Base Metals & Iron Ore

Highlights As the global economy ex-China recovers from COVID-19, pent-up demand for consumer goods like cars and appliances will lift demand for stainless steel, which, in turn, will push up prices for the nickel required to make it (Chart of the Week).   Developing new nickel supply will become more expensive, as governments respond to carmakers’ and ESG investors’ environmental concerns, as well as consumer preferences for cleaner transportation technology. This already is apparent in Indonesia, where the government has stopped permitting deep-sea disposal of mine tailings. Increasing use of nickel in electric-vehicle (EV) batteries is additive to existing demand.  Over the next 20 years, as EVs’ share of the global fleet continues to grow, nickel-intensive battery technology could lift demand by close to 300%.  By 2050, demand could increase exponentially from there, depending on battery technology. Against this backdrop, EV manufacturers have begun seeking long-term supply contracts directly with governments, to get out ahead of an increasingly tighter market. The balance of risks in the nickel market is to the upside.  Our tactical long nickel position recommended last week is up ~1%.  We are lowering our target to $26k/MT by July, which would represent a ~23% gain if realized. Feature At present, ~ 70% of the 2.5mm MT of nickel consumed annually goes into the stainless steel used in everything from cars and planes to operating tables, waste-water treatment plants and toasters.1 As government subsidies and other incentives propel consumers’ demand for lower-carbon transportation technologies, an increasing share of nickel consumption will be accounted for by EV batteries. The global nickel supply-demand balance is narrowing, as consumption converges on production (Chart 2). Chart of the WeekPent Up Consumer Demand Ex China Will Keep Nickel Well Bid Pent Up Consumer Demand Ex China Will Keep Nickel Well Bid Pent Up Consumer Demand Ex China Will Keep Nickel Well Bid Chart 2Tighter Nickel Balances Going Forward Will Push Prices Higher Tighter Nickel Balances Going Forward Will Push Prices Higher Tighter Nickel Balances Going Forward Will Push Prices Higher This year, we expect pent-up consumer demand ex-China to be unleashed in the wake of the global recovery from the COVID-19 pandemic.  Massive government income-support and fiscal-stimulus programs supporting household budgets will be augmented by organic wage growth this year, which will fuel demand for white goods, autos and other consumer products made with stainless steel (Chart 3).2 Chart 3Pandemic Recovery Will Spur Pent-Up Demand Nickel's Decade-Long Rally Is Underway Nickel's Decade-Long Rally Is Underway Lower Nickel Ore Output On the supply side, following steady growth in unrefined nickel production from 2016 to 2019, production in the world’s top five nickel producers accounting for ~ 70% of total ore output fell close to 20% in 2020 (Chart 4). This is partly due to the COVID-19 pandemic’s impact on mining operations, and residual effects of Indonesia’s nickel ore ban implemented in 2019, which caused nickel ore supply to contract at the margin. Indonesia is the largest producer in the world, accounting for ~20% of global nickel ore output.  Earlier this month its government said it no longer would permit deep-sea tailings (DST) disposal of mine waste.  Environmentalists and EV manufacturers, which will be huge consumers of nickel going forward, are pressuring miners to maintain an environmentally conscious public image, as they do not want to be associated with the dumping of mine waste into coral reefs, even if this raises costs.  The Philippines also is demanding that mine operators adopt environmentally sensitive practices. Host governments like Indonesia will have greater control over environmental regulations, as more and more of the value-added in nickel supply chains is vertically integrated domestically with ore mining.  Nickel is one of the few base-metals markets in which China’s share of global refined production is less than 50%, which reflects Indonesia’s efforts to capture more of the value added in supply chains via such integration (Chart 5). Chart 4Nickel Ore Production Is Falling Nickel Ore Production Is Falling Nickel Ore Production Is Falling Chart 5Nickel Production More Competitive Nickel's Decade-Long Rally Is Underway Nickel's Decade-Long Rally Is Underway COVID-19-induced demand destruction kept refined nickel demand in the top five countries representing ~ 72% of global consumption flat y/y.  This offset the slight increase in refined nickel supplies.  This likely reflected lower aggregate demand for consumer products ex-China.  China accounts for ~56% of global refined-nickel consumption as seen in Chart 5.  EV Nickel Demand Could Surge EVs still are a small slice of the global nickel market – ~ 5% to 6% – given they represent ~ 1% of the global fleet (Chart 6).  The IEA estimates there were just over 7mm EVs on the road in 2019, the last year for which data are available from the Agency.  Close to 50% of those EVs were in China.  According to Adamas Intelligence, global EV registrations in 2H20 were up close to 60%, with 3.5mm units sold.3 Going forward, demand for high-grade nickel used in electric-vehicle (EV) batteries will continue to grow, if the demand trends in 2H20 are any indication.  By 2030, EV battery demand could hit 36% of total nickel demand, according to Roskill Information Services.4 As EV sales increase over the next 20 years and their share of the global fleet expands, nickel-intensive battery technology could lift demand by close to 300%, based on an analysis done by Roskill for the EU earlier this year: “Automotive electrification is expected to represent the single-largest growth sector for nickel demand over the next twenty years. Within this sector alone, we forecast global demand to increase by 2.6Mt Ni to 2040, up from only 92kt Ni in 2020.” Chart 6EV Nickel Demand Will Grow Sharply In The 2020s Nickel's Decade-Long Rally Is Underway Nickel's Decade-Long Rally Is Underway Depending on how quickly EVs are adopted and how their battery technology evolves, nickel demand – along with other battery materials like lithium and cobalt – could increase exponentially beyond 2030.  Xu, Dai and Gaines (XDG, 2020) et al used the IEA’s Stated Policies (STEP) and Sustainable Development (SD) scenarios to examine possible metals-demand scenarios out to 2050.5 In XDG’s modeling, EVs could account for up to 14% of the light-duty vehicle fleet (166mm) by 2030.  They extend this model to 2050 to assess long-term demand for lithium, cobalt and nickel.  While the assumptions of the model could be viewed as aggressive, the results are interesting.  Over the next 50 years, the XDG model’s expectation for the world EV fleet rises to ~ 1 billion vehicles under the STEP scenario – an increase of 72x current levels – with annual sales hitting just under 110mm units.  Under the SD scenario, the fleet expands to 2 billion units (an increase of 102x), with annual sales of 211mm. Nickel demand soars under these scenarios, increasing from 0.13mm tons to between 1.5mm and 3.7mm tons, depending on whether the lower demand STEP scenario plays out or the SD is used (Chart 7). Lithium and cobalt demand soars as well, going, respectively, from 0.036mm tons to 0.62mm to 0.77mm tons, and from 0.035mm tons to 0.25mm to 0.62mm tons. Chart 7Nickel Rally Is Just Getting Started Nickel Rally Is Just Getting Started Nickel Rally Is Just Getting Started EV Carmakers Lining Up Nickel Supply Anything close to the neighborhood of these estimates would require a massive increase in supply or a major battery technology breakthrough to satisfy such demand. Against this backdrop, EV manufacturers have begun seeking long-term supply contracts directly with governments, to get out ahead of an increasingly tighter market.  Elon Musk’s Tesla is believed to have entered negotiations with the government of Indonesia for long-term nickel supplies, as have other battery makers. Bottom Line: Base metals demand – particularly for nickel and copper – is set to surge if EV sales pick up sharply in the post-COVID-19 world, and governments around the globe begin to follow through on their plans to dramatically expand renewable generation. We are bullish base metals for the next 5-10 years on the back of this expected demand increase.  Higher prices will be required to incentivize the build-out of base metals supplies required to meet this demand. We remain tactically long nickel, which is up ~1% since our recommendation last week.  We are lowering our price target to $26k/MT from $29k/MT by July, but expect to see nickel close in on our earlier target later in the year.   Robert P. Ryan Chief Commodity & Energy Strategist rryan@bcaresearch.com   Commodities Round-Up Energy: Bullish We expect the Kingdom of Saudi Arabia (KSA) and fellow OPEC 2.0 member states to use their massive 7mm-plus b/d of spare capacity – and short-haul crude inventories situated close to refining centers – to make up for the ~ 7mm barrel loss of US crude production that resulted from the massive winter storm that engulfed the US Midwest and Gulf regions last week. The global recovery, particularly in EM economies, remains fragile. We do not believe the leadership of OPEC 2.0 (KSA and Russia) wants to risk a global oil-demand recovery with a price shock at this point. We expect April deliveries to be increased out of spare capacity, and for this to be communicated to the market at next week’s OPEC 2.0 meeting. This should keep Brent and WTI crude oil prices below $70/bbl in 1H21, in our estimation (Chart 8). In the wake of the Polar Vortex wake, US distillate and propane inventories used in space heating led a US oil inventory drawdown of almost 14mm barrels in the week ended 19 February, according to the US EIA. Base Metals: Bullish Copper prices are poised to challenge long-term resistance of $4.45/lb on the COMEX, following this week’s huge rally above $4.25/lb (Chart 9). Markets appear to be dialed into the supply constraints and tight inventories we have been highlighting in our research.6 Our long Dec21 copper futures position recommended on September 10, 2020 is up ~37%, while the PICK ETF recommended on December 10, 2020 is up ~20%. Precious Metals: Bullish Our long COMEX silver position is up ~2% from last week when we recommended the position. As markets continue to price in a recovery ex-China this year, we expect silver prices to continue to rally on the back of supportive fiscal and monetary conditions and a revival in organic growth. Ags/Softs: Neutral The Brazilian soybean harvest is off to a decade-low seasonal start, as rainfall slows work in the field, according to agriculture.com  Chart 8 Brent Prices To Be Below USD70 per barrel In 1H21 Brent Prices To Be Below USD70 per barrel In 1H21 Chart 9 Copper Prices Poised To Challenge Resistance Copper Prices Poised To Challenge Resistance   Footnotes 1     Please see the Nickel Institute’s website post Stainless steel: The role of nickel for additional information. 