Chile

Highlights Over the short term – 1-2 years – the pick-up in re-infection rates in Asia and LatAm states with large-scale deployments of Sinopharm and Sinovac COVID-19 vaccines will re-focus attention on demand-side risks to the global recovery (Chart of the Week). The UAE-Saudi impasse re extending the return of additional volumes of OPEC 2.0 spare capacity to the oil market over 2H21 will be short-lived.  The UAE's official baseline production will be increased to 3.8mm b/d from 3.2mm b/d presently, and its output in 2H21 will be adjusted accordingly.  Over the medium term – 3-5 years out – the risk to the expansion of metal supplies needed for renewables and electric vehicles (EVs) will rise, as left-of-center governments increase taxes and royalties, and carbon prices move higher. Rising metals costs will redound to the benefit of oil and gas producers, and accelerate R+D in carbon- and GHG-reduction technologies. Longer-term – 5-10 years out – the active discouragement of investment in hydrocarbons will contribute to energy shortages. In anticipation of continued upside volatility in commodity prices and share values of oil, gas and metals producers, we remain long the S&P GSCI and COMT ETF, and long equities of producers and traders via the PICK ETF. Feature Our conversations with clients almost invariably leads us to considering the risks to our long-standing bullish views for energy and metals. This week, we reprise some of the highlights of these conversations. In the short term, our bullish call on oil is underpinned by the assumption of continued expansion in vaccinations, which we believe will lead to global economic re-opening and increased mobility, as the world emerges from the devastation of COVID-19. This expectation is once again under scrutiny. On the supply side, the very public negotiations undertaken by the UAE and the leaders of OPEC 2.0 – the Kingdom of Saudi Arabia (KSA) and Russia – over re-basing the UAE's production reminds investors there is substantial spare capacity from the coalition available for the market over the short term. The slow news cycle going into the US Independence Day holiday certainly was a fortuitous time to make such a point. Chart of the WeekWorrisome Uptick Of COVID-19 Cases KSA-UAE Supply-Side Worries The abrupt end to this week's OPEC 2.0 meeting was unsettling to markets. Shortly after the meeting ended – without being concluded – officials from the Biden administration in the US spoke with officials from KSA and the UAE, presumably to encourage resolution of outstanding issues and to get more oil into the market to keep crude oil prices below $80/bbl (Chart 2). We're confident the KSA-UAE impasse re extending the return of additional volumes of spare capacity to the oil market over 2H21 will be short-lived. The UAE's official baseline production number (i.e., its October 2018 output level) will be increased to 3.8mm b/d from 3.2mm b/d presently, and its output in 2H21 will be adjusted accordingly. Coupled with a likely return of Iranian export volumes in 4Q21, this will bring prices down into the mid- to high-$60/bbl range we are forecasting. Chart 2US Pushing For Resolution of KSA-UAE Spat Longer term, markets are worried this incident is a harbinger of a breakdown in OPEC 2.0's so-far-successful production-management strategy, which has lifted oil prices 200% since their March 2020 nadir. At present, the producer coalition has ~ 6-7mm b/d of spare capacity, which resulted from its strategy to keep the level of supply below demand. A breakdown in this discipline – in extremis, another price war of the sort seen in March 2020 or from 2014-2016 – could plunge oil markets into a price collapse that re-visits sub-$40/bbl levels. In our view, economics – specifically the cold economic reality of the price elasticity of supply – continues to work for the OPEC 2.0 coalition: Higher revenues are realized by members of the group as long as relatively small production cuts produce larger revenue gains – e.g., a 5% (or less) cut in production that produces a 20% (or more) increase in price trumps a 20% increase in production that reduces prices by 50%. Besides, none of the members of the coalition possess the wherewithal to endure another shock-and-awe display from KSA similar to the one following the breakdown of the March 2020 OPEC 2.0 meeting. We also continue to expect US shale-oil producers to be disciplined by capital markets, and to retain a focus on providing competitive returns to their shareholders, which will limit supply growth to that which maintains profitability. Until we see actual evidence of a breakdown in the coalition's willingness to maintain its production-management strategy, we will continue to assume it remains operative. Worrisome COVID-19 Re-Infection Trends Reports of increased re-infection rates in Latin American and Asia-Pacific states providing Chinese Sinopharm and Sinovac COVID-19 vaccines will re-focus attention on demand-side risks to the global recovery. Conclusive data on the efficacy of these vaccines is not available at present, based on reporting from Health Policy Watch (HPW).1 The vast majority of these vaccines were purchased in Latin America and the Asia-Pacific region, where ~ 80% of the 759mm doses of the two Chinese vaccines were sold, according to HPW's reporting. This will draw the attention of markets to this risk (Chart 3). Of particular concern are the increases in re-infection rates in the Seychelles and Chile, where the majority of populations in both countries were inoculated with one of the Chinese vaccines. Re-infections in Indonesia also are drawing attention, where more than 350 healthcare workers were re-infected after receiving the Sinovac vaccination.2 The risk of renewed global lockdowns remains small, but if these experiences are repeated globally with adverse health consequences, this assessment could be challenged. Chart 3COVID-19 Returning In High-Vaccination States Transition Risks To A Low-Carbon Economy Over the medium- to long-terms, our metals views are premised on the expectation the build-out of the global EV fleet and renewable electricity generation – including its supporting grids – will require massive increases in the supply of copper, aluminum, nickel, and tin, not to mention iron ore and steel. This surge in demand will be occurring as governments rush headlong into unplanned and unsynchronized wind-downs of investment in the hydrocarbon fuels that power modern economies.3 The big risk here is new metal supplies will not be delivered fast enough to build all of the renewable generation, EVs and their supporting grids and infrastructures to cover the loss of hydrocarbons phased out by policy, legal and boardroom challenges. Such a turn of events would re-invigorate oil and gas production. Renewable energy and electric vehicles are the sine qua non of the drive to achieve net-zero carbon emissions by 2050. However, the rising price of base metals will add to already high costs of rebuilding power grids to make them suitable for green energy. Given miners’ reluctance to invest in new mines, we do not expect metals prices to drop anytime soon. According to Wood Mackenzie, in 2019 the cost of shifting just the US power grid to renewable energy over the next 10 years will amount to $4.5 trillion.4 Given these cost and supply barriers, fossil fuels will need to be used for longer than the IEA outlined in its recent and controversial report on transitioning to a net-zero economy.5 To ensure that fossil fuels can be used while countries work to achieve their net zero goals, carbon capture utilization and storage (CCUS) technology will need to be developed and made cheaper. The main barrier to entry for CCUS technology is its high cost (Chart 4). However, like renewable energy, the more it is deployed and invested in, the cheaper it will become, following the trend seen in the development of renewable energy and EVs, which were aided by large-scale subsidies from governments to encourage the development of the technology. These cost reductions are already visible: In its 2019 report, the Global CCS Institute noted the cost of implementing CCS technology initially used in 2014 had fallen by 35% three years later. Chart 4CCUS Can Be Expensive Metals Mines' Long Lead Times In 2020 the total amount of discovered copper reserves in the world stood at ~ 870mm MT (Chart 5), according to the US Geological Service (USGS). As of 2017, the total identified and undiscovered amount of reserves was ~ 5.6 billion MT.6 The World Bank recently estimated additional demand for copper would amount to ~ 20mm MT p.a. by 2050 (Chart 6).7 Glencore’s recently retired CEO Ivan Glasenberg last month said that by 2050, miners will need to produce around 60mm MT p.a. of copper to keep up with demand for countries’ net zero initiatives.8 Even with this higher estimate, if miners focus on exploration and can tap into undiscovered reserves, supply will cover demand for the renewable energy buildout. Chart 5Copper Reserves Are Abundant Chart 6Call On Base Metals Supply Will Be Massive Out To 2050 While recent legislative developments in Chile and Peru, which together constitute ~ 34% of total discovered copper reserves, could lead to significantly higher costs as left-of-center governments re-write these states' constitutions, geological factors would not be the main constraint to copper supply for the renewables energy buildout: Even if copper mining companies were to move out of these two countries, there still is about 570 million MT in discovered copper reserves, and nearly ten times that amount in undiscovered reserves. As we have written in the past, capital expenditure restraint is the principal reason the supply side of copper markets – and base metals generally – is challenged (Chart 7). Unlike in the previous commodity boom, this time mining companies are focusing on providing returns to shareholders, instead of funding the development of new mines (Chart 8). Chart 7Copper Prices Remains Parsimonious Chart 8Shareholder Interests Predominate Metals Agendas Of course, it is likely metals miners, like oil producers, are waiting to see actual demand for copper and other base metals pick up before ramping capex. Sharp increases in forecasted demand is not compelling for miners, at this point. This means metals prices could stay elevated for an extended period, given the 10-15-year lead times for copper mines (Chart 9). For example, the Kamoa-Kakula mine in the Democratic Republic of Congo (DRC) now being brought on line took roughly 24 years of exploration and development work, before it started producing copper. Technological breakthroughs that increase brownfield projects’ productivity, or significant increases in the amount of recycled copper as a percent of total copper supply would address some of the price pressures arising from the long lead times associated with the development of new copper supply. Another scenario with a non-trivial probability that threatens the viability of metals investing is a breakthrough – or breakthroughs – in CCUS technology, which allows oil and gas producers to remove enough carbon from their fuels to allow firms using these fuels to achieve their net-zero carbon goals. Chart 9Long Lead Times For Mine Development Investment Implications Short-term supply-demand issues affecting the oil market at present are transitory, and do not signal a shift in the fundamentals supporting our bullish call on oil. Our thesis based on continued production discipline remains intact. That said, we will continue to subject it to rigorous scrutiny on a continual basis. Our average Brent forecast for 2021 remains $66.50/bbl, with 2H21 prices averaging $70/bbl. For 2022 and 2023 we continue to expect prices to average $74 and $81/bbl, respectively (Chart 10). WTI will trade $2-$3/bbl lower. Our metals view has become slightly more nuanced, thanks to our client conversations. One of the unintended consequences of the unplanned and uncoordinated rush to a net-zero carbon future will be an improvement in the competitive position of oil and gas as transportation fuels and electric-generation fuels going forward. This will be driven by rising costs of developing and delivering the metals supplies needed to effect the net-zero transition. We expect markets will provide incentives to CCUS technologies and efforts to decarbonize oil and gas fuels, which will contribute to the global effort to arrest rising temperatures. This suggests the rush to sell these assets – which is underway at present – could be premature.9 In the extreme, this could be a true counterbalance to the metals story, if it plays out. Chart 10Our Oil Price View Remains Intact     Robert P. Ryan Chief Commodity & Energy Strategist rryan@bcaresearch.com Ashwin Shyam Research Associate Commodity & Energy Strategy ashwin.shyam@bcaresearch.com   Commodities Round-Up Energy: Bullish The monthly OPEC 2.0 meeting ended without any action to increase monthly supplies, following the UAE's bid to increase its baseline reference production – determined based on October 2018 production levels – to 3.8mm b/d, up from 3.2mm b/d. S&P Global Platts reported the UAE's Energy Minister, Suhail al-Mazrouei, advanced a proposal to raise its monthly production level under the coalition's overall output deal, while KSA's energy minister, Prince Abdulaziz bin Salman, insisted the UAE follow OPEC 2.0 procedures in seeking an output increase. We do not expect this issue to become a protracted standoff between these states. The disagreement between the ministers is procedural to substantive. Remarks by bin Salman last month – to wit, KSA has a role in containing inflation globally – and his earlier assertions that production policy of OPEC 2.0 would be driven by actual oil demand, as opposed to forecasted oil demand, suggest the Kingdom is not aiming for higher oil prices per se. Base Metals: Bullish Spot benchmark iron ore (62 Fe) prices traded above $222/MT this week in China on the back of stronger steel demand, according to mining.com (Chart 11). Market participants are anticipating further steel-production restrictions and appear to be trying to get out in front of them. Precious Metals: Bullish The USD rally eased this week, allowing gold prices to stabilize following the June Federal Open Market Committee (FOMC) meeting. In the two weeks since the FOMC, our gold composite indicator shows that gold started entering oversold territory (Chart 12). We believe gold prices will start correcting upwards, expecting investor bargain-hunting to pick up after the price drop. The mixed US jobs report, which showed the unemployment rate ticked up more than expected, implies that interest rates are not going to be raised soon. Our colleagues at BCA Research's US Bond Strategy (USBS) expect rates to increase only by end-2022.10 This, along with slightly higher odds of a potential COVID-19 resurgence, will support gold prices in the near-term. Ags/Softs: Neutral The USDA's Crop Progress report for the week ended 4 July 2021 showed 64% of the US corn crop was in good to excellent condition, down from the 71% reported for the comparable 2020 date. The Department reported 59% of the bean crop was in good to excellent shape vs 71% the year earlier. Chart 11 Chart 12     Footnotes 1     Please see Are Chinese COVID Vaccines Underperforming? A Dearth of Real-Life Studies Leaves Unanswered Questions, published by Health Policy Watch, June 18, 2021. 2     According to HPW, the World Health Organization's Emergency Use Listing for these two vaccines "were unique in that unlike the Pfizer, AstraZeneca, Moderna, and Jonhson & Johonson vaccines that it had also approved, neither had undergone review and approval by a strict national or regional regulatory authority such as the US Food and Drug Administration or the European Medicines Agency. Nor have Phase 3 results of the Sinopharm and Sinovac trials been published in a peer-reviewed medical journal.  More to the point, post-approval, any large-scale tracking of the efficacy of the Sinovac and Sinopharm vaccine rollouts by WHO or national authorities seems to be missing." 3    Please see A Perfect Energy Storm On The Way, which we published on June 3, 2021 for additional discussion.  It is available at ces.bcaresearch.com. 4    Please refer to The Price of a Fully Renewable US Grid: $4.5 Trillion, published by greentechmedia 28 June 2019. 5    Please refer to the IEA's Net Zero By 2050, published in May 2021. 6    Please refer to USGS Mineral Commodity Summaries, 2021. 7     Please refer to Minerals for Climate Action: The Mineral Intensity of the Clean Energy Transition, published by the World Bank. 8    Please refer to Copper supply needs to double by 2050, Glencore CEO says, published by reuters.com on June 22, 2021. 9    Please see the FT's excellent coverage of this trend in A $140bn asset sale: the investors cashing in on Big Oil’s push to net zero published on July 6, 2021. 10   Please refer to Watch Employment, Not Inflation, published by the USBS on June 15, 2021.   Investment Views and Themes Strategic Recommendations Tactical Trades Commodity Prices and Plays Reference Table Trades Closed in 2021 Summary of Closed Trades

