administration as it cancelled its plans last week to increase the Strategic Petroleum Reserve (SPR) due to elevated price levels. The Department of Energy said its decision not to purchase 3 million barrels for a SPR in Louisiana was in part due to keeping taxpayer’s interests in mind. The administration has done very little to replenish the SPR.
The administration drew down a record 180 million barrels following the Russia/Ukraine war and supply is currently at a 40-year low.[5] The SPR was created in the 1970s as a means to counter foreign oil supply disruption to the U.S. in times of turmoil. The Energy Department aims to increase the reserve at or below $79 per barrel, although its most recent purchase of 2.8 million barrels averaged $81 a barrel.[6]
Chart 2: U.S. SPR Crude Oil Reserves End March at 363 Million Barrels[7]
Robust Activity in the Energy Sector
Over the last few months, U.S. energy companies have sought to consolidate competition through acquisitions. Last Tuesday, Schlumberger NV (SLB) announced its plans to buy rival ChampionX (CHX) in a deal valued at $7.75 billion. The acquisition is expected to improve SLB’s operational abilities through providing production chemicals and artificial lift technologies to its portfolio of products. This marks the second acquisition for SLB in a little over a week following its recent acquisition of Norway’s Aker Carbon Capture for about $380 million.
Global deal values closed the first quarter up nearly 21% y/y at over $660 billion.[8] A better economic outlook, coupled with higher growth expectations and falling interest rates, has helped M&A activity bounce back from a few years of lower-than-average deal volume and size. There have been 10 announced deals this year valued at $10 billion or more, double the amount at the same time last year.7 With rate cuts on the horizon and growth expectations strong, it can be expected that M&A activity will continue to pick up momentum going forward.
Our portfolios are overweight energy, and we see the sector as a bright spot in an expanding economy with higher growth. Top producers and operators in the Permian Basin have shown strong growth, specifically Exxon Mobil (XOM), Chevron (CVX), Diamondback Energy (FANG) and Occidental Petroleum (OXY). Companies with greater diversification and international exposure include BP (BP), Shell (SHEL) and Schlumberger NV (SLB).
Gold Hits Record High
Gold and other precious metals have rallied in recent weeks on differing sentiment regarding the timing of central bank rate cuts across the globe. Gold was trading at $2,117 per ounce on March 26 and is up over 10% since then.[9] International political tensions and central bank buying can often bolster the demand for gold.
The U.S. leads all countries in total gold holdings with 70% of reserves, but other countries have been increasing their holdings over the past year as well. In 2023, China added more gold than any other central bank, adding 225 tons to its reserve, the highest increase since 1977.[10] In March, China’s central bank purchased gold for a 17th straight month, bringing its total reserve assets to the highest level since November 2015.[11] Central banks buy gold because it retains its value in periods of falling bond prices and volatile currency movement. It also provides diversification, liquidity and a store of value, among other things.
Gold has historically been an inflation-hedging asset that is used as a safe haven investment in times of uncertainty. Many Fed members last week referenced the idea that interest rates will likely remain higher than expected this year given the strength of the economy. Interest rate uncertainty has increased demand for gold. Importantly, as the U.S. debt-to-GDP ratio is above 120% with a continued fiscal deficit, gold is a way to diversify away from this risk.
Chart 3: Gold and Treasury Yields Have Historically Had an Inverse Relationship, Although Both Have Been Trending Higher Since Late 2022[12]
Looking back on previous easing cycles, gold has performed well following rate cuts. This is likely because the Fed lowers interest rates in times of economic stress to boost investment and spending – a situation that bodes well for gold. Also, lower risk-free rates and fixed income yields broadly mean the opportunity cost of holding gold is less. From mid-2007 to late 2009, gold returned +80%, and from early 2019 to late 2020, gold gained +50%.[13]
It is important to note that we do not expect any economic downturn or recession to take place during this cycle. Data has been pointing to an expanding economy with a tight job market and strong consumer. Gold is likely to continue to rally as long as rate cut timing remains uncertain.
Chart 4: Policy Easing Has Resulted in Higher Gold Prices[14]
Overall, cyclical sectors of the economy have seen a bounce following stronger-than-expected economic data. Energy has been the best performing sector year-to-date, up over 16%, with technology up 7%.[15] Higher growth expectations, along with the Fed likely keeping rates higher for longer, have pushed market yields higher. The economy is able to withstand higher rates, proven by the tight labor market, positive real wage growth, expanding ISM figures and overall consumer confidence and activity – all of which should lead to strong earnings ahead.
[1] Source: BusinessInsider. As of April 9, 2024.
[2] Source: FactSet. As of April 8, 2024.
[3] Source: Bloomberg. As of April 1, 2024.
[4] Source: Barron’s. As of April 8, 2024.
[5] Source: Bloomberg. As of April 2, 2024.
[6] Source: Bloomberg. As of April 8, 2024.
[7] Source: EIA. As of April 3, 2024.
[8] Source: Bloomberg. As of March 26, 2024.
[9] Source: FactSet. As of April 8, 2024.
[10] Source: Axios. As of January 31, 2024.
[11] Source: Bloomberg. As of April 7, 2024.
[12] Source: FactSet. As of April 8, 2024.
[13] Source: FactSet. As of April 8, 2024.
[14] Source: FactSet. As of April 9, 2024.
[15] Source: FactSet. As of April 8, 2024.