2     Please see Requiem For Volcker And The Gipper, a Special Report written by Doug Peta and Matt Gertken, BCA Research’s managing editors for US Investment Strategy and Geopolitical Strategy.  In their excellent analysis, they note government policy in the US, which has deployed massive income-support and fiscal stimulus, continues to move to the left and will be more progressive (in the US usage, meaning more populist): “The problems of slow growth, inadequate health and education, racial injustice, creaky public services, and stagnant wages are by far the more prevalent concerns – and they require more, not less, spending and government involvement.”  Practically speaking, for commodities this means policy will be directed toward restoring purchasing power of working-class households in the US, which will translate into higher demand for commodities generally, as these households tend to spend income as opposed to save it. 3    The Adamas Intelligence report is cited in mining.com’s article Global EV sales pushed battery metals deployment in H2 2020 – report, published 22 February 2021. 4    Please see Fraser, Jake; Anderson, Jack; Lazuen, Jose; Lu, Ying; Heathman, Oliver; Brewster, Neal; Bedder, Jack; Masson, Oliver, Study on future demand and supply security of nickel for electric vehicle batteries, Publications Office of the European Union, Luxembourg, 2021. 5    The STEP and SD scenarios reflect, respectively, current government policies and regulations and the Paris Agreement’s goals augmented by the IEA’s EV30@30 scenario Please see Xu, C., Dai, Q., Gaines, L. et al. “Future material demand for automotive lithium-based batteries.” Commun Mater 1, published 9 December 2020 by nature.com.  The IEA’s EV30@30 represents an aspirational goal of 30% of global auto sales being EVs by 2030. It can be seen at IEA EV30@30. 6    Please see Copper Surge Welcomes Metal Ox Year, which we published 11 February 2021.  It is available at ces.bcaresearch.com.   Investment Views and Themes Recommendations Strategic Recommendations Tactical Trades Commodity Prices and Plays Reference Table Summary of Closed Trades Higher Inflation On The Way Higher Inflation On The Way

Highlights The multiple paid for oil sector profits is collapsing because the market fears that the profits slump will not be short-lived. The fear is not just of a lasting hit to aviation and a slower recovery in road mobility, but an existential fear for fossil-fuelled road transportation in the post-pandemic world. Stay structurally underweight oil and gas. Within the cyclical and value segments of the equity market, overweight metals and miners versus oil and gas. Structurally underweight the stock markets of Norway and the UK which are oil and gas heavy. Structurally overweight the stock markets of Germany, Switzerland, and Denmark which have zero exposure to oil and gas or basic resources. Fractal trade: tin’s near-vertical rally is at high risk of correction. Feature Chart of the WeekOil Production Has Gone Nowhere Oil Production Has Gone Nowhere Oil Production Has Gone Nowhere The Brent crude oil price recently hit $65, not far below its pre-pandemic level of $69. Yet in the stock market, oil and gas equities remain the dogs, languishing 32 percent below their pre-pandemic price level. Relative to the market, the oil and gas sector has underperformed by 42 percent, and the underperformance has been almost a straight line down. Moreover, since last June when the crude oil price has risen by 50 percent, oil and gas equity prices have gone nowhere. This massive divergence of a surging crude oil price from slumping oil and gas equities raises the obvious question, what can explain this dichotomy? (Chart I-2 and Chart I-3) Chart I-2Oil And Gas Equities Have Slumped In Absolute Terms... Oil And Gas Equities Have Slumped In Absolute Terms... Oil And Gas Equities Have Slumped In Absolute Terms... Chart I-3...And In Relative ##br##Terms ...And In Relative Terms ...And In Relative Terms One apparent puzzle is that the oil sector’s profits have underperformed their established relationship with the crude oil price. In fact, there is no puzzle. The oil sector’s profits might appear to track the oil price, but the reality is that profits track the value of oil production, meaning the product of oil production and the oil price. Clearly though, if output is flat, then profits will appear to track the oil price.  But as it took a massive cut in oil output to support the oil price, the value of oil production and therefore, the oil sector’s profits, have significantly underperformed the oil price. Put another way, if you need to cut output to boost the commodity price it might help the commodity price, but it doesn’t much help the equity sector’s profits! (Chart I-4 and Chart I-5). Chart I-4Oil And Gas Profits Appear To Track The Oil Price Oil And Gas Profits Appear To Track The Oil Price Oil And Gas Profits Appear To Track The Oil Price Chart I-5In Reality, Oil And Gas Profits Track The Value Of Oil Output In Reality, Oil And Gas Profits Track The Value Of Oil Output In Reality, Oil And Gas Profits Track The Value Of Oil Output Will Fossil-Fuelled Road Transportation Be Driven To Extinction? We can now explain the 42 percent underperformance of oil equities, and perhaps more importantly, forecast what will happen next. When the pandemic took hold, and economic mobility ground to a halt, the oil sector’s 12-month forward profits slumped. Bear in mind that aviation accounts for 8 percent of oil consumption but, more crucially, road transportation accounts for half of all oil consumption. However, as the pandemic’s impact was expected to be short-lived, the multiple paid for those depressed 12-month forward profits rose. This partly compensated for the profit slump, but still left oil equity prices much lower. The multiple paid for oil sector profits is collapsing because the market fears that the profit slump will not be short-lived. When profits started to recover – albeit, as just discussed, by much less than the oil price rise – it should have boosted oil equity prices. The problem was that the multiple paid for those profits fell by much more than the recovery in profits, with the result that oil equities continued to underperform. Begging the question, why is the multiple paid for oil sector profits collapsing? (Chart I-6) Chart I-6Why Is The Multiple Paid For Oil Sector Profits Collapsing? Why Is The Multiple Paid For Oil Sector Profits Collapsing? Why Is The Multiple Paid For Oil Sector Profits Collapsing? The multiple paid for oil sector profits is collapsing because the market fears that the profit slump will not be short-lived. The fear is not just of a lasting hit to aviation and a slower recovery in road mobility. The fear has become existential. Governments’ plans for pandemic stimulus and recovery have put green energy at front and centre stage. Thereby the recovery has fast-tracked the ultimate nemesis of the oil industry – the extinction of fossil-fuelled road transportation. Are the fears for oil consumption justified? Yes. Aviation is not likely to reach its pre-pandemic level of oil consumption for many years, and long-haul aviation may never get there. But the much bigger threat is fossil-fuelled road transportation. From October 2021, London will extend its Ultra Low Emission Zone (ULEZ) to an 8 mile radius from the city centre.1 The effect will be to banish from London all diesel-fuelled vehicles made before 2015 as well as some older petrol-fuelled vehicles. We expect other major cities to follow London’s example. In most cases, this initiative will happen regardless of the success (or not) of electric vehicles (EVs). Combined with other green initiatives around the world, policymakers’ unashamed aim is to drive fossil-fuelled road transportation to extinction. To repeat, road transportation accounts for half of all oil consumption. The upshot is that the structural downtrend in oil consumption will persist unless the shift away from fossil-fuelled road transportation hits a brick wall, or at least a bottleneck. We do not see such a brick wall or a bottleneck in the foreseeable future. We conclude that though the sector may offer occasional countertrend tactical buying opportunities, long-term equity investors should underweight oil and gas. Structurally Prefer Metals And Miners To Oil And Gas The preceding analysis of the oil sector can be extended to other commodity equities, like the metals and miners. To reiterate, it is the total value of commodity output – the product of commodity production and the commodity price – that drives the profits of commodity equities. On this basis, the long-term prospects for the metals and miners appear somewhat brighter than for oil and gas equities (Chart I-7). Chart I-7Commodity Sector Profits Track The Value Of Commodity Output Commodity Sector Profits Track The Value Of