Highlights Political and corporate climate activism will increase the cost of developing the resources required to produce and deliver energy going forward – e.g., oil and gas wells; pipelines; copper mines, and refineries. Over the short run, the fastest way for investor-owned companies (IOCs) to address accelerated reductions in CO2 emissions imposed by courts and boards is to walk away from the assets producing them, which could be disruptive over the medium term. Longer term, state-owned companies (SOCs) not facing the constraints of IOCs likely will be required to provide an increasing share of the resources needed to produce and distribute energy. The real difficulty will come in the medium term. Capex for critical metals like copper languishes, just as the call on these metals steadily increases over the next 30 years (Chart of the Week). The evolution to a low-carbon future has not been thought through at the global policy level. A real strategy must address underinvestment in base metals and incentivize the development of technology via a carbon tax – not emissions trading schemes – so firms can innovate to avoid it. We remain long energy and metals exposures.1 Feature And you may ask yourself, "Well … how did I get here?" David Byrne, Once In A Lifetime Energy markets – broadly defined – are radically transforming from week to week. The latest iteration of these markets' evolution is catalyzed by climate activists, who are finding increasing success in court and on corporate boards – sometimes backed by major institutional investors – and forcing oil and gas producers to accelerate CO2 emission-reduction programs.2 Climate activists' arguments are finding increasing purchase because they have merit: Years of stiff-arming investors seeking clarity on the oil and gas producers' decarbonization agendas, coupled with a pronounced failure to provide returns in excess of their cost of capital, have given activists all of the ammo needed to argue their points. Chart of the WeekCall On Metals For Energy Will Increase This activism is not limited to the courts or boardrooms. Voters in democratic societies with contested elections also are seeking redress for failures of their governments to effectively channel mineral wealth back into society on an equitable basis, and to protect their environments and the habitats of indigenous populations. This voter activism is especially apparent in Chile and Peru, where elections and constitutional conventions likely will result in higher taxes and royalties on metals IOCs operating in these states, which will increase production costs and ultimately be passed on to consumers.3 These states account for ~ 40% of world copper output. IOCs Walk Away Earlier this week, Exxon walked away from an early-stage offshore oil development project in Ghana.4 This followed the unfavorable court rulings and boardroom setbacks experienced by Royal Dutch Shell, Chevron and Exxon recently (referenced in fn. 2). While the company had no comment on its abrupt departure, its action shows how IOCs can exercise their option to put a project back to its host government, thus illustrating one of the most readily available alternatives for energy IOCs to meet court- or board-mandated CO2 emissions targets. If these investments qualify as write-offs, the burden will be borne by taxpayers. As climate activism increases, state-owned companies (SOCs) not facing the constraints of IOCs likely will be required to provide an increasing share of the resources – particularly oil and gas – needed to produce and distribute energy going forward. This is not an unalloyed benefit, as the SOCs still face stranded-asset risks, if they invest in longer-lived assets that are obviated by a successful renewables + grid buildout globally. That is a cost that will have to be compensated, when the SOCs work up their capex allocations. Still, if legal and investor activism significantly accelerates IOCs' capex reductions in oil and gas projects, the SOCs – particularly those in OPEC 2.0 – will be able to expand their position as the dominant supplier in the global oil market, and could perhaps increase their influence on price levels and forward-curve dynamics (Chart 2).5 Chart 2OPEC 2.0s Could Expand If Investor Activism Increases Higher Call On Metals At present, there is a lot of talk about the need to invest in renewable electricity generation and the grid structure supporting it, but very little in the way of planning for this transition. Other than repeated assertions of its necessity, little is being said regarding how exactly this strategy will be executed given the magnitude of the supply increase in metals required. Nowhere is this more apparent than in the refined copper market, which has been in a physical deficit – i.e., production minus consumption is negative – for the last 6 years (Chart 3). Physical copper markets in China, which consumes more than 50% of refined output, remain extremely tight, as can be seen in the ongoing weakness of treating charges and refining charges (TC/RC) for the past year (Chart 4). These charges are inversely correlated to prices – when TC/RCs are low, it means there is surplus refining capacity for copper – unrefined metal is scarce, which drives down demand for these services. Chart 3Coppers Physical Deficit Likely Persist Chart 4Chinas Refined Copper Supply Remains TightTheoretically, high prices will incentivize higher levels of production. However, after the last decade’s ill-timed investment in new mine discoveries and expansions, mining companies have become more wary with their investments, and are using earnings to pay dividends and reduce debt. This leads us to believe that mining companies will not invest in new mine discoveries but will use capital expenditure to expand brownfield projects to meet rising demand. In the last decade, as copper demand rose, capex for copper rose from 2010-2012, and fell from 2013-2016 (Chart 5). During this time, the copper ore grade was on a declining trend. This implies that the new copper brought online was being mined from lower-grade ore, due to the expansion of existing projects(Chart 6). Chart 5Copper Capex Growth Remains Weak Chart 6Copper Ore-Quality Declines Persist Through Capex Cycle Capex directed at keeping ore production above consumption will not be sufficient to avoid major depletions of ore supplies beginning in 2024, according to Wood Mackenzie. The consultancy foresees a cumulative deficit of ~ 16mm MT by 2040. Plugging this gap will require $325-$500 billion of investment in the copper mining sector.6 The Case For A Carbon Tax The low-carbon future remains something of a will-o'-the-wisp – seen off in the future but not really developed in the present. Most striking in discussions of the low-carbon transition is the assumption of resource availability – particularly bases metals –in, e.g., the IEA's Net Zero by 2050, A Roadmap for the Global Energy Sector, published last month. In the IEA's document, further investment in hydrocarbons is not required beyond 2025. The copper, aluminum, steel, etc., required to build the generation and supporting grid infrastructure will be available and callable as needed to build all the renewable generation the world requires. The document is agnostic between carbon trading and carbon taxes as a way to price carbon and incentivize the technology that would allow firms and households to avoid a direct cost on carbon. A real strategy must address the fact that most of the world will continue to rely on fossil fuels for decades, as development goals are pursued. Underinvestment in base metals and its implications for the buildout of generation and grids has to be a priority if these assets are to be built. Given the 5-10-year lead times base metals mines require to come online, it is obvious that beyond the middle of this decade, the physical reality of demand exceeding supply will assert itself. A good start would be a global effort to impose and collect carbon taxes uniformly across states.7 This would need to be augmented with a carbon club, which restricts admission and trading privileges  to those states adopting such a scheme. Harmonizing the multiple emissions trading schemes worldwide will be a decades-long effort that is unlikely to succeed. Such schemes also can be gamed by larger players, producing pricing distortions. A hard and fast tax that is enforced in all of the members of such a carbon club would immediately focus attention on the technology required to avoid paying it – mobilizing capital, innovation and entrepreneurial drive to make it a reality. This would support carbon-capture, use and storage technologies as well, thus extending the life of existing energy resources as the next generation of metals-based resources is built out. In addition, a carbon tax raises revenue for governments, which can be used for a variety of public policies, including reducing other taxes to reduce the overall burden of taxation. Lastly, a tax eliminates the potential for short-term price volatility in the pricing of carbon – as long as households and firms know what confronts them they can plan around it.  Tax revenues also can be used to reduce the regressive nature of such levies. Investment Implications The lack of a coherent policy framework that addresses the very real constraints on the transition to a low-carbon economy makes the likelihood of a volatile, years-long evolution foreordained. We believe this will create numerous investment opportunities as underinvestment in hydrocarbons and base metals production predisposes oil, natural gas and base metals prices to move higher in the face of strong and rising demand. We remain long commodity index exposure – the S&P GSCI and GSCI Commodity Dynamic Roll Strategy ETF (COMT), which is optimized to take advantage of the most backwardated commodity forward curves in the index. These positions were up 5.3% and 7.2% since inception on December 7, 2017 and March 12, 2021, respectively, at Tuesday's close. We also remain long the MSCI Global Metals & Mining Producers ETF (PICK), which is up 33.9% since it was put on December 10, 2020. Expecting continued volatility in metals – copper in particular – we will look for opportunities to re-establish positions in COMEX/CME Copper after being stopped out with gains. A trailing stop was elected on our long Dec21 copper position established September 10, 2020, which was closed out with a 48.2% gain on May 21, 2021. Our long calendar 2022 vs short calendar 2023 COMEX copper backwardation trade established April 22, 2021, was closed out on May 20, 2021, leaving us with a return of 305%.   Robert P. Ryan Chief Commodity & Energy Strategist rryan@bcaresearch.com Ashwin Shyam Research Associate Commodity & Energy Strategy ashwin.shyam@bcaresearch.com   Commodities Round-Up Energy: Bullish OPEC 2.0 offered no surprises to markets this week, as it remained committed to returning just over 2mm b/d of production to the market over the May-July period, 70% of which comes from the Kingdom of Saudi Arabia (KSA), according to Platts. While Iran's return to the market is not a given in OPEC 2.0's geometry, we have given better than even odds it will return to the market beginning in 3Q21 and restore most of the 1.4mm b/d not being produced at present to the market over the course of the following year. OPEC itself expects demand to increase 6mm b/d this year, somewhat above our expectation of 5.3mm b/d. Stronger demand could raise Brent prices above our average $63/bbl forecast for this year (Chart 7). Brent was trading above $71/bbl as we went to press. Base Metals: Bullish BHP declared operations at its Escondida and Spence mines were running at normal rates despite a strike by some 200 operations specialists. BHP is employing so-called substitute workers to conduct operation, according to reuters.com, which also reported separate unions at both mines are considering strike actions in the near future. Precious Metals: Bullish The Fed’s reluctance to increase nominal interest rates despite indications of higher inflation will reduce real rates, which will support higher gold prices (Chart 8). We agree with our colleagues at BCA Research's US Bond Strategy that the Fed is waiting for the US labor market to reach levels consistent with its assessment of maximum employment before it makes its initial rate hike in this interest-rate cycle. Subsequent rate changes, however, will be based on realized inflation and inflation expectations. In our opinion, the Fed is following this ultra-accommodative monetary policy approach to break the US liquidity trap, brought about by a rise in precautionary savings due to the pandemic. In addition, we continue to expect USD weakness, which also will support gold and precious metals prices. We remain long gold, expecting prices to clear $2,000/oz this year. Ags/Softs: Neutral Corn prices fell more than 2% Wednesday, following the release of USDA estimates showing 95% of the corn crop was planted by 31 May 2021, well over the 87% five-year average. This was in line with expectations. However, the Department's assessment that 76% of the crop was in good-to-excellent condition exceeded market expectations. Chart 7 Chart 8 Footnotes 1     Please see Trade Tables below. 2     Please see OPEC, Russia seen gaining more power with Shell Dutch ruling and EXCLUSIVE BlackRock backs 3 dissidents to shake up Exxon board -sources published by reuters.com June 1, 2021 and May 25, 2021. 3    Please see Chile's govt in shock loss as voters pick independents to draft constitution published by reuters.com May 17, 2021, and Peru’s elite in panic at prospect of hard-left victory in presidential election published by ft.com June 1, 2021.  Peru has seen significant capital flight on the back of these fears.  See also Results from Chile’s May 2021 elections published by IHS Markit May 21, 2021 re a higher likelihood of tax increases for the mining sector.  The risk of nationalization is de minimis, according to IHS. 4    Please see Exxon walks away from stake in deepwater Ghana block published by worldoil.com June 1, 2021. 5    Please see OPEC 2.0's Production Strategy In Focus, which we published on May 20, 2021, for a recap our how we model OPEC 2.0's strategy.  It is available at ces.bcaresearch.com. 6    Please see Will a lack of supply growth come back to bite the copper industry?, published by Wood Mackenzie on March 23, 2021. 7     Please see The Challenges and Prospects for Carbon Pricing in Europe published by the Oxford Institute for Energy Studies last month for a discussion of carbon taxes vs. emissions trading schemes.     Investment Views and Themes Strategic Recommendations Tactical Trades Commodity Prices and Plays Reference Table Trades Closed in 2021 Summary of Closed Trades

Highlights China's high-profile jawboning draws attention to tightness in metals markets, and raises the odds the State Reserve Board (SRB) will release some of its massive copper and aluminum stockpiles in the near future. Over the medium- to long-term, the lack of major new greenfield capex raises red flags for the IEA's ambitious low-carbon pathway released last week, which foresees the need for a dramatic increase in renewable energy output and a halt in future oil and gas investment to achieve net-zero emissions by 2050. Copper demand is expected to exceed mined supply by 2028, according to an analysis by S&P, which, in line with our view, also sees refined-copper consumption exceeding production this year (Chart of the Week). A constitution re-write in Chile and elections in Peru threaten to usher in higher taxes and royalties on mining in these metals producers, placing future capex at risk. Chile's state-owned Codelco, the largest copper producer in the world, fears a bill to limit mining near glaciers could put as much as 40% of its copper production at risk. We remain bullish copper and look to get long on politically induced sell-offs as the USD weakens. Feature Politicians are inserting themselves in the metals markets' supply-demand evolutions to a greater degree than in the past, which is complicating the short- and medium-term analysis of prices. This adds to an already-difficult process of assessing markets, given the opacity of metals fundamentals – particularly inventories, which are notoriously difficult to assess. Chinese Communist Party (CCP) jawboning of market participants in iron ore, steel, copper and aluminum markets over the past two weeks has weakened prices, but, with the exception of steel rebar futures in Shanghai – down ~ 17% from recent highs, and now trading at ~ 4911 RMB/MT –  the other markets remain close to records.  