Commodity Output Commodity Sector Profits Track The Value Of Commodity Output Looking at the production of copper, it has increased by around 25 percent over the past decade, albeit this is just in line with world real GDP. By comparison, the production of oil has gone nowhere (Chart of the Week). It is the total value of commodity output that drives the profits of commodity equities. Turning to price, relative to the 2011 high the copper price is around 15 percent lower, whereas the oil price is 50 percent lower (Chart I-8). Chart I-8The Copper Price Has Outperformed The Oil Price The Copper Price Has Outperformed The Oil Price The Copper Price Has Outperformed The Oil Price Hence, on the all-important value of output, copper has moved in a sideways channel over the past decade while oil has been in an unmistakeable structural downtrend, with lower highs and lower lows (Chart I-9). Chart I-9The Value Of Output Is Trending Sideways For Copper, But Downwards For Oil The Value Of Output Is Trending Sideways For Copper, But Downwards For Oil The Value Of Output Is Trending Sideways For Copper, But Downwards For Oil This relative trend is likely to continue as the shift from fossil-fuelled road transportation to EVs will weigh on oil demand, while supporting copper (and other metal) demand. We do not recommend an outright overweight in metals and miners given that their profits are just moving in a sideways channel. However, within the cyclical and value segments of the equity market, a good structural position is to overweight metals and miners versus oil and gas. When Oil And Gas Underperforms, So Does Norway’s OBX And The UK’s FTSE 100 Regional and country equity market performances is driven by the dominant sectors within each stock market. In relative terms, it is also driven by the sectors that are missing. If the oil and gas sector is a structural underperformer, then oil and gas heavy stock markets such as Norway and the UK will be structural underperformers too. If the oil and gas sector is a structural underperformer, it inevitably means that oil and gas heavy stock markets such as Norway and the UK will be structural underperformers too (Chart I-10 and Chart I-11). Chart I-10When Oil And Gas Underperforms, Norway's OBX Underperforms... When Oil And Gas Underperforms, Norway's OBX Underperforms... When Oil And Gas Underperforms, Norway's OBX Underperforms... Chart I-11...And The UK's FTSE 100 ##br##Underperforms ...And The UK's FTSE 100 Underperforms ...And The UK's FTSE 100 Underperforms The corollary is that stock markets which are under-exposed to the structurally underperforming sector will be at a relative advantage. This supports our structural overweighting to the stock markets of Germany, Switzerland, and Denmark, which all have zero exposure to oil and gas and basic resources. Fractal Trading System* Tin’s near-vertical rally is at high risk of correction based on fragility on all three fractal structures: 65-day, 130-day, and 260-day. A good trade is to short tin versus lead, setting a profit target and symmetrical stop-loss at 13 percent. In other trades, the underweights to China and Korea surged, but short AUD/JPY and short copper/gold reached their stop-losses. The rolling 12-month win ratio stands at 57 percent. Chart I-12Tin Vs. Lead Tin Vs. Lead Tin Vs. Lead When the fractal dimension approaches the lower limit after an investment has been in an established trend it is a potential trigger for a liquidity-triggered trend reversal. Therefore, open a countertrend position. The profit target is a one-third reversal of the preceding 13-week move. Apply a symmetrical stop-loss. Close the position at the profit target or stop-loss. Otherwise close the position after 13 weeks. * For more details please see the European Investment Strategy Special Report “Fractals, Liquidity & A Trading Model,” dated December 11, 2014, available at eis.bcaresearch.com.   Dhaval Joshi Chief European Investment Strategist dhaval@bcaresearch.com Footnotes 1   ULEZ will be the zone inside London’s North Circular and South Circular Roads. Fractal Trading System   Cyclical Recommendations Structural Recommendations Closed Fractal Trades Trades Closed Trades Asset Performance Currency & Bond Equity Sector Country Equity Indicators Bond Yields Chart II-1Indicators To Watch - Bond Yields - Euro Area Indicators To Watch - Bond Yields - Euro Area Indicators To Watch - Bond Yields - Euro Area Chart II-2Indicators To Watch - Bond Yields - Europe Ex Euro Area Indicators To Watch - Bond Yields - Europe Ex Euro Area Indicators To Watch - Bond Yields - Europe Ex Euro Area Chart II-3Indicators To Watch - Bond Yields - Asia Indicators To Watch - Bond Yields - Asia Indicators To Watch - Bond Yields - Asia Chart II-4Indicators To Watch - Bond Yields - Other Developed Indicators To Watch - Bond Yields - Other Developed Indicators To Watch - Bond Yields - Other Developed   Interest Rate Chart II-5Indicators To Watch - Interest Rate Expectations Indicators To Watch - Interest Rate Expectations Indicators To Watch - Interest Rate Expectations Chart II-6Indicators To Watch - Interest Rate Expectations Indicators To Watch - Interest Rate Expectations Indicators To Watch - Interest Rate Expectations Chart II-7Indicators To Watch - Interest Rate Expectations Indicators To Watch - Interest Rate Expectations Indicators To Watch - Interest Rate Expectations Chart II-8Indicators To Watch - Interest Rate Expectations Indicators To Watch - Interest Rate Expectations Indicators To Watch - Interest Rate Expectations  

Highlights Copper prices will continue to rally, following a surge this week to highs not seen since early 2013 on the back of falling inventories, particularly in China, where physical demand has taken stocks to their lowest levels in almost 10 years (Chart of the Week). Physical premiums for the copper cathodes delivered to off-exchange bonded warehouses in China this week are up almost 60% since November – to $73/MT – providing further evidence of market tightness. Mine output in Peru, the second largest producer behind Chile, was down 12.5% to 2.15mm MT last year in the wake of COVID-19 containment measures. Given this large decline in output, the multi-year flattening of supply growth will continue. Upside demand pressure is building, as COVID-19 vaccination rates rise. Funding for the build-out of renewable energy generation is ramping up, and now includes expected US fiscal stimulus focused on renewables. Recovering global GDP, and China’s metals-intensive Five-Year Plan also will contribute to demand growth. We continue to expect COMEX copper to trade above $4/lb this year, but the likelihood this occurs in 1H21 (vs 2H21 as we earlier forecast) is increasing. Forward curves will become more backwardated, as markets continue to tighten. Feature Copper prices will continue to surge on the back of unexpected strength in Chinese demand, which has taken inventory levels to near-decade lows. This is something of an anomaly going into a Lunar New Year – the year of the Metal Ox – when activity typically slows. The big draw from global stocks that went into China’s inventories last year means global stocks will remain tight as the rest of the world continues its recovery from the COVID-19 pandemic (Chart 2). Particularly noteworthy are the huge drops in copper inventories held in the Shanghai Futures Exchange (SHFE, panel 3), and the London Metal Exchange (LME, panel 5), which are driving global drawdowns. Away from the commodity-exchange inventories, premiums for delivery of copper cathodes from bonded warehouses into China surged close to 60% from November levels to $73/MT earlier this week, as demand for physical material surges, according to reuters.com. Cathodes are used to make wire, tubes, for melting stock and in copper alloys. Demand for cathodes is rising outside China, which indicates they will retain a physical premium, even with exports from Chile restored to normal following weather-related disruptions. Chart of the WeekCopper Prices Surge As Global Storage Draws Copper Prices Surge As Global Storage Draws Copper Prices Surge As Global Storage Draws   Chart 2Falling Global Inventories Support Copper Prices Falling Global Inventories Support Copper Prices Falling Global Inventories Support Copper Prices Chart 3Sources of Copper Demand Strength Sources of Copper Demand Strength Sources of Copper Demand Strength This year’s departure from a seasonal demand downturn in Chinese copper demand likely is due to government efforts to limit travel to contain COVID-19 contagion, which means workers remain available to meet stronger demand for manufactured goods domestically and abroad. In addition, domestic demand – from electrification and infrastructure to housing – is particularly robust, which has kept pressure on inventories (Chart 3). Longer-Term Copper Demand Strength Baseline industrial, construction and infrastructure demand for copper – what’s already in place and continues to grow in line with the expansion of global GDP – will be augmented by the global build-out of renewables-based electricity generation, as the world moves toward a low-carbon future (Chart 4). Chart 4Incremental Renewables Demand Requires Significant Capex Copper Surge Welcomes Metal Ox Year Copper Surge Welcomes Metal Ox Year While this will not tax existing resources to the extent other materials will – e.g., copper demand from renewables will require less than 20% of existing identified reserves to meet cumulative demand to 2050 vs. the more than 100% of reserves required to meet cobalt demand by 2050 – this is still significant in a market requiring large capex increases to battle declining ore quality (Chart 5).1 Chart 5Higher Prices Needed To Spur Mining CAPEX Higher Prices Needed To Spur Mining CAPEX Higher Prices Needed To Spur Mining CAPEX Copper Supply Side Remains Challenged Short- and long-term challenges to global copper supply abound. Peru’s mine output was down 12.5% last year – to 2.15mm MT – in the wake of