Benchmark 62% Fe iron ore at the port of Tianjin was trading ~ 4% lower at $211/MT, while copper and aluminum were trading ~ 5.5% and 6.5% off their recent records at $4.535/lb and $2,350/MT, respectively. In addition to copper, aluminum markets are particularly tight (Chart 2). Jawboning aside, if fundamentals continue to keep prices elevated – or if we see a new leg up – China's high-profile jawboning could presage a release by the State Reserve Board (SRB) of some of its massive copper and aluminum stockpiles in the near term. In the case of copper, market guesses on the size of this stockpile are ~ 2mm to 2.7mm MT. On the aluminum side, Bloomberg reported CCP officials were considering the release of 500k MT to quell the market's demand for the metal. Chart of the WeekContinue Tightening In Copper Expected Chart 2Aluminum Remains Tight Brownfield Development Not Sufficient Our balances assessments continue to indicate key base metals markets are tight and will remain so over the short term (2-3 years). Economies ex-China are entering their post-COVID-19 recovery phase. This will be followed by higher demand from renewable generation and grid build-outs that will put them in direct competition with China for scarce metals supplies for decades to come. Markets will continue to tighten. In the bellwether copper market, we expect this tightness to remain a persistent feature of the market over the medium term – 3 to 5 years out – given the dearth of new supply coming to market. Copper prices are highly correlated with the other base metals (Chart 3) – the coefficient of correlation with the other base metals making up the LME's metals index is ~ 0.86 post-GFC – and provide a useful indicator of systematic trends in these markets. Chart 3Copper Correlation With LME Index Ex-Copper Copper ore quality has been falling for years, as miners focused on brownfield development to extend the life of mines (Chart 4). In Chart 5, we show the ratio of capex (in billion USD) to ore quality increases when capex growth is expanding faster than ore quality, and decreases when capex weakens and/or ore quality degradation is increasing. Chart 4Copper Capex, Ore Quality Declines Chart 5Capex-to-Ore-Quality Decline Set Market Up For Higher Prices Falling prices over the 2012-19 interval coincide with copper ore quality remaining on a downward trend, likely the result of previous higher prices that set off the capex boom pre-GFC. The lower prices favored brownfield over greenfield development. Goehring and Rozencwajg found in their analysis of 24 mines, about 80% of gross new reserves booked between 2001-2014 were due not to new mine discoveries but to companies reclassifying what was once considered to be waste-rock into minable reserves, lowering the cut-off grade for development.1 This is consistent with the most recent datapoints in Chart 5, due to falling ore grade values, as companies inject less capex into their operations and use it to expand on brownfield projects. Higher prices will be needed to incentivize more greenfield projects. A new report from S&P Global Market Intelligence shows copper reserves in the ground are falling along with new discoveries.2 According to the S&P analysts, copper demand is expected to exceed mined supply by 2028, which, in line with our view, sees refined-copper consumption exceeding production this year. Renewables Push At Risk Just last week, the IEA produced an ambitious and narrow path for governments to collectively reach a net-zero emissions (NZE) goal by 2050.3 Among its many recommendations, the IEA singled out the overhaul of the global electric grid, which will be required to accommodate the massive renewable-generation buildout the agency forecasts will be needed to achieve its NZE goals. The IEA forecasts annual investment in transmission and distribution grids will need to increase from $260 billion to $820 billion p.a. by 2030. This is easier said than done. Consider the build-out of China's grid, which is the largest grid in the world. To become carbon neutral by 2060, per its stated goals, investment in China’s grid and associated infrastructure is expected to approach ~ $900 billion, maybe more, over the next 5 years.4 The world’s largest fossil-fuel importer is looking to pivot away from coal and plans to more than double solar and wind power capacity to 1200 GW by 2030. Weening China off coal and rebuilding its grid to achieve these goals will be a herculean lift. It comes as no surprise that IEA member states have pushed back on the agency's NZE-by-2050 plan. This primarily is because of its requirement to completely halt fossil-fuel exploration and spending on new projects. Japan and Australia have pushed back against this plan, citing energy security concerns. Officials from both countries have stated that they will continue developing fossil fuel projects, as a back-up to renewables. Japan has been falling behind on renewable electricity generation (Chart 6). Expensive renewables and the unpopularity of nuclear fuel could make it harder for the world’s fifth largest fossil fuels consumer to move away from fossil fuels. Around the same time the IEA released its report, Australia committed $464 million to build a new gas-fired power station as a backup to renewables. Chart 6Japan Will Continue Building Fossil-Fuel Back-Up Generation Just days after the IEA report was published, the G7 nations agreed to stop overseas coal financing. This could have devastating effects for emerging and developing nations‘ electricity grids which are highly dependent on coal. In 2020 70% and 60% of India and China’s electricity respectively were produced by coal (Chart 7).5 Chart 7EM Economies Remain Reliant On Coal-Fired Generation Near-Term Copper Supply Risks Rise Even though inventories appear to be rebuilding, mounting political risks keep us bullish copper (Chart 8). Lawmakers in Chile and Peru are in the process of re-writing their constitutions to, among other things, raise royalties and taxes on mining activities in their respective countries. This could usher in higher taxes and royalties on mining for these metals producers, placing future capex at risk. In addition, Chile's state-owned Codelco, the largest copper producer in the world, fears a bill to limit mining near glaciers could put as much as 40% of its copper production at risk.6 None of these events is certain to occur. Peruvian elections, for one thing, are too close to call at this point, and Chile has a history of pro-business government. However, these are non-trivial odds – i.e., greater than Russian roulette odds of 1:6 – and if any or all of these outcomes are realized, higher costs in copper and lithium prices would result, and miners would have to pass those costs on to buyers. Bottom Line: We remain bullish base metals, especially copper. Another leg up in copper would pull base metals higher with it. We would look to get long on politically induced sell-offs, particularly with the USD weakening, as expected Chart 8Global Copper Inventories Rebuilding But Still Down Y/Y   Robert P. Ryan Chief Commodity & Energy Strategist rryan@bcaresearch.com Ashwin Shyam Research Associate Commodity & Energy Strategy ashwin.shyam@bcaresearch.com     Commodities Round-Up Energy: Bullish Next Tuesday's OPEC 2.0 meeting appears to be a fairly staid affair, with little of the drama attending previous gatherings. Russian minister Novak observed the coalition would be jointly "calculating the balances" when it meets, taking into account the likely official return of Iran as an exporter, according to reuters.com. We expect a mid-year deal on allowing Iran to return to resume exports under the nuclear deal abrogated by the Trump administration in 2019, and reckon Iran has ~ 1.5mm b/d of production it can bring back on line, which likely would return its crude oil production to something above 3.8mm b/d by year-end. We are maintaining our forecast for Brent to average $64.45/bbl in 2H21; $75 and $78/bbl, in 2022 and 2023, respectively. By end 2023, prices trade to $80/bbl. Our forecast is premised on a wider global recovery going into 2H21, and continued production discipline from OPEC 2.0 (Chart 9). Base Metals: Bullish Our stop-losses was elected on our long Dec21 copper position on May 21, which means we closed the position with 48.2% return. The stop loss on our long 2022 vs short 2023 COMEX copper futures backwardation recommendation also was elected on May 20, leaving us with a return of 305%. We will be looking for an opportunity to re-establish these positions. Precious Metals: Bullish We expect the collapse in bitcoin prices, the US Fed’s decision to not raise interest rates, and a weakening US dollar to keep gold prices well bid (Chart 10). China’s ban on cryptocurrency services and Musk’s acknowledgment of the energy intensity of Bitcoin mining sent Bitcoin prices crashing. The Fed’s decision to keep interest rates constant, despite rising inflation and inflation expectations will reduce the opportunity cost of holding gold. According to our colleagues at USBS, the Fed will make its first interest rate hike only after the US economy has reached "maximum employment". The Job Openings and Labor Turnover Survey reported that job openings rose nearly 8% in March to 8.1 million jobs, however, overall hiring was little changed, rising by less than 4% to 6 million. As prices in the US rise and the dollar depreciates, gold will be favored as a store of value. On the back of these factors, we expect gold to hit $2,000/oz. Ags/Softs: Neutral Corn futures were trading close to 20% below recent highs earlier in the week at ~ $6.27/bu, on the back of much faster-than-expected plantings. Chart 9 Chart 10     Footnotes 1     Please refer to Goehring & Rozencwajg’s Q1 2021 market commentary. 2     Please see Copper cupboard remains bare as discoveries dwindle — S&P study published by mining.com 20 May 2021. 3    Please see Net Zero by 2050 – A Roadmap for the Global Energy Sector, published by the IEA. 4    Please see China’s climate goal: Overhauling its electricity grid, published by Aljazeera.  5    We discuss this in detail in Surging Metals Prices And The Case For Carbon-Capture published 13 May 2021, and Renewables ESG Risks Grow With Demand, which was published 29 April 2021.  Both are available at ces.bcaresearch.com. 6    Please see A game of chicken is clouding tax debate in top copper nation, Fujimori looks to speed up projects to tap copper riches in Peru and Codelco says 40% of its copper output at risk if glacier bill passes published by mining.com 24, 23 and 20 May 2021, respectively.    Investment Views and Themes Strategic Recommendations Tactical Trades Commodity Prices and Plays Reference Table Trades Closed in 2021 Summary of Closed Trades

Highlights Political volatility and uncertainty have peaked for the time being, which should serve to reduce the equity risk premium in Chile. Chilean equities are cheap. We are upgrading Chilean stocks from underweight to overweight within an EM equity portfolio. The upside in local bond yields is limited. Fixed-income investors should favor Chilean domestic bonds and sovereign credit versus their EM counterparts. That said, the Chilean peso is at a risk of depreciation as copper prices drop in the coming months. Feature Chart 1Chilean Equities: Absolute And Relative Performance The failure of right-wing parties to win a one-third majority in last weekend’s Constitutional Assembly elections has produced a mini crash in the Chilean equity market. Interestingly, the equity index has relapsed from a major technical resistance (Chart 1). Such a configuration suggests that in absolute terms share prices could still have more downside as overall EM stocks continue to drop. Nevertheless, the underperformance of Chilean share prices against the EM equity benchmark is very late (Chart 1, bottom panel). Odds are that Chilean equities will outperform their EM peers in the next 6 to 12 months.  Critically, we view the results of Constitutional Assembly elections as generally positive for Chile. We are therefore upgrading our allocation on Chilean stock prices, local currency bonds and sovereign credit in their respective EM portfolios to overweight.   Equities Are Attractive Chilean share prices will outperform the EM equity benchmark due to a solid economic recovery and appealing valuations: Chile is running one of the most successful vaccination campaigns in the world, using both Chinese and Western vaccines. Only Israel is ahead of Chile in terms of fully vaccinated individuals as a share of the population (Chart 2). Chile is significantly ahead of the rest of Latin America. This will allow Chile to be one of the first countries in the world to achieve herd immunity and fully open its economy. Chile is one of the few EM economies to have a positive fiscal thrust this year (Chart 3). The government has augmented the COVID-19 relief package this year by an additional 2% of GDP, which will support domestic demand in the months ahead. Chart 2Chile is Among Leaders In Vaccinations Worldwide Chart 3Fiscal Thrust In Chile Is Much Better Than EM   Another government policy initiative to support income loss is allowing another round of withdrawal from private pension funds. This was approved earlier this month and withdrawals could amount to around 8% of GDP, propping up spending among low- and middle-income households.  Commercial banks are generally in a healthy position. Chart 4 shows that provisions have been rising steadily even though non-performing loans have plunged partly due to the government-mandated loan forbearance by banks. Equity valuations have been structurally cheapening for some time. The cyclically adjusted P/E ratio is below its historical mean (Chart 5, top panel). Relative to the EM benchmark, equity valuations are also very attractive (Chart 5, bottom panel). Chart 4Commercial Banks Are Healthy Chart 5Chilean Equities Are Cheap!   Meantime, the discount rate, used in stock valuation, will drop – due to a shrinking equity risk premium and a stable risk-free rate (government bond yields) – leading to higher share prices (please refer to the political analysis and the discussion about local rates below). Finally, the Chilean bourse is dominated by value stocks, particularly financials and consumer staples. As global value stocks outperform global growth/TMT stocks, Chile will outperform EM. Bottom Line: We recommend EM equity portfolios to upgrade Chilean stocks from underweight to overweight. Inflation Is Not A Matter Of Concern While US financial markets will likely be preoccupied by concerns about rising inflation and inflation expectations, consumer price inflation will not be a problem in Chile. Hence, the nation’s central bank will not be forced to hike interest rates earlier and more than is currently priced in by the fixed-income market. Consequently, the upside in local bond yields is limited. Chart 6 shows that three core measures of inflation are all in the lower range of the central bank’s target band. Corporate and consumer credit growth are extremely weak/contracting (Chart 7). It will take some time before improved confidence among businesses, consumers and bankers translates into high credit growth and strong domestic demand. Chart 6Inflation Is Low In Chile Chart 7Bank Credit Is Still Weak   Labor market slack has become enormous, which will cap wage inflation (Chart 8). In stark contrast to the US where job vacancies are at all-time highs, job vacancies in Chile have plummeted and remain extremely low (Chart 8, top panel). Employment is 9% below its pre-pandemic level and the unemployment rate is at 10% (Chart 8). Chart 8Chile: Labor Slack Is Enormous Chart 9The Yield Curve Is Already Steep   Due to the renewed harsh lockdown this year, the level of economic activity remains depressed. Unlike the US, it will require more time for the negative output gap to close, thereby reinforcing downward pressure on core inflation. Bottom Line: The central bank will keep the policy rate at the technical minimum of 0.5% for longer than the fixed-income market is pricing in now. Given that the yield curve is already very steep (Chart 9), we believe the upside in local long-term yields is limited from the current levels. BOX 1 Copper And Chilean Share Prices We expect copper prices to decline in the coming months due to the deceleration in China’s “old economy”. In the linked report titled The Dawn Of A Commodities Supercycle?, we argued that copper demand from the global green energy revolution is too small to offset China’s falling industrial demand for copper in the next 6-12 months. There is a close correlation between copper prices and Chilean share prices in absolute terms. The basis is that all EM markets and commodity prices often move in tandem. Nevertheless, there is no clear link between copper prices and Chile’s relative equity performance versus overall EM (Chart 10). Therefore, falling copper prices will not necessarily preclude Chilean equity outperformance versus the EM benchmark. The reasons why Chilean share prices did and could outperform the aggregate EM equity index (amid falling copper prices) are as follows: Unlike many other commodity-producing countries, Chile’s central bank has the ability to cut rates amid falling commodities prices and currency depreciation. This is due to structurally low inflation in Chile. Chart 11 shows that periods of a weakening peso have coincided with rate cuts. Chile’s capital spending in the broader economy does not swing with spot copper prices. Rather, investment expenditures are more sensitive to business confidence (Chart 12). The latter, and thereby capital spending, will recover as socio-political jitters subside and the economy reopens. Even though we expect copper prices to fall considerably over the next several months, average copper prices in the coming years will be above the levels of the last decade. Such is the structural importance of copper for global green energy/decarbonization efforts as discussed in our report titles The Dawn of A Commodities Supercycle? Copper prices have little effect on fiscal policy. While direct copper revenues (in the form of taxes) used to bring in up to 20% of total government revenues in 2007, today they only amount to 2.2%. This means that the government will not be forced to trim its spending in response to a decline in copper prices in the coming months. Chart 13 contends that government revenues do not correlate with copper prices. Further, Chile has amassed a countercyclical fund from copper revenues worth 3.4% of GDP, ready to be tapped into during periods of recession. There are no copper mining companies listed on the Chilean bourse. Codelco, the largest copper producer in the world, is a state-owned company, and BHP, who operates the largest copper mine in Chile, is listed in the Australian and US Stock Exchanges. The only mining company listed in the Chile MSCI index, Sociedad Quimica y Minera de Chile (SQM), accounts for 17.4% of the Chilean equity index. It mines cobalt and lithium but does not produce any copper. Chart 10There Is No Correlation Between Chile vs. EM Relative Stock Prices And Copper Chart 11The Chilean Central Bank Can Cut Rates Amid Currency Depreciation Chart 12Chile: Investment Expenditures Depend On Business Confidence Chart 13Copper Prices Do Not Drive Fiscal Revenues An Apex In Political Uncertainty? We believe that political volatility has peaked for the time being. Fears about a radical agenda being incorporated into the new constitution are overblown. Table 1Constituional Vote Resulted In A Fragmented Assembly Last weekend’s elections have produced a fragmented Assembly. Table 1 shows the distribution of seats among the new Constitutional Assembly. While the results were an upset for the governing right-wing coalition, the fragmented nature of the Assembly will make the passing of extreme proposals difficult. There will be significant steps taken to increase the size of state-led social programs, but not a complete overhaul of the free-market system. Our baseline scenario for the new constitution in Chile remains the same as that which we articulated in our December 5th, 2019 report. Most Chileans remain socially conservative and are in favor of minimal government intervention. However, they will favor higher public spending on education, pensions, unemployment benefits and healthcare. We therefore believe that the new constitution will pivot Chile’s social and economic model into more of a Welfare State (akin to Canada and Scandinavia) and not into a full-blown Socialist model. Subsequently, there have been economic concessions in the past year from the government and congress. The most notable are proposed reforms to increase state participation in private pension funds and legislation to increase royalties on copper mining companies. As the presidential and legislative elections are in November of this year, traditional center-right and center-left politicians will continue making conscious efforts to appease a wider swath of the population. Notably, President Piñera acknowledged the poor results for his right-wing coalition with a reconciliatory tone, stating that traditional parties must do more to listen to the demands of Chilean voters. Further, this weekend’s results were a clear win for many Chileans as they signified the rejection of traditional governing parties. This will quell political volatility for now. Finally, the voting mechanism for new constitutional amendments discourages radical legislation. In order to pass new articles in the constitution, proposals must be supported by over two thirds of all members of the Assembly. This will marginalize the most radical policies as the traditional center right and center left, as well as some independents, coalesce. Bottom Line: We infer that political volatility has peaked for the time being, which should serve to reduce the equity risk premium in Chile. Investment Recommendations Chart 14The Chilean Peso Is Not Cheap And Correlates With Copper Taken together, subsiding political risks, the successful national vaccination campaign and the full reopening of the economy as well as a positive fiscal thrust and lasting accommodative monetary policy point to Chilean equities and fixed-income markets that are set to outperform their EM counterparts. We have been underweighting Chilean equities within an EM equity portfolio but now are upgrading it to overweight. Local currency bonds offer good value. The lack of genuine inflationary pressures means that the central bank will stay put longer than the market is pricing in. A steep yield curve and historically attractive local bond yield spreads over the EM GBI benchmark lead us to recommend overweighting Chile in an EM domestic bond portfolio. As for sovereign credit, we are also upgrading it to overweight within an EM credit portfolio. Gross public debt remains at an incredible low of 32.5% of GDP. Political changes will not be extremely populist. Nevertheless, we will maintain our short CLP/long USD trade as a play on falling copper prices in the coming months. The Chilean peso is slightly expensive according to its Real Effective Exchange Rate (Chart 14, top panel). Unlike the Chilean bourse, the currency is highly correlated with copper prices (Chart 14, bottom panel).   Juan Egaña Research Analyst juane@bcaresearch.com Arthur Budaghyan Chief Emerging Markets Strategist arthurb@bcaresearch.com Footnotes

Highlights Rising CO2 emissions on the back of stronger global energy growth this year will keep energy markets focused on expanding ESG risks in the buildout of renewable generation via metals mining (Chart of the Week).   EM energy demand is expected to grow 3.4% this year vs. 2019 levels and will account for ~ 70% of global energy demand growth.  Demand in DM economies will fall 3% this year vs 2019 levels.  Overall, global demand is expected to recover all the ground lost to the COVID-19 pandemic, according to the IEA.  Rising energy demand will be met by higher fossil-fuel use, with coal demand increasing by more than total renewables generation this year and accounting for more than half of global energy demand growth. Demand for renewable power will increase by 8,300 TWh (8%) this year, the largest y/y increase recorded by the IEA.  As renewables generation is built out, demand for bulks (iron ore and steel) and base metals will increase.1  Building that new energy supply will contribute to rising CO2, particularly in the renewables' supply chains. Feature Energy demand will recover much of the ground lost to the COVID-19 pandemic last year, according to the IEA.2 Most of this is down to successful rollouts of vaccination programs in systemically important economies – e.g., China, the US and the UK – and the massive fiscal and monetary stimulus deployed to carry the global economy through the pandemic. The risk of further lockdowns and uncontrolled spread of variants of the virus remains high, but, at present, progress continues to be made and wider vaccine distribution can be expected. The IEA expects a global recovery in energy demand of 4.6% this year, which will put total demand at ~ 0.5% above 2019 levels. The global rebound will be led by EM economies, where demand is expected to grow 3.4% this year vs. 2019 levels and will account for ~ 70% of global energy demand growth. Energy demand in DM economies will fall 3% this year vs 2019 levels. Overall, global demand is expected to recover all the ground lost to the COVID-19 pandemic, according to the IEA. Chart of the WeekGlobal CO2 Emissions Will Rebound Post-COVID-19 Coal demand will lead the rebound in fossil-fuel use, which is expected to account for more than total renewables demand globally this year, covering more than half of global energy demand growth. This will push CO2 emissions up by 5% this year. Asia coal demand – led by China's and India's world-leading coal-plant buildout over the past 20 years – will account for 80% of world demand (Chart 2). Chart 2China, India Lead Coal-Fired Generation Buildout Demand for renewable power will post its biggest year-on-year gain on record, increasing by 8,300 TWh (8%) this year. This increase comes at the back of roughly a decade of an increasing share of electricity from renewables globally (Chart 3). As renewables generation is built out, demand for bulks (iron ore and steel) and base metals will increase.3 Building that new energy supply will contribute to rising CO2, particularly in the renewables' supply chains. Chart 3Share of Electricity From Renewables Has Been Increasing ESG Risks Increase With Renewables Buildout Governments have pledged to invest vast sums of money into the green energy transition, to reduce fossil fuels consumption and deforestation, thus curbing temperature increases. In addition, banks have pledged trillions will be made available to support the buildout of renewable technologies over the coming years. The World Bank, under the most ambitious scenarios considered (IEA ETP B2DS and IRENA REmap), projects that renewables, will make up approximately 90% of the installed electricity generation capacity up to 2050. This analysis excludes oil, biomass and tidal energy. (Chart 4). Building these renewable energy sources will be extremely mineral intensive (Chart 5). Chart 4Renewables Potential Is Huge … While we have highlighted issues such as a lack of mining capex and decreasing ore grades in past research – both of which can be addressed by higher metals and minerals prices – the environmental, social and governance (ESG) risks posed by mining are equally important factors for investors, policymakers and mining companies to consider.4 The mining industry generally uses three principal sources of energy for its operations – diesel fuel (mostly in moving mined ore down the supply chain for processing), grid electricity and explosives. Of these three, diesel and electricity consumption contributes substantially to mining’s GHG emissions. In the mining stage, land clearing, drilling, blasting, crushing and hauling require a considerable amount of energy, and hence emit the highest amounts of greenhouse gases (GHGs). Chart 5… As Are Its Mineral Requirements The Environmental Impact Of Mining Under the scenarios depicted in Chart 5, copper suppliers could be called on to produce approximately 21mm MT of the red metal annually between now and 2050, which is equivalent to a 7% annual increase of supplies vs. the 2017 reference year shown in the chart. Mining sufficient amounts of copper, a metal which is critical to the renewable energy buildout, both in terms of quantity and versatility, will test miners' and governments' ability to extract sufficient amounts of ore for further processing without massively damaging the environment or indigenous populations' habitats (Chart 6). Chart 6Copper Spans All Renewables Technologies A recent risk analysis of 308 undeveloped copper orebodies found that for 180 of the orebodies – roughly equivalent to 570mm MT of copper – ore-grade risk was characterized as moderate-to-high risk.5 High risk implies a lower concentration of metal in the ore deposits. Mining in ore bodies with lower copper grades will be more energy intensive, and thus will emit more greenhouse gases. Table 1 is a risk matrix of the 40 mines that have the most amount of copper tonnage in this analysis: 27 of these mines displayed in the matrix have a medium-to-high grade risk. Table 1Mining Risk Matrix Another analysis established a negative relationship between the ore-grade quality and energy consumption across mines for different metals and minerals.6 This paper found that, as ore grade depletes, the energy needed to extract it and send it along the supply chain for further processing is exponentially higher (Chart 7). Lastly, a recent examination found that in 2018, primary metals and mining accounted for approximately 10% of the total greenhouse gases. Using a case study of Chile, the world’s largest producer of the red metal, the researchers found that fuel consumption increased by 130% and electricity consumption per unit of mined copper increased by 32% from 2001 to 2017. This increase was primarily due to decreasing ore grades.7 As ore grades continue to fall, these exponential relationships likely will persist or become more significant. Chart 7Energy Use Rises As Ore Quality Falls Bottom Line: While technology can improve extraction, it cannot reduce the minimum energy required for the mining process. This increased energy use will contribute to the total amount of CO2 and other GHGs emitted in the process of extracting the ores required to realize a low-carbon future. Trade-Off Between CO2 Emissions And Economic Development A recent Reuters analysis highlights the gap between EM and DM from the perspective of their renewable energy transition priorities.8 Of the 17 UN Sustainable Development Goals (SDGs), “Taking action to combat climate change” takes precedence over the rest for DM economies. This is largely because they have already dealt with other energy and income intensive SDGs such as improvements in healthcare and poverty reduction. The large scale of unmet energy demand in developing countries poses a huge challenge to controlling CO2 emissions. The populations of these countries are growing fast and are projected to continue increasing over the next three decades. Rising populations, make the issue of a "green-energy transition" extremely dynamic – i.e., not only do EM economies need to replace existing fossil fuels, but they also need to add enough extra zero-emission fuel sources to meet the growth in energy demand. Bottom Line: Coupled with the increased amount of energy required to mine the same amount of metal (due to lower ore grades), rising energy demand resulting from a burgeoning population in EM economies - which use fossil fuels to meet their primary needs - will require more metals to be mined for the renewable energy transition. This will further increase the amount of carbon dioxide and other greenhouse gas emissions from mine activity, and increase the risk to indigenous populations living close-by to the sources of this new metals supply. ESG risks will increase as a result, presenting greater challenges to attracting funding to these efforts.   Ashwin Shyam Research Associate Commodity & Energy Strategy ashwin.shyam@bcaresearch.com Robert P. Ryan Chief Commodity & Energy Strategist rryan@bcaresearch.com   Commodities Round-Up Energy: Bullish OPEC 2.0 was expected to stick with its decision to return ~ 2mm b/d of supply to the market at its ministerial meeting Wednesday. Markets remain wary of demand slowing as COVID-19-induced lockdowns persist and case counts increase globally. The production being returned to market includes 1mm b/d of voluntary cuts by Saudi Arabia, which could, if needs be, keep barrels off the market if demand weakens. Base Metals: Bullish Front-month COMEX copper is holding above $4.50/lb, after breaching its 11-year high earlier this week. The proximate cause of the initial lift above that level was news of a strike by Chilean port workers on Monday protesting restrictions on early pension-fund drawdowns, according to mining.com. After a slight breather, prices returned to trading north of $4.50/lb by mid-week. Last week, we raised our Dec21 COMEX copper price forecast to $5.00/lb from $4.50/lb. Separately, high-grade iron ore (65% Fe) hit record highs, while the benchmark grade (62% Fe) traded above $190/MT earlier in the week on the back of lower-than-expected production by major suppliers and USD weakness. Steel futures on the Shanghai Futures Exchange hit another record as well, as strong demand and threats of mandated reductions in Chinese steel output to reduce pollution loom (Chart 8). Precious Metals: Bullish Rising COVID cases, especially in India, Brazil and Japan are increasing gold’s safe-haven appeal (Chart 9). The US CFTC, in its Commitment of Traders (COT) report for the week ending April 20, stated that speculators raised their COMEX gold bullish positions. At the end of the two-day FOMC meeting, the Fed decided against lifting interest rates and withdrawing support for the US economy. However, officials sounded more optimistic about the economy than they did in March. The decision did not give any sign interest rates would be lifted, or asset purchases would be tapered against the backdrop of a steadily improving economy.  Net, this could increase demand for gold, as inflationary pressures rise. As of Tuesday’s close, COMEX gold was trading at $1778/oz. Ags/Softs: Neutral Corn and bean futures settled down by mid-week after a sharp rally earlier. After rising to a new eight-year high just below $7/bushel due to cold weather in the US, and fears a lower harvest in Brazil will reduce global grain supplies, corn settled down to ~ $6.85/bu at mid-week trading. Beans traded above $15.50/bu earlier in the week, their highest since June 2014, and settled down to ~ $15.36/bu by mid-week. Attention remains focused on global supplies. The uptrend in grains and beans remains intact. Chart 8 Chart 9   Footnotes 1     Please see Renewables, China's FYP Underpin Metals Demand, published 26 November 2020, for further discussion.  It is available at ces.bcaresearch.com. 2     Please see Global Energy Review 2021, the IEA's Flagship report for April 2021. 3    Please see Renewables, China's FYP Underpin Metals Demand, published 26 November 2020, for further discussion.  It is available at ces.bcaresearch.com. 4    We discussed these capex issues in last week's research, Copper Headed Higher On Surge In Steel Prices, which is available at ces.bcaresearch.com. 5    Please see Valenta et al.’s ‘Re-thinking complex orebodies: Consequences for the future world supply of copper’ published in 2019 for this analysis. 6    Please see Calvo et. al.’s ‘Decreasing Ore Grades in Global Metallic Mining: A Theoretical Issue or a Global Reality?’ published in 2016 for this analysis. 7     Please see Azadi et. al.’s ‘Transparency on greenhouse gas emissions from mining to enable climate change mitigation’ published in 2020 for this analysis. 8    Please see John Kemp's Column: CO2 emission limits and economic development published 19 April 2021 by reuters.com.   Investment Views and Themes Strategic Recommendations Tactical Trades Commodity Prices and Plays Reference Table Trades Closed in 2021 Summary of Closed Trades