COVID-19 containment measures (Chart 6). Given Peru’s unexpectedly large decline in output, the multi-year flattening of supply growth we highlighted last month will continue.2 Indeed, we expect mined and refined output to show little or no growth this year, as was the case last year. This can partly be blamed on a lethargic recovery in mining capex, which hit a 10-year low in 2017. Longer term, as the continued global inventory drawdowns illustrate, the rate of growth in mined and refined production is far below the rate of growth in consumption globally. This is occurring as the pace of China’s recovery from COVID-19 aggregate demand destruction can be expected to start winding down later this year and growth ex-China ramps up (Chart 7). Chart 6Peru Posts Sharply Lower Output Peru Posts Sharply Lower Output Peru Posts Sharply Lower Output Prices for ore and refined copper will have to move higher to incentivize new production over the near term just to meet existing demand, to say nothing of new demand coming on from the global buildout in renewable-energy generation.3 Chart 7Supply Growth Lags Demand Growth Supply Growth Lags Demand Growth Supply Growth Lags Demand Growth Investment Implications As the rates of COVID-19 infection, hospitalization and deaths continue to fall globally, markets will begin to see evidence of an organic recovery in aggregate demand globally taking hold (Chart 8). We also expect this will remove a significant amount of the embedded risk premium in the broad trade-weighted USD, which will be bullish for commodities generally. The combination of organic growth and a weaker USD will boost the level of copper demand globally, even if China is slowing in 2H21, as our China Investment Strategy expects. This will put the weak y/y production growth in mined and refined copper in sharp perspective vis-à-vis copper demand, and will push copper prices higher. These fundamentals also will deepen the backwardation in CME COMEX copper futures for high-grade refined metal, as inventories continue to draw, and markets continue to tighten. We remain long the PICK ETF, and December 2021 COMEX copper futures, which are up 8.42% and 21.7% respectively since their inception dates on December 10, 2020 and September 10, 2020. Chart 8As COVID-19 Receeds Copper Demand Will Increase As COVID-19 Receeds Copper Demand Will Increase As COVID-19 Receeds Copper Demand Will Increase   Robert P. Ryan Chief Commodity & Energy Strategist rryan@bcaresearch.com   Commodities Round-Up Energy: Bullish The US EIA estimates December and January LNG exports will hover close to 10 BCF/d, continuing a trend noted at the end of last year (Chart 9). November and December LNG exports last year were at record levels – 9.4 BCF/d and 9.8 BCF/d. In January, LNG exports were 9.8 BCF/d, another record for that month. Below-normal temperatures in Asia have spurred demand for US LNG at a time when spot outages at other exporting states reduced global supplies. The EIA expects US LNG exports to average 8.5 BCF/d and 9.2 BCF/d this year and next. Working natural gas stocks at the end of January were 2.7 BCF, up 2% y/y and 8% over the rolling five-year average inventory level. Base Metals: Bullish The European Commission estimates EV nickel demand will be the “single-largest growth sector for nickel demand over the next twenty years.” In a study released by the Commission, global nickel demand is expected to increase by 2.6mm tons by 2040, versus 92k tons in 2020. Internal supply will be sufficient to meet demand for the 27 EU states to 2024/25, according to the study, and thereafter physical deficits will follow. The study notes that without an end-of-life recycling buildout, this deficit will persist, as mining.com noted in its report on the study. Precious Metals: Bullish After sustaining a triple bottom in at ~ $840/oz, platinum prices have rallied almost $400/oz since November (Chart 10). Lower supplies and investor demand drove the rally. Going forward, we expect increasing auto demand – first in China, and then, later, in the rest of the world as organic growth revives – will support demand for platinum-group metals, particularly for platinum and palladium. Platinum posted a 390k-ounce deficit in 2020, while palladium demand exceeded supply by just over 600k oz, according to Johnson Matthey, the PGM refiner. The world consumes ~ 10mm ounces of palladium and ~ 7mm ounces of platinum p.a. Ags/Softs: Neutral Corn, wheat and soybeans were trading 2 – 3% lower, following the USDA’s February 2021 World Agricultural Supply and Demand Estimates (WASDE) released on Tuesday. Markets drastically overestimated the amount by which the USDA would cut ending stocks for the 2020/21 crop year, with the Department trimming corn stocks to 1.5mm bushels (vs a 1.4mm bushel estimate of analysts), according to farmprogress.com. Chart 9 Copper Surge Welcomes Metal Ox Year Copper Surge Welcomes Metal Ox Year Chart 10 Platinum Price Rally USD 400 Since November Platinum Price Rally USD 400 Since November     Footnotes 1     Please see Table 13, p. 27 in Dominish, E., Florin, N. and Teske, S., 2019, Responsible Minerals Sourcing for Renewable Energy. Report prepared for Earthworks by the Institute for Sustainable Futures, University of Technology Sydney. 2     Please see Pandemic Uncertainty Will Fall, Weakening USD, Boosting Metals, published 28 January 2021. It is available at ces.bcaresearch.com. 3    Please see Renewables, China's FYP Underpin Metals Demand, published 26 November 2020. It is available at ces.bcaresearch.com.   Investment Views and Themes Recommendations Strategic Recommendations Commodity Prices and Plays Reference Table Summary of  Closed Trades Higher Inflation On The Way Higher Inflation On The Way

Highlights Pandemic uncertainty is keeping the USD well bid by raising global economic policy uncertainty. When this breaks – i.e., as higher vaccination rates push contagion rates down – the USD will resume its bear market. Renewable-energy output surpassed fossil-fuel generation in Europe for the first time in 2020. With the Biden administration re-committing to renewables, and China and Europe continuing their build-outs, copper demand will rise to meet grid-expansion needs. Copper mine output fell 0.5% in Jan-Oct 2020. Treatment and refining charges – already at 10-year lows – will remain depressed as supplies tighten. Major exchanges’ refined copper inventories were down 17% y/y in December, suggesting weak mine output continued into end-2020. Stocks will continue to fall this year, backwardating the COMEX's copper forward curve (Chart of the Week). Based on the World Bank’s forecast for real global GDP growth of 4% this year, and our expectation for a weaker USD, COMEX copper prices will likely breach $4.00/lb by 2H21. COVID-19 uncertainty drives metals: If infection and hospitalization rates outpace vaccinations, additional lockdowns in the US and Europe will stymie the recovery. Success in expanding vaccinations will push economic activity higher. We expect the latter outcome. Feature Pandemic uncertainty is driving global economic policy uncertainty, which is keeping a safe-haven bid under the USD (Chart 2). Chart of the WeekPhysical Copper Deficit Signals Continued Inventory Draws Physical Copper Deficit Signals Continued Inventory Draws Physical Copper Deficit Signals Continued Inventory Draws This continues to stymie the recovery in industrial commodity prices, particularly oil and base metals.1 The uncertainty caused by the COVID-19 pandemic feeds directly into global economic policy uncertainty, which drives USD safe-haven demand. Chart 2USD Remains In The Thrall Of Pandemic Uncertainty USD Remains In The Thrall Of Pandemic Uncertainty USD Remains In The Thrall Of Pandemic Uncertainty Pandemic uncertainty will not abate until vaccination distribution is sufficient to put infection, hospitalization and death rates on a clear downward trajectory, and remove the threat of widespread lockdowns, which once again are required to deal with rampant contagion rates and the possible spread of vaccine-resistant COVID-19 mutations locally and globally. As markets see empirical evidence of falling COVID-19-related infection, hospitalization and mortality, safe-haven demand for USD will weaken. Massive fiscal and monetary support will continue to support GDP globally, until organic growth takes off after sufficient populations are vaccinated, per the World Bank’s assumptions (Chart 3).2 Fiscal stimulus in the US exceeds 25% of GDP, and will continue to expand as the Biden administration rolls out additional spending measures. With the Fed remaining willing and able to accommodate this massive fiscal profligacy in the US, the USD will face increasing pressure on the downside as normalcy returns. Chart 3Massive Fiscal Support Globally Will Be Replaced By Organic Growth Pandemic Uncertainty Will Fall, Weakening USD, Boosting Metals Pandemic Uncertainty Will Fall, Weakening USD, Boosting Metals A weaker USD and stronger economic growth would boost copper prices this year and the next. A 5% decline in the broad trade-weighted USD this year would push spot COMEX copper prices above $4.30/lb, all else equal, while a 4% boost in world GDP – in line with the World Bank’s forecast for real growth this year – would lift prices to just under $4.05/lb, based on our modeling (Chart 4).3 Chart 4Lower USD, Stronger GDP Bullish For Copper Prices Lower USD, Stronger GDP Bullish For Copper Prices Lower USD, Stronger GDP Bullish For Copper Prices Renewable Generation Will Boost Copper Demand In addition to these stronger fundamentals, base metals demand – particularly for copper – will continue to benefit from the build-out of renewable-energy electricity generation globally, particularly in Europe and China. The return of the US to the Paris Agreement to combat climate change, and a renewed effort by the Biden administration to fund expanded renewable-energy resources will add to the increase in base-metals demand accompanying this global build-out (Chart 5).4 Europe is moving out ahead of the US in its deployment of renewable electricity generation, which, for the first time ever, surpassed fossil-fuel generation in 2020.5 S&P Global Market Intelligence this week reported renewable energy sources accounted for 38% of electricity generation in the EU vs 37% for fossil fuels. Renewables also surpassed fossil-fuel generation in the UK last year. Wind, solar and hydro all saw strong gains. Chart 5Copper Is Indispensible For A Low-Carbon Future Pandemic Uncertainty Will Fall, Weakening USD, Boosting Metals Pandemic Uncertainty Will Fall, Weakening USD, Boosting Metals Copper Supply Continues To Tighten It is important to once again note that all of these, and other renewable technologies, will require higher base metals output, none moreso than copper, which spans all renewable technologies. With copper-mining capex still weak and ore qualities falling in the mines that are producing, the supply side remains challenged (Chart 6). Over the past two years, p.a. supply growth on the mining side has been close to flat. The International Copper Study Group (ICSG) this week reported copper mine output fell 0.5% in the first 10 months of 2020. Refined copper output was up 1.5% over the same interval. Treatment and refining charges – already at 10-year lows – will remain depressed as supplies tighten. We expect full-year mined and refined output to fall on either side of zero growth for 2020, and 2021 (Chart 7).6 Major exchanges’ refined copper inventories were down 17% y/y in December, according to the ICSG, suggesting weak mine output continued into end-2020. An apparent increase in refined copper consumption of 2% noted by the ICSG also contributed to lower inventories. The Group estimates global refined copper balances adjusted for changes in Chinese bonded stocks, which are believed to have increased 105k tons y/y in the Jan-Dec 2020 interval, posted a physical deficit of ~ 380k tons. Chart 6Weak Capex, Lower Copper Ore Quality Remain Chief Supply-Side Challenges Weak Capex, Lower Copper Ore Quality Remain Chief Supply-Side Challenges Weak Capex, Lower Copper Ore Quality Remain Chief Supply-Side Challenges Chart 7Mined, Refined Copper Supply Growth Remains Weak Mined, Refined Copper Supply Growth Remains Weak Mined, Refined Copper Supply Growth Remains Weak We expect inventories will continue to fall this year – as seen in the Chart of the Week – as demand strengthens and supply growth remains weak, which will backwardate the COMEX copper forward curve. Metal Ox Year Brings Short-Term Uncertainties The approach of the Chinese New Year beginning 12 February 2021 normally would herald massive travel and celebration, which, all else equal, would dampen economic growth until festivities ended. This year, however, reports of a re-emergence of COVID-19 infections is casting doubt on this year’s celebrations. In addition, winter industrial curtailments to reduce pollution also should reduce short-term demand for metals generally. These transitory factors should show up in lower levels of economic activity on the industrial side. For this reason, we expect seasonal weakness to show up in 1Q21 activity, to be followed in 2Q21 by higher growth y/y. Bottom Line: Copper fundamentals continue to paint a bullish price picture, particularly on the supply side. Although risks abound on both sides of the market, we expect the massive support being provided by fiscal and monetary policy globally to transition to organic growth in 2H21, in line with the World Bank’s expectations. The enormous fiscal stimulus being unleashed by the US – coupled with an ultra-accommodative Fed – will result in a weakening of the USD that will provide a tailwind to copper prices in 2H21 and next year. We remain long the PICK ETF, expecting copper miners and traders to benefit from this bullish backdrop, which we expect to persist for the next decade. The recommendation is up 6.4% since inception December 10, 2020. We also remain long December 2021 copper, which is up 19.6% since it was recommended on September 10, 2020.   Robert P. Ryan Chief Commodity & Energy Strategist rryan@bcaresearch.com   Commodities Round-Up Energy: Bullish After falling 11% in 2020 due to COVID-19-induced demand destruction, US energy-related CO2 emissions will rebound this year and next, according to the Energy Information Administration (Chart 8).  The EIA forecasts US energy-related CO2 emissions this year and next will be 4.8 and 4.9 billion MT, which would amount to a 4.7% and 3.2% gains, respectively.  The EIA tracks emissions from coal, petroleum and natural gas usage in the US in its estimates.  Petroleum accounts for ~ 46% of total emissions in 2021 and 2022, while natgas contributes ~ 33% of all energy-related emissions in both years, on average.  Reflecting its market-share loss in the power-generation market, coal accounts for ~ 21% of total US energy-related CO2 emissions in 2021 and 2022. Base Metals: Bullish Globally, crude steel production was down 0.9% y/y at 1.864 billion MT, the World Steel Association reported this week.  China’s steel production was up 5.2% last year, to 1.053 billion MT, the country a market share of 56.5%, up from 2019’s level of 53.3%.  Output in all of Asia totalled 1.375 billion MT, up 1.5% y/y, with India’s production falling close to 11% to 99.6 billion MT.  China’s iron-ore imports set a record last year on the back of its strong steel-making performance, reaching 1.2 billion tonnes, a 9.5% increase y/y.  Higher infrastructure spending was the primary driver of increased steel demand last year.  Iron ore delivered to the Chinese port of Tianjin (62% Fe) closed just above $169/MT on Tuesday, up ~ 9% YTD. Precious Metals: Bullish Gold continues to trade ~ $1,850/oz, down more than $100/oz from its highs earlier this month on the back of persistent USD strength (Chart 9).  The pandemic uncertainty feeding into global economic policy uncertainty is the proximate cause of dollar strength.  COVID-19 vaccine rates are increasing, and governments remain committed to widespread distribution, which likely will be visible to markets during 1H21.  Once this occurs, we expect gold to rally along with other commodities, as the safe-have bid is priced out of the USD. Ags/Softs: Neutral US corn prices rallied on the back of stronger China purchases of the grain on Tuesday.  Farm Futures reported a 53.5mm-bushel order out of China on Tuesday was responsible for the gain earlier this week.  Farmers continue to expect Chinese buying to remain strong, given falling corn stocks in China. Chart 8 Pandemic Uncertainty Will Fall, Weakening USD, Boosting Metals Pandemic Uncertainty Will Fall, Weakening USD, Boosting Metals Chart 9 Gold Trading Lower On The Back of A Strong Dollar Gold Trading Lower On The Back of A Strong Dollar   Footnotes 1     At the margin, this increases the cost of purchasing commodities and lowers the cost of producing them ex-US in local-currency terms, both of which depress prices. Pandemic uncertainty and global economic policy uncertainty (GEPU) are cointegrated; the USD and GEPU also are cointegrated. We discussed the effects of pandemic uncertainty on the USD and its impact on oil prices in last week’s balances and price forecast update entitled Brent Forecast: $63 This Year, $71 Next Year. This report is available at ces.bcaresearch.com. 2     Please see the Bank's Global Economic Prospects released 5 January 2021 entitled Subdued Global Economic Recovery. The IMF upgraded its global growth outlook to 5.5% this year and 4.2% next year, in its World Economic Outlook Update released this week. We continue to use the more conservative World Bank forecasts. The Israeli economy is providing something of a natural experiment vis-à-vis the rate of COVID-19 vaccination and economic growth. According to reuters.com, the country got an early start on vaccinations, and has one of the highest rates in the world. If maintained, this will result in GDP growth of 6.3% in 2021 and 5.8% next year. Without these early and intensive vaccination rates, 2021 growth likely would be 3.5%. 3    The models in Chart 4 use the broad trade-weighted USD and global copper stocks as common regressors, and estimate copper prices given the World Bank estimates for World, EM ex-China, China and DM real GDPs. In the discussion above, we use elasticities from the World GDP model to highlight the impact of changes in copper prices from the different variables. 4    Please see Renewables, China's FYP Underpin Metals Demand, which we published 26 November 2020. We discuss the implications of essentially rebuilding the global electric-generation grid to accommodate more renewable energy resources vis-à-vis base metals demand. Copper, in particular, spans all technologies that will be deployed to achieve a low-carbon generation pool globally, as Chart 5 illustrates. 5    Please see For 1st time, renewables surpass fossil fuels in EU power mix published by S&P Global Market Intelligence 25 January 2021. 6    Benchmark treatment and refining fees charged by smelters to refine raw ore fell to 5.9 cent/lb this year, down from 6.2 cent/lb last year, according to reuters.com. This 10-year low reflects an abundance of smelting capacity relative to concentrates on the supply side needing to be refined.   Investment Views and Themes Recommendations Strategic Recommendations Commodity Prices and Plays Reference Table Summary of Closed Trades Higher Inflation On The Way Higher Inflation On The Way