Highlights A Biden victory with a Republican Senate (28% odds) poses the greatest risk to the global reflation trade. The US is the most susceptible to social unrest of all the developed markets. Europe is stable relative to the US, but political risks are rising as new lockdowns go into effect. Emerging markets are also susceptible to social unrest – even those that look best on paper. Chile and Thailand have more downside due to politics, despite underlying advantages. Turkey and Nigeria are among those at risk of major unrest in a post-COVID world. Book gains on EUR-GBP volatility, Indian pharma, and rare earths. Cut losses. Feature This week saw a long-awaited risk-off move in global financial markets. A new wave of COVID lockdowns plus the US failure to pass a fiscal package finally registered with investors. Over the past two months we have argued that rising COVID cases without stimulus would produce a pre-election selloff that would drive the final nail in President Trump’s re-election bid. That should still be the case (Chart 1).  While we are sticking with our view that Biden will win, we have upgraded Trump’s odds from 35% to 45%. We are focused on Trump’s momentum – not alleged polling errors – in Florida and Pennsylvania, and Biden’s loss of altitude in Arizona, as these trends open a clear Electoral College path to another Trump victory (Chart 2). Nevertheless Biden is tied with Trump among men and leads by 17 percentage points among women. He is also in a statistical tie among the elderly.  Chart 1COVID Rising + Stimulus Falling = Red Ink Chart 2Trump's Momentum In Swing States   Even assuming Trump’s comeback proves too little, too late, it could produce a contested election in which Trump has constitutional advantages, or a Republican Senate. Either of these two scenarios would extend the election season volatility for one-to-three months. Our updated US election probabilities are shown in Table 1 alongside the odds from the popular online betting site PredictIt.org. Table 1There Is A 72% Chance The Post-Election Policy Setting Will Favor Reflation A Biden victory with a Republican Senate (28% odds) is the only deflationary scenario in the near term, since fiscal stimulus will be reduced in size and uncertain in timing. However, assuming financial market pressure forces senators to agree, this is actually the best outcome over the full two-year Senate election period, since neither tariffs nor corporate taxes would rise. Notably Treasury yields have risen regardless of election scenario, but there is little doubt that this scenario poses the greatest risk to the global reflation trade (Chart 3). Why does this election matter? Trump’s re-election would prolong US political polarization and “maximum pressure” foreign and trade policy. Trump must win through the constitutional system, not the popular vote, so a win would push polarization up. Polarization at home, including Democratic opposition in the House of Representatives, would drive him abroad. By contrast, a Biden win would include a popular majority and might include a united Democratic Congress, which would result in a clear popular mandate and would concentrate Biden's administration on an ambitious domestic agenda.   A Biden victory with a Republican Senate (28% odds) poses the greatest risk to the global reflation trade. Hence Trump’s election would bolster the USD and US equity outperformance, along with global policy uncertainty relative to the United States (Chart 4). Whereas Biden’s election, if it also brings a Democratic Senate, would bolster global equity outperformance, cyclical equities, and US policy uncertainty relative to global. Chart 3Republican Senate Less Reflationary Chart 4Trump Would Boost US Equity Outperformance   The election will have a geopolitical fallout. First, Trump is still president through January 20 regardless of outcome and could take aggressive actions to seal his legacy and lock the Biden administration into conflict with China or Iran. Second, a contested election would create a power vacuum in which other nations could seek to take advantage of American distraction. Third, a Trump victory spells strategic conflict with Iran and China, and either could try to seize the advantage by acting first. Fourth, a Biden win spells confrontation with Russia and ultimately China, and both countries would test his resolve early in his administration. Diagram 1 summarizes these key market takeaways of the US election scenarios. This week we provide our monthly GeoRisk Update with a special focus on our COVID-19 Social Unrest Index and implications for select developed, emerging, and frontier markets. Diagram 1Scenarios For US Election Outcomes And Market Impacts The United States The market can get hit by negative surprises after the US election just as easily as before.1 The US is a powder keg of social and political angst, ranking the worst among developed markets in our COVID-19 Social Unrest Index (Table 2). The lower a country ranks on the list, the less stable it is and the more susceptible to unrest. Social unrest becomes market-relevant if it weighs on consumer or business sentiment, or if it causes a major change in government or policy. Table 2The US Is The Developed Market Most Susceptible To Social Unrest The first US risk is a contested election. By rallying in the swing states in the final weeks of the election, Trump has increased the likelihood of a disputed outcome. Armies of lawyers will descend upon the swing state election boards. The Supreme Court’s intervention in Florida in 2000 has incentivized political parties to seek a judicial intervention, especially if they think they are losing the popular vote narrowly. Mail-in counts, recounts, and other disputes could push up against the December 14 Electoral College voting date. Worse, if the Electoral College is hung, the House of Representatives would have to decide the outcome in January. Volatility and risk-off sentiment would predominate. Emerging markets are showing the first signs of upheaval in the wake of this year’s crisis. The second risk is resistance to the election results. If Trump wins on a constitutional technicality, the country faces widespread unrest. This would be relevant to investors if it paralyzes major cities, exacerbates the COVID outbreak, or snowballs into something big enough to suppress consumer confidence. If Biden wins on a technicality, the country faces not widespread unrest but isolated pockets of potentially armed resistance or domestic terrorist attacks. The FBI, DHS, and recent news events have confirmed the presence of armed or violent extremist groups of various ideological stripes that pose a rising threat in the current climate of pandemic, unemployment, and polarization.2 They could strike any time after the election.     Europe And Brexit Chart 5European Lockdowns Push Up Political Risk Europe and Canada have reinstated lockdowns in response to their rise in COVID-19 cases. The surge in political risk is evident from our GeoRisk Indicators (Chart 5). These lockdowns will not be as draconian as earlier this year as the death rate has been found to be lower than once feared. While most governments have time on the political clock to take a hardline approach today, at the start of what could be a nasty winter season, they do not have so much leeway in 2021. Greece, Spain, Italy, the UK, and France are next in line for social unrest, after the US, in our index, Table 2 above. These countries are also vulnerable because fiscal support is not as robust as elsewhere, as can be seen by our global fiscal stimulus tracker (Chart 6). France is in better shape than the others and marks the dividing line – the 2017 election was a turning point in which the political establishment unified to defeat a right-wing populist challenge. President Emmanuel Macron’s popularity is holding up decently and it will now be buttressed by his tough stance against a spate of radical Islamist terrorist attacks. Extremist incidents will continue to be a problem, given the lockdowns and economic slump. Macron will focus on economic reflation in 2021 leading up to an election for which he is clearly favored in spring of 2022. Anything that derails his political trajectory before that time is of great importance for Europe’s political future, since Macron will be the de facto leader once Angela Merkel steps down in October 2022. Italy and Spain will be ongoing sources of political risk. Italy was the first major European hotspot of the pandemic, and euroskeptic attitudes are quietly ticking back up, but the ruling coalition and especially Prime Minister Giuseppe Conte have received popular backing for their handling of the crisis. Spain, on the other hand, has seen Prime Minister Pedro Sánchez lose support, while conservative parties tick up in popular opinion. These two countries are candidates for early elections when the hens come home to roost for the pandemic and recession (Chart 7). Chart 6More Stimulus Needed In Europe Chart 7Europe’s Leaders Fare Better Than Others   The other major countries with looming elections in 2021-22 are seeing relatively positive outcomes in popular opinion (e.g. the Netherlands, Germany). The exception is the UK, which is on the lower end of the social unrest index and is in the midst of internal disruption due to Brexit. Our assessment remains that Prime Minister Boris Johnson and the Tories will have to accept a trade deal with the EU over the next month (Chart 8). They can afford to leave on paper, but the economy would suffer and Scotland’s nationalists would be empowered to attempt secession. Our European Strategist Dhaval Joshi believes a Biden win in the US will hasten Johnson’s capitulation. We don’t expect much more upside in our GBP-EUR volatility trade after the US election result is known (Chart 9).  Chart 8Go Long Sterling Chart 9Close EUR-GBP Volatility Trade Chart 10Trump Would Weigh On Euro Trump’s re-election would be negative for the European Union’s economic and political stability (Chart 10). It would portend a greater trade war, Middle Eastern instability and refugees, Russian aggression, or European populism. By contrast, Biden will not use sweeping tariffs to resolve trade tensions, will seek to restore the 2015 nuclear deal with Iran, will suppress anti-establishment politics, will seek a multilateral approach to China trade tensions, and will only substantially aggravate the Europeans by being too aggressive on Russia. EM: Chile And Thailand Emerging markets are showing the first inevitable signs of upheaval in the wake of this year’s global crisis. What is critical to note about our Social Unrest Index for EM is that even if a country ranks high on the list overall, it could still face significant sociopolitical upheaval. This is manifest in the top-ranked countries of our list – Chile, Malaysia, Thailand, Russia, Indonesia – all of which have already seen some degree of social and/or political unrest in this crisis year (Table 3).  Table 3Even Emerging Markets That Look Good On Paper Are Susceptible To Unrest The best example is Chile, which is top-ranked in the index but ranks ninth in the “Household Grievances” column, which measures inequality, inflation, and unemployment. The latter measure helps explain how Chile erupted last fall and again this fall in mass protests. Chart 11Political Risk Weighs On Chile Over the past week Chileans voted overwhelmingly in a referendum to revise their constitution with a constitutional convention that will be elected, i.e. not overdetermined by current members of the National Congress. The constitutional revision process is ultimately a positive way for a country with good governance to assuage its household grievances. But the process will continue through a revision process in April 2021, the November 2021 general election, and a final referendum in 2022, ensuring that political risk persists. Chilean assets have fallen short of their expected performance based on global copper prices, suggesting that they have upside in the near term (Chart 11). Positive news is driven by macro fundamentals, including Chinese stimulus, but political risk will periodically put a cap on rallies by highlighting Chile’s transition to expansive social spending, higher debts, and hence future currency risk. Thailand’s case is different, as it is not household grievances per se but rather the ongoing governance problem that is triggering mass protests. The governance problem stems from regional disparities in wealth and representative government. Modern society and pro-growth populism have repeatedly clashed with the royalist political establishment and its military backers over the past 20 years and that process is set to continue. Chart 12Thailand Not Fully Pricing New Instability Cycle The newest round of the crisis will build for some years and ultimately culminate in some degree of bloodshed before a new political settlement is achieved. Typically, over the past 20 years, Thai political unrest creates a buying opportunity for investors. But the previous major wave of unrest, from 2006-14, occurred during the lead-up to the all-important royal succession. Now the succession is “over” and it is not clear that the new king, Vajiralongkorn, will live up to his father’s legacy as a successful arbiter of society’s conflicts. It is possible that he will overreact to domestic opposition and abuse his powers. Our Emerging Markets Strategy has downgraded Thailand in its portfolio, showing that the economy is suffering from insufficient stimulus as a negative credit impulse offsets public spending during the crisis. Thai equities do not offer relative value within the emerging market space at present (Chart 12). Most likely Thai political troubles will continue to provide a buying opportunity, but at the moment the risks are not sufficiently priced. If Chile, Malaysia, and Thailand are already experiencing significant political risk despite their high rankings on our index, then Brazil, South Africa, Turkey, and the Philippines face even greater challenges going forward. We have written about Brazil recently – we continue to see a rising political risk premium there (Chart 13). We will update our views on South Africa and the Philippines in forthcoming special reports. For now we turn to Turkey. Turkey: One Step Forward, Two Steps Back Turkey scores near the bottom of our Social Unrest Index. The regime of President Recep Tayyip Erdogan has been in power for nearly two decades, is suffering cracks in public support, is continuing to suffer the inflationary consequences of populist monetary and fiscal policy, and is embroiled in a range of international adventures and conflicts, now including Nagorno-Karabakh. After a brief pause of tensions in September, we argued that President Recep Tayyip Erdogan’s retreat would be temporary and that geopolitical tensions would re-escalate. They have done so even sooner than we thought. The lira is collapsing, as registered by our GeoRisk Indicator, which is once again on the rise (Chart 14). Chart 13Brazilian Political Risk Nearing 2018 Levels Chart 14Turkish Political Risk Spikes Anew   Relations with Europe have worsened significantly. Aggressive rhetoric between Erdogan and Macron in response to France’s treatment of French Muslims and handling of recent terrorist incidents has led to a diplomatic crisis: Paris recalled its ambassador. The episode highlights both Erdogan’s increased assertiveness vis-à-vis the EU as well as his Neo-Ottoman bid to become the leader of the Muslim world. Erdogan has called for a boycott of French goods (alongside similar popular calls in various Muslim countries). The European Commission warned Turkey could face punitive action at its December summit.   The feud in the eastern Mediterranean is also escalating. Turkey’s Oruc Reis seismic research vessel was once again sent out on an exploratory mission in contested waters on October 12. The mission’s duration was extended multiple times.    The EU may impose sanctions as early as December. Brussels' response to Turkish provocations may include targeted anti-dumping measures, likely on steel and fish. There have also been calls to suspend the customs union, but this would require the conflict to rise above rhetoric as it would harm EU investments in Turkey. Turkey is growing even more assertive in its neighborhood with its support for Azerbaijan in the conflict with Armenia. Tensions with Russia are rising yet again. Erdogan is already overextended in Syria and Libya, and recently threatened to launch a new military operation in northern Syria if Kurdish militants do not relocate from along Turkey’s border. The warning follows a Russian airstrike on Turkey-backed Syrian rebels in Idlib earlier this week – the deadliest strike in Idlib since March. Provoking the United States, Turkey also tested its newly purchased Russian S400 missile defense system on October 16. This was swiftly followed by US warnings that Turkey faces US sanctions under the Countering America’s Adversaries Through Sanctions Act if it operationalizes the system. The risk of punitive action would rise under a Biden presidency as he is more likely to adopt a tougher stance on Erdogan than President Trump. Chart 15More Downside For Turkish Lira These developments all point to a continuation in geopolitical tensions, as Erdogan flouts various risks and constraints. Turkey’s relationship with NATO allies is continuing to deteriorate meaningfully. The lira’s collapse is also in response to economic developments. After a surprise 200 basis points rate hike in September, the CBRT disappointed markets by keeping the benchmark 1 week repo rate on hold at its October 22 meeting. Investors had hoped that the September hike marked a reversal of Erdogan’s unorthodox policies. However, the October decision disconfirms this hope, as the central bank is instead opting for stealth measures to raise the cost of funding (e.g. limiting funding at the benchmark rate and thus forcing banks to borrow at higher costs; widening the interest rate corridor to give itself more room to raise the weighted average cost of funding). These decisions come amid rising inflation, debt monetization, a loss in foreign interest in Turkish equities and bonds, and deteriorating budget and current account balances. All point to further lira weakness (Chart 15). Bottom Line: The TRY faces downside pressure from the deteriorating geopolitical and economic backdrop. Although the EU has so far shown restraint in penalizing Ankara, its stance has not dissuaded Erdogan from adopting a provocative foreign policy stance. Moreover tensions with the US are at risk of escalating due to the possibility of a Biden presidency. Economic factors also point to continued weakness as monetary policy is too loose and the CBRT has not abandoned Erdoganomics. Nigeria: No Political Change Waves of protests have erupted across Nigeria in recent weeks, largely driven by the country’s youth. Protests center on calls to end the special anti-robbery squad (SARS), an arm of the national police service, which has long been accused of extrajudicial killings, torture, extortion, and corruption. Most recently, dozens of soldiers and police officers approached the scene of a major protest site in Lekki, a large district in Lagos, and opened fire, killing 12 people. The violence fueled outrage toward the government and security forces. To quell unrest, the government announced that SARS would be disbanded and promised a host of reforms. Demonstrators are skeptical of government promises without clearly specified timeframes. After all, previous incumbents have suggested police reform would be expedited. This has yet to happen, so we do not expect national policy to meet public demand. Moreover, President Buhari is a former military dictator who has maintained a hard line on security matters. He is in his final term in office and not legally required to step down until 2023. While discontent grows toward the government for social injustices, the Nigerian economy remains vulnerable and imbalanced. The local currency is facing considerable risk of major devaluation stemming from strains on its balance of payments, as BCA’s Emerging Markets Strategy pointed out in a recent report. Low oil prices and weak FDI inflows will foster various imbalances impeding the nation’s structural adjustments and its potential growth rate. The US election will act as a positive catalyst for markets in the short run as long as it produces a clear result and resolves the US fiscal stalemate. Nigeria’s current account excluding oil has been structurally wide, a sign of weak domestic productivity and an uncompetitive currency (Chart 16). Foreign currency reserves stand at $36bn, barely above foreign debt obligations at $28bn. FDI inflows have reached their second lowest point over the past decade, weighing on productivity growth, which is near 0%. A positive for Nigeria’s macro fundamentals is that public debt is low, at 23% of GDP, decreasing the likelihood of a sovereign default in the near term. Government officials refrained from large COVID fiscal relief, keeping spending in check. Coupled with low debt servicing costs, of which the foreign share only represents 2% of government revenues, a currency depreciation to improve competitiveness would not make public debt dynamics a concern. Nominal GDP is above short-term rates (Chart 17). Hence there is room for the currency to fall and government spending to pick up into next year to support the economy.  