Highlights Rising commodity prices and a weaker dollar will lead to higher inflation at the consumer level beginning this year. In the real economy, tighter commodity fundamentals – restrained supply growth, increasing demand, and falling inventories in oil, metals and grain markets – will push prices higher, which will feed US CPI inflation and inflation expectations going forward. Stronger fiscal stimulus, and the expanding budget deficits that will accompany it – along with the Fed’s oft-affirmed willingness to accommodate them – will allow the USD to resume its bear market, and will also boost commodity prices. Policy support will be kicking into a higher gear as COVID-19 vaccines are more widely distributed, contributing to a revival in organic growth globally. This will keep the rate of growth in commodity demand above that of supply. Increasing inflation expectations will be evident in longer-dated CPI swaps markets used by traders, portfolio and pension-fund managers to manage longer-term inflation risks (Chart of the Week). Risks remain elevated to the upside and downside: Fundamentals and policy are supportive; public-health risks are acute, and political risk is elevated, particularly in the US, where tensions remain high following the assault on the Capitol in Washington. Feature In the real economy, industrial commodities – particularly oil and copper – are signaling prices will move higher. The real economy and financial markets are pointing to higher inflation going forward. This will become apparent in the longer-term US CPI swaps markets used by traders, portfolio and pension managers as commodity prices continue to rise and the USD resumes its bear market.1 In the real economy, industrial commodities – particularly oil and copper – are signaling prices will move higher. Production-management in the oil market is keeping the rate of growth in supply below that of demand, a trend we expect will continue this year. In the copper market, demand growth will outstrip supply growth this year and next (Chart 2). As a result, both markets will see physical supply deficits this year. Chart of the WeekReal And Financial Markets Point To Higher Inflation Real And Financial Markets Point To Higher Inflation Real And Financial Markets Point To Higher Inflation Chart 2Copper Supply-Demand Balances Point To Growing Deficits Physical Deficits in Oil, Copper Indicate Supplies Are Tightening Copper Supply-Demand Balances Point To Growing Deficits Physical Deficits in Oil, Copper Indicate Supplies Are Tightening Copper Supply-Demand Balances Point To Growing Deficits Physical Deficits in Oil, Copper Indicate Supplies Are Tightening Fiscal stimulus in the US will be accommodated by the Fed, which, despite some dissonant messaging, continues to signal its policy of targeting average inflation can be expected to result in lower real rates, as inflation overshoots its 2% target. Policy support is helping to maintain commodity demand globally. Fiscal policy worldwide continues to be supportive. In the US, it likely will become even more expansionary, following the electoral wins of Democrats in Senate run-off elections last week, which will bolster president-elect Joe Biden's position in stimulus-package negotiations after he takes office next week. This expansion of fiscal stimulus will dwarf the levels seen in the wake of the Global Financial Crisis (GFC) in 2008-09 (Chart 3). This fiscal stimulus in the US will be accommodated by the Fed, which, despite some dissonant messaging, continues to signal its policy of targeting average inflation can be expected to result in lower real rates, as inflation overshoots its 2% target. This continued policy support will lead to a resumption of the USD bear market, following a brief dead-cat bounce over the past few days. This will support demand by lowering the local-currency costs of dollar-denominated commodities, and restrict supply growth at the margin by raising the local-currency cost of production. Chart 3Massive US Fiscal Stimulus Will Grow Higher Inflation On The Way Higher Inflation On The Way Real Economy Will Boost Inflation Expectations Global fiscal and monetary policy support will further energize the rebound in industrial activity and trade globally. This will keep the rate of growth in commodity demand generally above that of supply, and keep prices elevated. The top panel in the Chart of the Week shows the relationship between CPI 5-year/5-year (5y5y) swaps and crude oil and copper prices, price indexes like the DJ UBS commodity index and the S&P GSCI index, and EM trade volumes in the post-GFC period (2010 to now). The curve in the top panel shows the average of single-equation regressions that use these variables as to estimate CPI 5y5y swap rates; the average coefficient of determination for these equations is just below 0.81, meaning these real variables explain ~ 81% of the level of the CPI 5y5y swaps level post-GFC. This also illustrates how prices and activity in the real economy feed into inflation expectations, which we have demonstrated in the past.2 There also is a correspondence between our measures of real activity – i.e., BCA’s Global Industrial Activity index, Global Commodity Factor and EM Commodity-Demand Nowcast – and CPI 5y5y swaps can be seen in Chart 4. These gauges are more heavily weighted to industrial, manufacturing and trade activity than the commodity indexes, and have an average correlation of ~51% with the level of CPI 5y5y swaps. These series are not as highly correlated with CPI 5y5y swaps as the real and financial variables we used above, but they are, nonetheless, useful indicators to track. Chart 4Real Economic Activity Feeds Into Inflation Expectations Real Economic Activity Feeds Into Inflation Expectations Real Economic Activity Feeds Into Inflation Expectations Real Economic Activity Feeds Into Inflation Expectations Real Economic Activity Feeds Into Inflation Expectations Real Economic Activity Feeds Into Inflation Expectations Financial Markets Point To Higher CPI Swaps The Fed’s oft-affirmed willingness to accommodate expanding fiscal deficit strongly supports a weaker-dollar view. The bottom panel in the Chart of the Week shows the average of single-equation estimates that use dollar-related financial variables as regressors against CPI 5y5y swap rates – i.e., the USD broad trade-weighted index, the DXY index, and DM financial-conditions index; the average coefficient of determination for these equations is just below 0.83, meaning these financial variables explain ~ 83% of the CPI 5y5y swaps levels. The Fed’s oft-affirmed willingness to accommodate expanding fiscal deficits strongly supports a weaker-dollar view, which also will boost commodity prices and feed into the CPI swaps market. This fiscal and monetary support will be kicking into a higher gear as COVID-19 vaccines are more widely distributed, contributing to a revival in organic growth globally. This will keep the rate of growth in commodity demand above that of supply. As CPI swaps rates continue to move higher, longer-maturity TIPS breakevens will follow suit (Chart 5). We remain strategically long TIPS versus nominal US Treasuries. We remain strategically long TIPS. Chart 5Expect TIPS Breakevens To Stay Well Bid Expect TIPS Breakevens To Stay Well Bid Expect TIPS Breakevens To Stay Well Bid Risks Remain Elevated CPI 5y5y swap rates will move higher on the back of rising commodity prices, growth in real economic activity, and a weaker dollar. While fundamentals and policy continue to be supportive – and jibe with our longer-term view that industrial commodity prices will move higher – downside risks remain acute. On the health front, COVID-19 pandemic risks remain high, with public-health officials now warning the risk of a more contagious variant of the virus that emerged in the UK could become the dominant strain by March. Public health officials are considering expanded lockdowns to contain the spread of this strain, which reportedly is 50% to 74% more transmissible, according to the MIT Technology Review.3 Fed policy remains supportive of markets in general and commodities in particular. However, with officials offering conflicting views on the policy stance going forward – specifically re the need to taper sooner rather than later – uncertainty around monetary policy will remain a near-constant feature of the market. Lastly, short-term political risk is elevated, particularly in the US, where tensions are high going into the second impeachment of US President Donald J. Trump, following the assault on the US Capitol. This is an evolving story we will be following closely. Bottom Line: CPI 5y5y swap rates will move higher on the back of rising commodity prices, growth in real economic activity, and a weaker dollar. While risks remain elevated, we expect policy risks to be managed and for organic growth to pick up going into 2H21.   Robert P. Ryan Chief Commodity & Energy Strategist rryan@bcaresearch.com   Commodities Round-Up Energy: Bullish Brent prices reached an 10-month high on Tuesday at close to $57/bbl. Saudi Arabia’s surprise cuts will offset the slowdown in demand growth caused by renewed lockdowns in most DM countries, which is expected to be most pronounced in 1Q21. Consequently, in its most recent forecast, the EIA revised its demand estimate for OECD demand by -450k b/d on average in 2021. Separately, cold weather in Asia, combined with supply and shipping constraints, pushed JKM LNG prices close to $20/MMBtu earlier this week (Chart 6). The cold wave will push storage in Europe lower ahead of the summer injection season, as LNG cargoes are redirected towards Asia to meet higher space-heating demand. Base Metals: Bullish Chinese imports of metallurgical coal from Australia fell to 447.5k MT in December, the lowest level since January 2015, when Refinitiv, a Reuters data and analytics service, started tracking them. Met coal imports peaked last year in June 2020 at 9.6mm MT, according to reuters.com. The proximate cause of this collapse is the Chinese retaliation to Australia’s call for an investigation into the source of the COVID-19 pandemic. China’s imports from Indonesia have surged, while India’s imports from Australia have picked up much of the loss in Chinese demand, Reuters notes. Precious Metals: Bullish Gold prices fell by $78/oz to $1,834/oz on Friday – a 2-week low – following Democrats win in run-off elections that gave them both of Georgia’s Senate seats last week. The decline in gold prices largely reflects the rise in US real rates, which rose following an increase in US nominal rates that was not accompanied by higher inflation reports in the short term (Chart 7). Going forward, we expect investors will increasingly focus on inflation risks as fiscal policy in the US expands. Democrats will be able to provide extra COVID relief – increasing monthly income-support payments to individuals to $2,000 from $600 – in a reconciliation bill in 2021. This will pressure real rates down as inflation expectations steadily move higher. Ags/Softs: Neutral In its global supply-demand estimates released earlier this week, the USDA lowered its global grain and soybean production and yields forecasts, which pushed prices sharply higher. CME spot corn prices held sharp price gains, which sent futures limit up Tuesday, on the back of lower production and yields. Soybean and wheat futures also responded to reduced supply estimates in the wake of the WASDE release. Chart 6DECLINE IN GOLD PRICES REFLECTS A RISE IN US REAL RATES DECLINE IN GOLD PRICES REFLECTS A RISE IN US REAL RATES DECLINE IN GOLD PRICES REFLECTS A RISE IN US REAL RATES Chart 7TIGHTENING MARKETS PUSH UP LNG PRICES TIGHTENING MARKETS PUSH UP LNG PRICES TIGHTENING MARKETS PUSH UP LNG PRICES   Footnotes 1 We focus on US CPI swaps because they are responsive to the perceived stance of US monetary policy, even if the Fed’s preferred inflation gauge is the PCE deflator and not the CPI. US monetary policy has a strong bearing on the trajectory of US interest rates and the USD, which impacts commodity prices directly. Please see Treasury Inflation-Protected Securities (TIPS), posted by the US Treasury, which notes: TIPS “provide protection against inflation. The principal of a TIPS increases with inflation and decreases with deflation, as measured by the Consumer Price Index. When a TIPS matures, you are paid the adjusted principal or original principal, whichever is greater.” A fixed interest payment, which changes as the CPI changes, is made twice a year. 2 See, e.g., Trade And Commodity Data Point To Higher Inflation, which we published 27 July 2017. Our approach – i.e., treating inflation expectations as a function of global real variables and financial variables – is consistent with that of the Bank for International Settlements (BIS), which is described in Has globalization changed the inflation process?, posted 4 July 2019. We treat the events of the GFC and central banks’ responses to them as a regime change. In our modeling we estimate dynamic OLS and ARDL equations, to ensure we are modeling cointegrated systems. The average of the coefficients of determination estimated using real variables in DOLS models is pulled lower by the model using COMEX copper futures as an explanatory variable. 3 Please see We may have only weeks to act before a variant coronavirus dominates the US published by the MIT Technology Review 13 January 2021.   Investment Views and Themes Recommendations Strategic Recommendations Commodity Prices and Plays Reference Table Summary of Closed Trades Higher Inflation On The Way Higher Inflation On The Way

Dear Client, Please note that this report will be our final publication of the year (what a year!). In addition to the Special Report we are sending you, please join me for the two webcasts I am hosting ("China 2021 Key Views: Shifting Gears In The New Decade") today at 10:00AM EST (English) and Thursday at 9:00 AM Beijing/HK/Taipei time, 12:00 PM Australian Eastern time (Mandarin).  Our publishing schedule will resume on January 6, 2021 with our monthly China Macro and Market Review. Our China Investment Strategy team wishes you a safe, healthy, and happy holiday season! Best regards, Jing Sima, China Strategist   Highlights Chinese crude steel output growth will moderate considerably next year, leading to a sharp reduction in the country’s iron ore imports. Rising domestic iron ore production as well as increasing use of scrap steel will partially substitute Chinese overseas purchases of iron ore next year. In the meantime, the global iron ore output growth will likely be stronger in 2021 than this year. Both iron ore and steel prices are vulnerable to the downside in 2021. Feature Global iron ore prices have rallied over 60% since February, propelled by surging Chinese iron ore imports (Chart 1). China accounts for about 70% of global iron ore imports (Chart 2). Chart 1Iron Ore: Surging Prices On Strong Chinese Imports Chinese Commodities Demand: An Unsustainable Boom? Part II: Iron Ore Chinese Commodities Demand: An Unsustainable Boom? Part II: Iron Ore Chart 2China Accounts For 70% Of Global Iron Ore Imports Chinese Commodities Demand: An Unsustainable Boom? Part II: Iron Ore Chinese Commodities Demand: An Unsustainable Boom? Part II: Iron Ore Iron ore is mainly used in the steel-making process. The surge in Chinese iron ore imports this year was largely due to its strong crude steel1 output growth. Chart 3Strong Crude Steel Production In China Chinese Commodities Demand: An Unsustainable Boom? Part II: Iron Ore Chinese Commodities Demand: An Unsustainable Boom? Part II: Iron Ore For past six months of this year, crude steel output increased by 8.2% compared with a year ago in China, while having contracted considerably in the rest of world (Chart 3, top panel). As the world’s largest steel producer, China currently accounts for 60% of world crude steel output (Chart 3, bottom panel).  However, the odds are that China’s crude steel output growth will decline considerably next year causing a sharp reduction in the country’s iron ore imports. In addition, rising domestic iron ore extraction as well as increasing use of scrap steel next year also point to a drop in Chinese iron ore imports in 2021. Moreover, global iron ore output is set to increase in 2021, putting further downward pressure on iron ore prices. While global steel output outside of China will likely increase next year, the increase in the world ex-China’s iron ore imports will not offset the drop in the Chinese iron ore imports. This is because nearly half of steel output outside China uses an electric-furnaced steelmaking process mainly requiring scrap steel. Puzzling Surge In Chinese Iron Ore Imports Chart 4Stronger Steel Output Growth But Weaker Iron Ore Imports In 2018 And 2019 Chinese Commodities Demand: An Unsustainable Boom? Part II: Iron Ore Chinese Commodities Demand: An Unsustainable Boom? Part II: Iron Ore It is not always true that strong Chinese steel output growth will boost the country’s iron ore imports. China’s annual crude steel output growth was much higher in both 2018 and 2019 than this year. Yet, the country’s iron ore imports still dropped by 1% in 2018 and only rose slightly in 2019, much lower than the strong 11% growth so far this year (Chart 4). The surge in Chinese iron ore imports this year was due not only to strong domestic steel output, but also to limited scrap steel availability, weak domestic iron ore production, and low domestic iron ore inventory. First, scrap steel availability and domestic iron ore supply can be swing factors that determine Chinese iron ore imports. Both scrap steel and domestically mined iron ore can be used as a replacement for imported iron ore in the steel-making process. China’s post-pandemic steel output growth this year reached a similar rate as in 2019, but this year’s scrap steel availability was limited due to a pandemic-induced disruption in the domestic scrap steel supply chain earlier this year. Meanwhile, Chinese authorities started clamping down on ferrous scrap imports in July 2019 due to environmental concerns. This has caused a collapse in the country’s scrap steel imports since then (Chart 5). Chart 5Tighter Scrap Steel Supply In 2020 Chinese Commodities Demand: An Unsustainable Boom? Part II: Iron Ore Chinese Commodities Demand: An Unsustainable Boom? Part II: Iron Ore In comparison, the scrap steel supply was more abundant in the past two years, thereby reducing the need for the country’s iron ore imports. China’s supply-side reforms and a nationwide clampdown on illegal sub-standard steel (Ditiaogang) production in 2017 led to a significant increase in scrap steel supply for steel producers in 2018. The World Steel Association data shows that Chinese crude steel output from the electric-furnace steel-making process—mainly using scrap steel as the feedstock—jumped significantly to a 33% annual growth rate in 2018.  In 2019, despite the decline in the country’s scrap steel imports, total scrap steel supply in China still had a net increase due to a 9% year-on-year growth in domestic scrap steel supply. Second, China’s domestic iron ore output during the first ten months of this year only rose by 0.4% year on year, compared with the sharp increase of approximately 11% in 2019 (Chart 6, top panel). Chart 6Weaker Domestic Iron Ore Output Growth This Year Chinese Commodities Demand: An Unsustainable Boom? Part II: Iron Ore Chinese Commodities Demand: An Unsustainable Boom? Part II: Iron Ore Finally, China’s iron ore inventory level remains low relative to its crude steel output this year, following a substantial destocking cycle in 2018 and 2019 (Chart 6, bottom panel). Chinese ore inventory increased by three million tons so far this year, after having declined 14 million tons in 2019 and nine million tons in 2018. Bottom Line: The surge in Chinese iron ore imports this year was due not only to strong domestic steel output, but also to low iron ore inventory, weak domestic iron ore production and limited scrap steel availability. Substitutes For China’s Imported Iron Ore Both domestic iron ore output and scrap steel supply are likely to rise in 2021. This will reduce the need for imported iron ore in China’s steel-making process.  