Chart 16Nigeria Struggles With Economic Rebalance Chart 17Nigeria Has Fiscal Firepower   In the post-dictatorship era, oil revenues knit the country’s predominantly Muslim north with its oil-rich and predominantly Christian south. The country has struggled to rebalance the economy in the wake of the 2014 oil shock. Crude production has fallen from over 2 million barrels per day to around 1.6 million bpd since 2010, and Nigeria struggles to meet its modest OPEC quotas. The current global crisis could have a negative long-term impact as rig counts have fallen again. We expect global oil demand to be supported in 2021, as lockdowns will be less stringent the second time and global fiscal stimulus will keep coming. And while Buhari’s age and poor health make him vulnerable, he is not without reserves of political strength. He is seen as someone who has kept up a good fight against the Islamist militant group Boko Haram. Considering that he is a northerner and a Muslim by faith, this strategy has helped ease sectarian tensions across the country, strengthening his grip. The problem is that the size of the global crisis could upset even the most stable of petro-states. Like most of sub-Saharan Africa, the youth population is large – the median age is around 18. If global oil demand relapses amid the second wave of the pandemic and a lack of domestic and global stimulus, the country will suffer yet another wave of unemployment. And if policy remains hawkish, sociopolitical troubles will be amplified.  Nigeria’s impact on global oil prices is limited – it only provides 2% of global oil supply – but it could become a contributor to rising unplanned outages if instability gets out of hand. Bottom Line: The SARS protests are not likely to threaten overall government stability, but mounting economic pressures could exacerbate social unrest, and the negative feedback with security forces. This could deliver a significant blow to the aging Buhari’s government if he does not enact expansionary fiscal policy to smooth out the external shocks. Investment Takeaways Chart 18Biden Good For Global Trade Rebound The US election will act as a positive catalyst for markets in the short run as long as it produces a clear result and resolves the US fiscal stalemate. But a contested election is not unlikely and a deflationary risk arises in the 28% chance that Biden wins while Republicans retain the Senate. Stimulus would still be agreed but its size and timing would be uncertain, prolonging the selloff. Therefore we are updating our portfolio to book some gains and cut some losses. We are booking gains on our EUR-GBP volatility trade for a return of 13%. We are closing our long Indian pharmaceuticals trade for a gain of 12%. We are throwing in the towel on our long defense and aerospace trade for a loss of 21%. And we are closing our rare earths basket trade for a gain of 5%. We are closing two pair trades and re-initiating them as absolute longs: long China Play Index relative to MSCI global stocks (0.1% return) and long ISE Cyber Security Index relative to the NASDAQ (-6.8%). Chinese reflation and global cyber-attacks will remain relevant themes.  The inverse of Trump, Biden is positive for the euro, negative for the dollar, and supportive of global trade. However, a range of higher taxes and levies on corporations suggests that his administration will ultimately weigh on S&P global stocks relative to those at home. And while Biden appears softer on China, we consider this a mispricing, as he has largely coopted Trump’s and Sanders’s trade agenda (Chart 18). Matt Gertken Vice President Geopolitical Strategy mattg@bcaresearch.com Roukaya Ibrahim Editor/Strategist Geopolitical Strategy RoukayaI@bcaresearch.com Guy Russell Research Analyst GuyR@bcaresearch.com Chart 19China: GeoRisk Indicator Chart 20Russia: GeoRisk Indicator Chart 21UK: GeoRisk Indicator Chart 22Germany: GeoRisk Indicator Chart 23France: GeoRisk Indicator Chart 24Italy: GeoRisk Indicator Chart 25Canada: GeoRisk Indicator Chart 26Spain: GeoRisk Indicator Chart 27Taiwan: GeoRisk Indicator Chart 28Korea: GeoRisk Indicator Chart 29Turkey: GeoRisk Indicator Chart 30Brazil: GeoRisk Indicator   Geopolitical Calendar Footnotes 1  There have been strange warnings in recent days – an unidentified aircraft intercepted over a Trump rally in Arizona, a Saudi warning of a potential Houthi attack on Americans, and a Chinese warning of a potential US drone attack against Chinese assets in the South China Sea. None of these have amounted to anything, and the idea of a US drone attack on China is absurd, but investors should be cautious nonetheless, particularly because a range of state and non-state actors will have an incentive to take actions once the US outcome is known. 2  Please see FBI Director Christopher Wray, “Statement Before The House Homeland Security Committee,” Washington DC, September 17, 2020, fbi.gov; Department of Homeland Security, “Homeland Threat Assessment,” October 2020, dhs.gov; Tresa Baldas and Paul Egan, “More details emerge in plot to kidnap Michigan Gov. Whitmer as suspects appear in court,” USA Today, October 13, 2020, usatoday.com.   

Special Report

Highlights Latin America faces a deep economic contraction and a new surge of social unrest and political unrest. However, the risks are increasingly priced into financial markets – especially if global monetary and fiscal stimulus continue. A looming global cyclical upturn, massive US and Chinese stimulus, a weaker dollar, and rising commodity prices will lift Latin American currencies and assets. Mexico faces lower trade risk and lower political risk. Colombia’s fundamentals are sound and political risk is contained. Chile’s political risk is significant but will benefit from the macro backdrop. Brazil will remain volatile. We are bearish on Argentina. Venezuela’s regime will be replaced before long. Our tactical positioning is defensive on COVID-19 and US political risk, but we see Latin America as an opportunity over the long run. Feature Cracks in the edifice of this year’s global stock market recovery are emerging with COVID-19 cases rebounding and US political risks rising. Emerging markets that rallied earlier this year have fallen back. This includes Latin America, where the pandemic’s per capita death toll is comparable only to Europe and the United States (Chart 1). Latin America is a risky region for investors because the past decade was a lost decade, particularly after the commodity bust in 2014. Poor macro fundamentals, deep household grievances, heavy dependency on commodity prices, and preexisting political polarization and social unrest have weighed on the region’s currencies and government bonds. Latin American equities have underperformed emerging markets over the period (Chart 2). Chart 1Pandemic Adds To Latin America’s Many Woes Chart 2Global Reflation Needed For LATAM To Outperform Looking beyond near-term risks, however, global economic recovery and gargantuan monetary and fiscal stimulus hold out the prospect of a sustained recovery in growth and trade, a weakening US dollar, and a boost to commodity prices (Chart 3). This outlook is favorable for Latin American economies and companies. Chart 3Global Stimulus Keeps Up Commodity Prices In this report, we analyze the coronavirus outbreak and its likely political impact in six Latin American markets: Argentina, Brazil, Colombia, Chile, and Mexico. The crisis is exacerbating the region’s longstanding problems and freezing attempts at supply-side reforms. However, a lot of political risk is already priced, particularly in Mexico and Colombia. Bullish Mexico: Trade War And Leftism Already Peaked As it stands, Mexico has over 740,000 confirmed cases and over 77,000 deaths, with new cases increasing daily (Chart 4). Testing occurs at a rate of 15,300 tests per 1 million people, one of the lowest rates of any major country. Hence the true number of cases is likely well higher than the official count. The health care system is overwhelmed. Chart 4Mexico Not Too Bad On Virus Death Toll The crisis has been a rude awakening for President Andrés Manuel López Obrador (AMLO), but we see Mexico as an investment opportunity rather than a risk. Chart 5Mexico: Left-Wing Unlikely To Outdo 2018 Win AMLO and his National Regeneration Movement (MORENA) swept to power in 2018 as champions of the poor fed up with the country’s corrupt political establishment. Two tailwinds fueled MORENA’s rise: First, the failure of Mexico’s ruling elites. The 2008 financial crisis knocked one of the dominant parties out of power, while the brief comeback of the traditional ruling party (the Institutional Revolutionary Party or PRI) faltered amid the slow-burn recovery of the 2010s. Second, AMLO’s victory was an answer to the populist and protectionist turn in the United States under President Trump, who had vowed to build a wall and make Mexico pay for it as well as to renegotiate NAFTA to be more favorable to the United States. Mexicans voted to fight fire with fire. Neo-liberalism and supply-side structural reform seemed discredited in a blaze of Yankee imperialism and AMLO and his movement offered the only viable alternative. AMLO became Mexico’s first left-wing populist president in recent memory, while MORENA won an outright majority in the Senate and, with its coalition partners, a three-fifths majority in the Chamber of Deputies (Chart 5). From this back story it is clear that investors interested in Mexican assets faced two primary structural risks: (1) a left-wing “revolution,” given AMLO’s lack of legislative roadblocks (2) American protectionism. About 29% of Mexico’s GDP consists of exports to the US (Chart 6). Chart 6Mexico Will Benefit From US Mega-Stimulus Investors took these risks seriously, judging by the relative performance of Mexican energy and industrial equities (Chart 7). Trade war threatened exporters while AMLO aimed to revitalize the moribund state-owned energy company at the expense of foreign investors admitted by his predecessor’s structural reforms Chart 7Investors DisappointedAfter AMLO Election Rally However, the left-wing revolution threat was always overstated: Mexico has become the largest fiscal hawk in the region under AMLO. Moreover, monetary policy had remained overly tight before the pandemic. Indeed, AMLO’s track record as mayor of Mexico City in the early 2000s showed his penchant for fiscal frugality. His left-wing policies have been focused on reviving the state-owned oil company PEMEX and increasing signature social programs, which have been funded by slashing other government expenditures, even during the COVID-19 outbreak. Going forward, Mexico’s orthodox economic policy is a major positive relative to emerging markets with out-of-control debt dynamics, often exacerbated by populist leaders, such as Brazil (Chart 8). MORENA will face greater constraints going forward. AMLO’s approval rating has normalized at around 60%, roughly the average for Mexican presidents (Chart 9). MORENA’s support rate has fallen from 45% to below 20%. With midterm elections looming in July 2021, MORENA is unlikely to outperform its 2018 landslide. So while AMLO will win his proposed 2021 presidential “referendum,” he will do so with a smaller share of the vote and a weakened parliament. Reality has set in for Mexico’s new ruling party. Chart 8Mexico’s Low Debts A Boon Chart 9AMLO’s Approval Rating Solid, But Normalizing AMLO and MORENA are likely to be chastened but not to fall from power, which means there is unlikely to be a wholesale reversal in national policy. The crisis has killed AMLO’s honeymoon but not his presidency. He still has 60% approval and his term in office lasts until 2024. The main opposition parties are still floundering (Chart 10). The creation of six new parties since 2018 will help MORENA either by adding to its coalition or taking votes away from the opposition. US fiscal stimulus and shift away from China benefit Mexico over the long run. Second, we now know that the US protectionist threat was also overstated: President Trump’s first term demonstrates that even if the US elects a populist and protectionist president who pledges to take an aggressive approach toward Mexico, the ties that bind the two countries will not be easily broken. One of the few times Senate Republicans openly defied President Trump was their refusal in June 2019 to allow sweeping 5%-25% unilateral tariff rates on Mexican imports. Hence even if Trump wins and the GOP retains the Senate, Mexico has some safeguards here. Trump would also be constrained by House Democrats on the issue of building a border wall and reforming the US immigration system. AMLO visited Trump in Washington to sign the USMCA ahead of the election. The trade deal is part of Trump’s legacy so Trump is more likely to attack other trade surplus countries than Mexico. Former Vice President Joe Biden and the Democratic Party are more likely to win the US election. In that case, US policy toward Mexico will turn more dovish. House Democrats helped negotiate the USMCA deal and voted to pass it. Biden is unlikely to impose large tariffs on Mexico. It is still possible that US-Mexico tensions will reignite later, if immigration swells under Biden, but the latter is not guaranteed. Two additional macro and geopolitical factors also play to Mexico’s favor over the long run: First, the US’s profligate fiscal policy will benefit its neighbor and trading partner. Massive American monetary and fiscal stimulus – about to receive another dollop of around $2-$2.5 trillion in new spending – will total upwards of 20% of US GDP in 2020 (Chart 11). This is especially likely in the event of a Democratic clean sweep. Yet Democrats are likely to retain the House, preventing Republicans from slashing spending too much even if they convince Trump to adopt their fiscal hawkishness in any second term. Chart 10MORENA’s Approval Comes Down To Earth Chart 11Mexican Exports Will Benefit From US Stimulus Chart 12US Leaving China Will Boost Mexico Industrialization Second, the US is leading a global movement to diversify supply chains away from China. This shift is rooted in US grand strategy and began under the Obama administration, and it is highly likely to continue whether Trump or Biden wins. A Biden victory will result in a more multilateral approach that is more beneficial for global trade, but still penalizes China – which is good for Mexico. No country has suffered a greater opportunity cost from China’s industrialization than Mexico (Chart 12). Both Biden and Trump are advertising a policy of on-shoring that will, in effect, benefit US trading partners ex-China. US current account deficits stem from its domestic savings-investment balance and therefore will persist even if China is cut out, driving production elsewhere. Bottom Line: We are optimistic about Mexico. Trade risk from the US is unlikely to rise higher than during 2017-19, while legislative hurdles facing AMLO and MORENA cannot get much lower than they are today. The currency is fairly valued and equities are not too pricey. Gargantuan US stimulus and a shift away from China dependency will boost growth and investment in Mexico. We will look for opportunities to go long the Mexican peso and assets. Volatile Brazil: Fiscal Restraint Is Gone While much of the world is focused on a second wave of Covid-19, Brazil has struggled to hurdle its first. The country has over 4.8 million confirmed cases (23 000 cases per 1 million people), and 143,000 deaths, second only to the United States. Coronavirus testing in Brazil stands at 73,900 tests per 1 million people, i.e. higher than Mexico’s but not enough to paint a complete picture of the virus’ course (Chart 13). The Brazilian government’s response has been chaotic. With a nearly universal health care system, albeit one that is under-funded, Brazil was not as poorly prepared as some countries. However, like his populist counterparts in Mexico and the United States, Bolsonaro chose to prioritize the economy over the virus response. Brazil was one of the few major countries in the world not to impose a national lockdown. The Ministry of Health, consumed with political turmoil, failed to develop a nationwide plan of action.1 Bolsonaro quarreled with governors who imposed state lockdown measures. With conflicting state and federal messages, Brazilians were unsure about the benefits of social isolation, hand washing, and face coverings, leading to a widespread lack of compliance and a major outbreak of the disease. Bolsonaro’s approach has led to some benefits, however, and the government implemented the largest fiscal response in the region at a whopping 16% of GDP. The economy is recovering faster than that of neighboring countries (Chart 14). Bolsonaro’s approval rating has also improved. The polling looks like a short-term “crisis bounce,” but Bolsonaro is now ahead of his likeliest rivals in 2022, including former President Lula Da Silva and former Justice Minister Sergio Moro. The crisis has catapulted Bolsonaro back into the approval range of other Brazilian presidents, at least for the moment (Chart 15). Chart 13Bolsonaro And Trump Prioritize Recession Over Pandemic Chart 14Bolsonaro's Economy Roaring Back All eyes will next turn to the municipal elections slated for November 15, 2020. The first elections since Bolsonaro came to power will be a test of whether the left-wing opposition can recover. One of the key pillars of Bolsonaro’s political capital was the collapse of the Worker’s Party after the economic crisis and Car Wash corruption scandal of the 2010s. The local government election will also reflect public views of the pandemic. Local governments are important when it comes to combating COVID-19. On April 15, Brazil’s Supreme Federal Court gave them the power to set quarantine restrictions and rules with regard to public transit, transport, and highway use. They are in charge of utilizing numerous rounds of aid from the federal government to mitigate the health and economic effects of the virus. Many have rejected Bolsonaro’s cavalier attitude, imposed stricter health measures, and established local teams comprised of medical professionals, public officials, and private donors to monitor the outbreak. If the Worker’s Party fails to recover from the shellacking it suffered in Brazil’s local elections in 2016, then Bolsonaro’s polling bounce would be reinforced and his administration would get a new lease on life. The opposite is also true: a strong recovery will undercut his political capital, especially because it is still possible that Da Silva will be cleared of corruption charges and capable of running for office in 2022. Bolsonaro also faces a test on another pillar of his political capital: the fight against corruption. A criminal investigation of the administration emerged after the resignation of popular justice Minister, Sergio Moro, who accuses the president of wrongdoing. There is an additional pending investigation for his team’s use of “fake news” during the 2018 campaign, which many deem illegal. So far, however, talk of impeachment has not hurt the president. Only about 46% of Brazilians support impeachment (Chart 16), which is not enough to get him removed from office. Any future impeachment push will depend on the following factors: Chart 15Bolsonaro Enjoys Popularity Boost Amid Pandemic Chart 16Nowhere Near Enough Support For Bolso Impeachment First, the president has allied with an alliance of center-right parties, called the Centrao, that controls 40% of seats in the Chamber of Deputies and has played a historic role in the rise and fall of Brazilian presidents (Chart 17). The Centrao can shield Bolsonaro from impeachment just as its opposition ultimately led to former President Dilma Rousseff’s removal in August 2016. By the same token, if these allies turn on him, removal will become the likely outcome. Second, powerful politicians like House Speaker Rodrigo Maia are reluctant to impeach because it would add “more wood in the fire,” i.e. worsen political instability. It would be bad politics for the impeachment directors as well. But this could change. The other two pillars of Bolsonaro’s political capital are law and order and structural economic reform. Bolsonaro has maintained his law-and-order image through cozy relations with the military, as well as through a slight decline in homicides (Chart 18). Chart 17Brazil: Presidential Parties Small, Need Support From ‘Centrists’ Chart 18Bolsonaro's "Law And Order" Message Works So Far Structural reform is the critical factor for investors, but the crisis has slowed the reform agenda, particularly on the fiscal front. The main way for Brazil to reform is to reduce the size of government. The government takes up a large share of national output, comparable to Argentina, and public debt is soaring. The country was already hurtling toward a sovereign debt crisis prior to COVID-19 (Chart 19). Bolsonaro’s signature legislative achievement, pension reform, has done little to arrest this trajectory, as it was watered down to gain passage and then the pandemic wiped out the fiscal gains. Ironically, Bolsonaro’s improved popularity is negative for fiscal consolidation, since it will encourage him to play the populist ahead of the 2022 election. Pension reform was never popular and passing it did nothing to boost Bolsonaro’s approval rating. On the contrary, his approval began to rise when the pandemic struck and he loosened fiscal policy. Going forward he will need to maintain fiscal spending to rebuild the economy. He is already jeopardizing Brazil’s key fiscal rules. As for the election, Brazil always increases government spending in the year before and year of a presidential election, as all parties hope to buy votes (Chart 20). Chart 19Brazil's Fiscal Crisis Accelerates Chart 20Brazil Cranks Up Spending Ahead Of Elections The implication is that any fiscal hawkishness will have to wait until Bolsonaro’s second term. Of course, if Bolsonaro loses the vote, left-wing parties may return to power and fiscal profligacy will be the order of the day. So investors do not have a good prospect for fiscal consolidation anytime soon, barring a successful candidacy by the aforementioned Moro on a reformist and anti-corruption ticket. Fiscal expansion and loose monetary policy are positive for domestic demand initially but negative for the out-of-control debt profile and hence ultimately the currency and government bond prices over the long term. Outside Brazil, geopolitical conditions are reasonably favorable. If Trump wins, Bolsonaro’s right-wing populism will gain some legitimacy and he may be able to negotiate good trade relations with the United States. If Trump loses, Bolsonaro will become politically isolated, but Brazil will benefit economically, as Joe Biden is friendlier to global trade than Trump. Brazil’s trade openness has grown rapidly, one area of reform that will continue. China is also interested in closer relations with Brazil as it faces trade conflict with the US and Australia. If Trump wins, Bolsonaro benefits from further Chinese substitution away from the United States. If Trump loses, Beijing will not return to former dependencies on the United States. Also, while China cannot substitute Brazil for Australia entirely, it is likely to increase imports from Brazil on the margin (Chart 21). Chart 21Brazil Benefits If China Diversifies From US And Oz Chart 22Brazilian Political Risk Down From 2015-16 Peak Ultimately Brazil is a country filled with political risk due to extreme inequality and indebtedness. But as long as the global economy and commodity prices recover, Bolsonaro will be able to ride the wave and short-term political risks will continue to subside from the extremely elevated levels of 2016 (Chart 22).   Bottom Line: Bolsonaro’s popularity bounced in the face of the national crisis. Local elections in November are an important barometer of whether his administration and its neoliberal structural reform agenda can survive beyond 2022. Either way, fiscal consolidation is on hold prior to the 2022 election. We are long Brazilian equities as a China play, but the outlook is ultimately negative for the currency. Bearish Argentina: Peronism Restored Argentina has 751,000 cases of coronavirus (16,800 cases per 1 million people) and about 16,900 deaths. Testing stands at 41,700 test per 1 million people. After the federal government eased quarantine restrictions and began reopening most of the country on June 7, total cases followed the general trend of the region (Chart 23). Chart 23Argentina’s COVID-19 Suppression Losing Steam Despite early measures to flatten the curve, Argentina lacks hospital beds, doctors, and medical supplies, especially in the capital of Buenos Aires where 88% of the country’s confirmed cases are found. The coronavirus has exposed stark differences between the rich and poor in terms of access and quality of health care, with about a third of the population uninsured. Politically secure, Fernandez has prioritized the medical crisis over the economy, imposing some of the world’s strictest lockdown measures in mid-March and declaring a one-year national health emergency – the first country in Latin America to do so. However, Argentina’s multi-decade economic mismanagement and recent policy vacillations mean that the crisis came at a bad time. Argentina has been in a deep recession for over two years, with skyrocketing inflation and peso devaluation, excessive budget deficits and external debts, and a 10% poverty rate in 2018 (Chart 24). Former President Mauricio Macri’s badly needed but ultimately failed attempt at supply-side reforms resulted in an economic collapse that saw the left-wing Peronist/Kirchnerista faction regain power in 2019. Argentina’s fiscal problems will continue on the back of populist economic unorthodoxy. Sovereign risk has temporarily fallen. Argentina received a $300 million emergency loan from the World Bank and another $4 billion loan from the Inter-American Development Bank. The country has defaulted on sovereign debt nine times, but the Fernandez government reached a deal with its largest creditors to restructure $65 billion in early August. The government agreed to bring some debt payments forward, thus buying itself immediate debt relief. It now has a little more than five years until the debt pile’s biggest wave of maturities comes due (Chart 25). Chart 24Poverty Rates Spike Amid Crisis, Including In Argentina Chart 25Argentina's Sovereign Risk Will Rise From Here This deal will give President Fernandez a significant boost. He took office in December 2019 so he has time to ride out the crisis before facing voters again in 2023. However, his reliance on populist economic unorthodoxy ensures that Argentina’s fiscal problems will continue. Consider the following: Before Covid-19, in an attempt to regain credibility among international lenders, Fernandez appointed Martin Guzman, as Minister of Economy. Guzman is an academic and a disciple of American Nobel-prize winner Joseph Stiglitz, but has little policy-making experience. Fernandez pushed an Economic Emergency Law through Congress, giving him emergency powers to renegotiate debt terms and intervene in the economy. He re-imposed import-substitution policies, such as large tax increases on agricultural exports, currency controls, and utility price freezes. In Fernandez’s inauguration speech, he justified a return to leftist policies by saying, “until we eliminate hunger we will ask for greater solidarity from those who have more capacity to give it.” This is a traditional trap for Argentina which results in worse economic outcomes over the long run. Chart 26Argentina’s Government Scores Well In Opinion Fernandez’s government has increased fiscal spending on food aid and other safety nets for the unemployed and furloughed. It has required banks to give out loans at reduced interest rates. Initially it pledged 2% of GDP to social and welfare relief programs, but that number has risen since the onset of the pandemic. For now, Fernandez has considerable political capital. The crisis will wipe out the memory of the Kirchneristas’ previous failings. Social spending is now flowing to Fernandez’s political base and the informal sector of the economy, which accounts for almost half of all Argentine workers. Public support for Fernandez has remained strong through the economic woes and pandemic, with his approval rating at around 67%. Over 80% of people polled have confidence in the government’s handling of the virus (Chart 26), according to opinion polls. Profligate spending will likely continue beyond the cyclical demands of the current crisis, adding to Argentina’s unsustainable debt profile. When the pandemic subsides, international lenders will be less willing to extend credit to Argentina and invest, given their record of default and high tax rates. International companies and even small caps have fled the country due to its draconian currency controls. Bottom Line: Argentina has witnessed a fall in uncertainty but going forward political risk will revive. Populist Kirchnerista policies do not create productivity improvements or reduce debt, and the country’s macro fundamentals will underperform in the long run. RIP Venezuela: The Final (Final) Nail In The Coffin For years, Venezuela has suffered an economic crisis with high levels of unemployment, hyperinflation, and mass shortages of food, medical supplies, and even gasoline. Many citizens claim they’re more likely to die from starvation than the coronavirus. Out of the country’s 47 hospitals that are supposedly dedicated to COVID-19, only 57% have a regular water supply, while 43% have a shortage of PPE kits for medical staff and practitioners. Nicolas Maduro – the hapless successor to Hugo Chavez – declared a state of emergency and implemented a nationwide and long-lasting lockdown, enforced by police. The government issued a unique “7 + 7” plan, where strict lockdowns are imposed for seven days, relaxed for another seven days, re-imposed, and so on. Nevertheless, cases have been increasing. Over time the crisis in Venezuela has forced around five million Venezuelans, including skilled workers and medical doctors, to leave the country (Chart 27). Spillover effects are straining neighboring Colombia, which has taken in 1.5 million of the refugees, and Brazil. Although thousands of Venezuelans have returned home during the pandemic, the massive movements will only make the virus more prevalent. In early June, Maduro reopened borders with Colombia after closing them in February when opposition leader (and rival claimant to the presidency) Juan Guaidó tried to import foreign aid. Maduro denied that Venezuela is in humanitarian crisis and warned against a coup d'état by the United States. The political opposition is stymied for now. In January 2019, Guaidó declared himself president of Venezuela over Maduro, whose government has circumvented the constitutional system since losing the parliamentary election of 2015. Guaido receives broad support from the international community, including Europe and the United States, while Maduro is backed by China, Russia, and Iran. Over 18 months later, Guaidó wields nearly no power at home and Maduro remains in place with the army’s top generals still backing him. However, the Trump administration has expanded sanctions throughout its term. Maduro is unable to access international financing from the IMF, after requesting an emergency $5 billion loan to combat COVID-19, partly due to US opposition. Food prices in Venezuela have risen 259% since January. Low worldwide demand for oil – representing 32% of Venezuelan GDP – means the last leg of the economy has weakened. The government has little room to maneuver fiscally or otherwise combat the virus. Maduro has used the crisis to strengthen his domestic security grip. The military, police, and revolutionary militias are enforcing lockdowns to thwart demonstrations. The opposition is divided, with Guaidó now quarreling with former opposition leader Henrique Capriles over whether to contend the parliamentary elections on December 6. The elections will inevitably be rigged; but to boycott them is to allow Maduro officially to retake the key constitutional body that he lost (and then sidelined) back in 2016. Nevertheless, the material foundations of the country have long collapsed (Chart 28). The pandemic and recession will ultimately prove the final (final, final) nail in the coffin. The military is ruling from behind the scenes but will not want to jeopardize its own status when the Bolivarian revolution is finally abandoned. The timing of this denouement is, as always, anybody’s guess. Chart 27Venezuela’s Refugees Show State Collapse Chart 28Venezuela's Regime Cannot Survive   Bottom Line: President Trump will maintain maximum on Maduro and Venezuela as long as he is in office. The regime will struggle to survive long enough to enjoy the benefits of the commodity price upswing next year. Whenever Maduro falls, the prospect of an eventual resuscitation of oil production will open up. Bullish Colombia: Political Risk Contained (For Now) Chart 29Colombia Flattened The Curve The Colombian government responded swiftly to COVID-19. President Ivan Duque shut seven border crossings with Venezuela, declared a state of emergency, and imposed lockdown measures in mid-March. The measures have been stringent and extended. The effect on the spread of the disease is discernible compared to Colombia’s neighbors (Chart 29). The city of Medellin, with 2.5 million residents and only 2,399 coronavirus deaths, became the best-case scenario for combating the virus. Through the use of an online app, the city government connected people with money and food, while obtaining important data to track cases. Despite the lockdowns, fiscal policy has been tight. True, the government provided payroll subsidies for formal and informal workers unable to work during lockdowns.2 But government spending as a whole is limited (Chart 30). This is positive for the country’s currency and government bonds but will exacerbate political tensions later. Chart 30Colombia's Fiscal Hawkishness Good For Currency, But Will Spur Opposition Duque’s approval ratings were low back in February (23%) but nearly doubled when the crisis struck (Chart 31). However, they have since fallen back to around 40% and high unemployment and fiscal restraint will challenge his government in coming years. Chart 31Colombia’s President Struggling, But Has Time To Recover Pre-Election Colombia is relatively politically stable but tensions are building beneath the surface that will challenge the country’s recent improvements in governance and the 2016 peace deal. On August 4, former President Alvaro Uribe was put under house arrest by a section of the Colombian Supreme Court amid an investigation on witness tampering. He was the first ex-president to be detained in Colombia’s history. Subsequently he resigned from the Senate to obtain better treatment at the hands of the more friendly Attorney General’s office. Uribe is powerful. He created Centro Democratico, which is the largest party in the Senate and the second largest in Congress. He also hand-picked President Duque. His case will continue to be a source of political polarization. Right-leaning factions have not yet convinced moderates to oppose the country’s UN-backed 2016 peace deal, which ended decades of fighting between government forces and the Revolutionary Armed Forces of Colombia (FARC), the leading rebel group. If that changes, then domestic security will decline and investor sentiment will decline at least marginally. Colombia’s political polarization will be contained by Venezuela’s collapse – as long as the economy recovers. In the wake of the oil bust in 2014, Colombia saw the left-wing factions unite around a single candidate – Gustavo Petro, an ex-guerilla – who challenged the conservative establishment in the 2018 election, pledging to tackle inequality. Petro was soundly defeated, giving markets reason to cheer. Now, however, inequality is combining with a deep recession, austerity, and the potential for a failed peace process to challenge the conservatives in 2022. Table 1Latin America Is Vulnerable To Social Unrest Chart 32MXN, COL, And CLP Outperform While BRL Lags The saving grace for the conservatives will likely be the global cyclical upswing, combined with Venezuela’s collapse continuing to unite the right and divide the left. However, the Uribe faction’s dominance is getting long in the tooth and Colombia is vulnerable to social unrest based on our COVID-19 Unrest Index (Table 1). The election is not all that soon. The Colombian peso is still relatively cheap and yet has outperformed other emerging market currencies due to the strong COVID-19 response and the oil rally (Chart 32). Bottom Line: Tight fiscal policy combined with a strong pandemic response – and the recovery in oil prices – will benefit the Colombian peso. Equities are attractively valued. Political risk will build as the 2022 election draws closer, however. Volatile Chile: Tactical Buys Hinge On Politics, China Chile has been a hotspot for the coronavirus. Its lackluster response to the pandemic is fanning the embers of the social unrest that erupted last year. Unrest is tied to a larger political crisis unfolding over the constitutional order, which evolved from the 1980 constitution of dictator Augusto Pinochet. Chile is transitioning from a neoliberal economic model to a welfare state, as Arthur Budaghyan and Juan Egaña of BCA’s Emerging Markets Strategy showed in an excellent special report last year. This transition raises headwinds for an currency, equities, and government bonds. The Chilean government, led by President Sebastián Piñera, declared a state of emergency in March and boosted health care spending throughout the country. The government also passed numerous emergency relief packages to small businesses, workers of the informal economy, and local governments. However, high levels of poverty and overcrowding, especially in the capital of Santiago, have hindered efforts to contain the coronavirus (Chart 33). The government imposed strict lockdowns, including a nationwide increase in police and up to five-year prison penalties for violating quarantines. The political opposition argues that Piñera’s extension of the “state of catastrophe” has allowed him to use emergency powers to restrict citizens’ rights in the name of curbing the pandemic. His approval rating has fallen beneath 22% while popular disapproval has surged above 68% (Chart 34). Chart 33Chile’s Handling Of COVID-19 Largely Successful Chart 34Chile’s Govt Embattled Amid Constitutional Rewrite Chart 35Chile: Inequality Falling, But High Level Still Sparks Unrest Chile was already a tinderbox before the pandemic. Beginning with a small hike to subway fares in Santiago in October 2019, pent-up social grievances erupted against the country’s elite. Protests have continued even during lockdowns and morphed into demands for broader social reform (Chart 35). Chile's top rank on our COVID-19 Social Unrest Index belies the fact that it has high wealth inequality, a threadbare social safety net, high debt levels, and now higher unemployment (Table 1). Table 1Latin America Is Vulnerable To Social Unrest In a concession to protesters, the Piñera administration agreed to revise the constitution. A popular referendum will be held on October 25, though it has already been delayed once. The referendum will determine whether to hold a direct constitutional assembly, whose members are drawn from the population as a whole, or a mixed constitutional assembly, in which congress takes up half of the seats. The latter is the more conservative option; the former is more progressive and will deepen political polarization as the political establishment will resist it (Chart 36). The process to revise the constitution is supposed to last until the end of 2022 but it could drag on longer. Moreover it will be complicated by presidential and legislative elections slated for November 2021. The timing of these events ensures that short-term partisan factors will have a major impact on constitutional revision, which bodes ill for resolving structural political problems. The Piñera administration’s goal is to pacify the protesters with some reforms, thus winning his party re-election, while preserving key elements of the current political establishment. But the pandemic has made it harder to do this, requiring either greater government concessions or a new round of unrest. The implication is that political risk will remain elevated over the next few years. Political risk will thus undermine good news on the macro front, including the peso’s strong performance this year so far (Chart 32 above). Of course, there are positive macro factors countervailing this political risk. One of which is China’s recovery. Beijing accounts for 51% of global copper demand, and Chile provides 28% of mine supply, and China is stimulating aggressively. Chilean exports track even more closely with China’s credit impulse than those of other Latin American economies (Chart 37). Chart 36COVID-19 Unrest Index: If Chile Faces Unrest, Then All Latin America Faces Unrest However, the market has partly priced China’s boost whereas Chile’s political risk will erupt again soon. With regard to the US election, Chile stands to benefit from a Democratic victory that improves the outlook for China’s economy and global trade. Like Peru, Chile is a member of the CPTPP and stands to benefit if Biden is elected and eventually rejoins this pact. Chart 37Chile Constitutional Battle Will Increase Political Risk   Bottom Line: A secular rise in domestic political risk as the country is pressured to expand the social safety net is a negative factor for the peso and stock market that will weigh on its otherwise positive macro backdrop. Investment Takeaways The above review reveals some common threads. First, the last decade has not led to lasting neoliberal reforms or major strides in promoting productivity. Attempts at supply-side structural reform have been modest or have failed entirely in Argentina, Brazil, Chile, and Mexico. Colombia’s attempt at a peace deal may falter. Venezuela is a failed state. Second, populism, whether left-wing or right-wing, entails that most governments will pursue economic growth at any cost. Fiscal hawkishness has been put on pause, with the exception of Mexico and Colombia, where it will benefit the currencies. Near-term risks abound in Q4 2020 but the long term is favorable for Latin American financial assets due to global reflation. China is stimulating its economy aggressively. US sanctions will weigh on China, but it will need to stimulate more in response to maintain internal stability. This will boost commodity prices. The dollar will eventually weaken as global growth recovers, the Fed avoids raising rates, and the US maintains large twin deficits. This is ultimately true even if Trump is re-elected. A weaker dollar helps commodities and Latin American countries with US dollar debts. All things considered, Mexico and Colombia will come out looking the best, but we will also look for opportunities when discounts on Chilean assets become excessive. The US’s secular confrontation with China over trade tensions holds out the prospect of Latin American markets reversing their long equity underperformance relative to Asian manufacturers (Chart 38). Latin American manufacturers like Mexico will benefit from American trade diversification. If the US joins the CPTPP, then Chile and Peru will also benefit. Metals producers like Chile will benefit most from China’s stimulus. Chart 38China's Stimulus A Boon For Latin America   Matt Gertken Vice President Geopolitical Strategy mattg@bcaresearch.com Daniel Kohen Consulting Editor Footnotes 1 The Ministry of Health exemplifies growing fractures across the administration. In mid-May, the Health Minister (Nelson Teich) resigned just four weeks into the job, after Bolsonaro fired the previous one (Luiz Henrique Mandetta) for defending lockdown measures imposed by some mayors and governors. 2 There are about 1.8 million Venezuelan refugees in Colombia. They rely on the informal work, with many falling back into poverty as a result of the mandatory quarantines.

Copper prices have staged an impressive rally in the past four months, but the performance of Chilean markets remains lackluster (Chart II-1). While the red metal has broken above its January highs, Chile’s equities and currency are still trading 25% and 5% below their January peak, respectively.    The government’s mismanagement of the pandemic has reignited and heightened the existing socio-political discontent, thus increasing the fragility of the situation. We therefore recommend that investors maintain a cautious stance on Chilean assets. As for dedicated EM portfolios, we recommend moving this bourse from neutral to underweight: First, the lockdowns resulting from the pandemic have revealed the precarious financial condition of low and middle-class households. The lack of savings among these groups prevented workers from self-isolating for more than a couple of weeks. The urge for them to return to work enabled the outbreak to escalate in May. Consequently, these social groups have suffered from infections, and Chile has rapidly become one of the worst affected countries in the world in terms of per-capita COVID-19 cases and deaths. Chart II-2 shows that, as a share of total population, Chile tops the region in terms of cummulative cases and deaths. Moreover, Chile has the eighth highest COVID-19 infections per capita in the world, even though its testing rate per capita is lower than that of Europe and the US. Chart II-1Chilean Markets Have Been Much Weaker Than Copper Chart II-2The Pandemic Has Hit Chile Hard   Chart II-3The Economy Is In The Doldrums Given the wide spread of the virus, Chile has implemented harsher quarantine measures than the rest of the region, which means that the economic reopening and recovery will start from a lower level of activity. The inability of President Pinera’s administration to protect low and middle-class households from being exposed to the virus has renewed a nation-wide distrust in the government. According to Cadem, one of the country’s most cited polling companies, President Pinera’s approval rating has fallen back to just 17%, not far from the lows seen during last year’s violent social unrest. In sum, these recent events have confirmed our major theme for Chile, discussed in our December Special Report. It reads as follows: Chile’s political elite has been greatly underestimating the depth and gravity of the popular frustration and has been reluctant to address the issue in a meaningful way. Consequently, Chile is set to experience a renewal in protests and a rise in political volatility as the date of the referendum on the Constitution, which is scheduled to take place in October, nears. Second, Chile is experiencing its worst recession in modern history. Chart II-3 shows that the economy was already in a slump at the beginning of the year, and the economic lockdown has caused double-digit contractions in many sectors. Further, business confidence never fully recovered from last year’s social protests and has been plummeting deeper since the start of the pandemic (Chart II-3, bottom panel). Chart II-4Banks' NPLs Are Set To Rise While President Pinera’s decision to prioritize small and medium-sized businesses (SMEs) has been popular among the middle class, the reality is that Chile remains a highly oligopolistic market, dominated by large companies. The failure to support these businesses will prevent a revival in business sentiment, hiring and investment and, hence, prolong the economic downtrend. This unprecedent economic contraction has caused a rapid surge in non-performing loans (NPLs), which will hurt banks’ capital profits and tighten lending standards. NPLs will rise much further given the record depth of this recession (Chart II-4). Moreover, bank stocks compose 25% of the MSCI Chile index, so a hit to banking profitability will exert downward pressure on the equity index. Third, even though fiscal and monetary stimuli have been large and were implemented rapidly, they are probably insufficient to produce a quick recovery. The government first announced a fiscal plan between March 19 and April 8 worth US$ 17 billion (or 6% of GDP), the third largest in the region. However, it is still quite small compared to that of OECD members. Excluding liquidity provisions for SMEs and tax reductions, the size of new government spending in 2020 is only 3.5% of GDP. On June 14, the government devised another fiscal plan, worth US$ 12 billon (or 5% of GDP). However, it will be spread out over the next 24 months – only 1.5% of GDP of additional stimulus will be injected over the next 12 months. This extra kick in spending seems too small given the depth of the recession.  In terms of monetary policy, the Chilean central bank has already reached the limits of its orthodox toolkit. The monetary authorities have cut the policy rate by 125 basis points since November of last year, but they have reached the constitutional technical minimum of 0.5%. The central bank is now using alternative tools to stimulate the economy, such as offering cheap lending to SMEs and a US$ 8 billion quantitative easing program for buying financial institutions’ bonds, as the Constitution forbids the purchasing of government and non-financial corporate debt. In a nutshell, the overall efficiency of these monetary policies will be subdued as the main drags on the economy are downbeat business and consumer confidence stemming from ongoing socio-political tensions, not high interest rates. Fourth, higher copper prices will help on the margin, but will not bail out the Chilean economy.  Even with the latest rally in copper prices, Chilean copper exports will continue contracting in US$ terms. The latest increase in prices will be more than offset by output cuts caused by social distancing rules and reduced staff in mines all over the country.  Bottom Line: Chile is shrouded in a cloud of political uncertainty. Monetary policy has reached its limits, and fiscal stimulus is insufficient for now. Investment recommendations Chart II-5Our CLP vs. USD Trade Continue shorting the CLP relative to a basket of the CHF, EUR and JPY. We closed our short CLP/USD on July 9th with a 29% profit (Chart II-5) and began shorting it versus an equal-weighted basket of the CHF, EUR and JPY. Within an EM equity portfolio, downgrade Chilean stocks from neutral to underweight. An ailing economy and political uncertainty will divert capital from the country despite attractive equity valuations. For an EM local bond portfolio, we are also downgrading Chile from neutral to underweight, as the risk of renewed currency depreciation is too large to ignore and downside in yields is limited due to the zero bound. Juan Egaña Research Associate juane@bcaresearch.com