Chart 7Chinese Iron Ore Output Is Set To Go Up In 2021 Chinese Commodities Demand: An Unsustainable Boom? Part II: Iron Ore Chinese Commodities Demand: An Unsustainable Boom? Part II: Iron Ore The considerable increase in profit margins for Chinese iron ore domestic miners and a declining number of loss-generating companies herald an upside for iron ore output in China (Chart 7). Chinese iron ore output in the past 12 months was still 56% lower than its peak output in 2014. We expect a 5-7% increase in the country’s iron ore output in 2021. Domestic scrap steel supply will also increase considerably in the coming years as the country puts more emphasis on the “green and sustainable development” of its economy. The increasing use of scrap steel clearly fits this narrative, as using one ton of scrap steel in the steel-making process can reduce emissions of 1.6 tons of carbon dioxide and three tons of solid waste.   Chinese domestic scrap steel supply is expected to reach 290-300 million tons by 2025 from approximately 240 million tons in 2019. This suggests an annual increase of about eight to 10 million tons in the country’s domestic scrap steel supply over the next five years. The use of one ton of scrap steel in the steel-making process can reduce iron ore imports by 1.65 tons. This means the increase of eight to ten million tons of scrap steel could reduce iron ore imports by about 13-17 million tons in the coming year. All else being equal, this alone would reduce this year’s 1,074 million tons of Chinese iron ore imports by 1.2-1.5% in 2021.   Moreover, China is also likely to allow the resumption of ferrous scrap imports in 1H2021. The country plans to reclassify eligible ferrous scrap as a recyclable resource so it would be no longer subject to the import ban. The country is expected to release new standards for steel scrap imports by the end of 2020. Scrap imports peaked at 13.7 million tons in 2009 and plunged to 180,000 tons by 2019. We expect China’s scrap steel imports to increase to 1-1.5 million tons in 2021 (Chart 5 on page 4).  The increased use of steel scrap and domestic iron ore will boost the bargaining power for Chinese steelmakers, as there will be greater volumes of raw materials available to Chinese steel mills. Bottom Line: The availability of steel scrap and domestic iron ore is set to increase for Chinese steel producers. This will likely lead to a considerable reduction in Chinese iron ore imports in 2021. What About China’s Steel Output In 2021? Chinese steel output remains a major determinant for the country’s iron ore imports. The growth of crude steel output in China is generally determined by the country’s underlying steel demand, the steel companies’ profit margins, and the extent of capacity expansion in that year. It is also subject to the government’s regulations in the steel sector.2 Chart 8Chinese Steel Consumption Structure Chinese Commodities Demand: An Unsustainable Boom? Part II: Iron Ore Chinese Commodities Demand: An Unsustainable Boom? Part II: Iron Ore First, our research shows that Chinese underlying steel demand growth will decline considerably next year. Chart 8 shows the structure of China’s underlying steel consumption in 2019. Chart 9Weaker Steel Demand Growth From Construction In 2021 Chinese Commodities Demand: An Unsustainable Boom? Part II: Iron Ore Chinese Commodities Demand: An Unsustainable Boom? Part II: Iron Ore About 55% of Chinese steel consumption is consumed in the construction sector. The sector includes development of properties and traditional infrastructure. There is a close correlation between building construction area starts and Chinese total steel demand proxy (Chart 9, top panel). The latter is calculated as China’s steel output plus net imports. Steel is heavily used in the early construction stage of buildings. Traditional infrastructure3 is also a major user of steel products. This year’s boost in traditional infrastructure investment also contributed a sharp rebound in steel use (Chart 9, bottom panel). As government credit and fiscal stimulus have already peaked, traditional infra-structure investment growth will decelerate from the current level. The weakness will be especially pronounced in 2H2021. Regarding building construction, in the October report, we made a case for a moderate growth in property starts over the following six months. For 2021 in its entirety, odds favor a slight contraction in building construction starts. The country’s property demand faces strong structural headwinds. In the meantime, the Chinese authorities seem determined to deleverage the country’s real estate developers. Hence, subdued property demand and shortage of financing for real estate developers will likely to lead to a decrease in building starts. Chart 10Chinese Machinery Output Will Likely Have A Growth Deceleration Next Year Chinese Commodities Demand: An Unsustainable Boom? Part II: Iron Ore Chinese Commodities Demand: An Unsustainable Boom? Part II: Iron Ore   The machinery sector accounted for 17% of Chinese steel consumption in 2019. Chinese machinery output has experienced significant growth this year due to fiscal stimulus. For example, construction machinery, including excavators, loaders, cranes, road rollers, bulldozers, ball graders and spreaders, surged 40% over the past six months and the annualized output reached a record high (Chart 10). We expect a growth deceleration in Chinese machinery output next year due to peak stimulus in 4Q2020. The automobile and shipbuilding sectors accounted for 6% and 2% of Chinese steel consumption in 2019, respectively. Automobile output showed a strong rebound in the past six months while the output of civilian ships was still in a deep contraction during the same period (Chart 11). We expect steel consumption in both sectors to improve only slightly in 2021, which will not offset the steel demand growth reduction in the construction and machinery sectors. The home appliance sector contributed 2% of Chinese steel consumption in 2019. Next year’s government-targeted stimulus in the consumption segment may provide a boost in output of home appliances, albeit a modest one (Chart 12). In addition, global demand for freezers and refrigerators due to the pandemic may diminish. Overall, we expect steel consumption in the home appliance sector will grow only slightly. Chart 11Steel Consumption Next Year Will Rise Slightly In Automobile And Shipbuilding Sectors… Chinese Commodities Demand: An Unsustainable Boom? Part II: Iron Ore Chinese Commodities Demand: An Unsustainable Boom? Part II: Iron Ore Chart 12… As Well As In The Home Appliance Sector Chinese Commodities Demand: An Unsustainable Boom? Part II: Iron Ore Chinese Commodities Demand: An Unsustainable Boom? Part II: Iron Ore The China Iron and Steel Association estimates that Chinese steel demand year-on-year growth for the first ten months of this year was at about 10.3%. We expect it to fall considerably to 3-5% next year, mainly due to diminishing steel demand growth in the construction and machinery sectors; combined, this accounts for about 72% of Chinese steel demand. Second, weakening demand growth will push down steel prices more than iron ore prices, resulting in a profit margin squeeze. This will force some unprofitable steel-making companies out of the market.   Chart 13Falling Profit Margins Of Chinese Steel Producers May Weigh On Their Steel Output Chinese Commodities Demand: An Unsustainable Boom? Part II: Iron Ore Chinese Commodities Demand: An Unsustainable Boom? Part II: Iron Ore Chart 13 shows a close correlation between crude steel output and steelmakers’ profit margins. Despite a recent rebound, Chinese steel producers’ profit margins have fallen sharply from last year. Finally, the new version of the capacity swap policy for the steel sector, which is expected to be released soon, will get stricter. The capacity swap policy, introduced by the authorities in 2017 and in effect since January 1, 2018, has allowed steel producers to add new capacity to replace obsolete capacity at a ratio of 1:1-1.25 (the range depends on region). Recently, it has been reported that the new version of the capacity swap policy will raise the ratio to 1:1.25-1.5. This new policy, if implemented next year, will likely curb new steel production capacity in 2021. Bottom Line: China’s steel output growth is likely to drift lower next year mainly due to diminishing steel demand growth. This will also weigh on Chinese iron ore imports. More Global Iron Ore Supply In 2021 Global iron ore supply outside China will go up next year due to larger capex. The world’s top four iron ore producers—Rio Tinto, Vale, BHP and Fortescue Metals Group (FMG) account for about half of global iron ore production. The year-on-year growth of their aggregate iron ore output will likely increase from 2% this year to 4-6% in 2021.  Table 1 shows the capex of these four companies this year and in 2021. All four will increase their capex considerably in 2021. Table 1The Capex of the World’s Top Four Iron Ore Producing Companies In 2020 & 2021 Chinese Commodities Demand: An Unsustainable Boom? Part II: Iron Ore Chinese Commodities Demand: An Unsustainable Boom? Part II: Iron Ore Chart 14Both Australian And Brazilian Iron Ore Producers Are Set To Increase Their Iron Ore Output Chinese Commodities Demand: An Unsustainable Boom? Part II: Iron Ore Chinese Commodities Demand: An Unsustainable Boom? Part II: Iron Ore Their aggregate capex will surge by 22% year on year in 2021. In particular, FMG4 will boost its capex by 60% next year. In 2019, 92% of FMG’s iron ore sales went to China. Next year, we expect Vale to considerably increase its iron ore output and exports to compete with Australian iron ore miners (Chart 14).  Very high current iron ore prices will likely boost the capex of other iron ore producers next year as well. We expect global iron ore output growth to accelerate in 2021. Moreover, the giant Simandou iron ore deposit in Guinea—the often-called “Pilbara-killer” (the Pilbara region accounts for over 90% of Australian iron ore exports)—is getting closer to development (Box 1).       Box 1 The Giant Simandou Iron Ore Deposit There are four blocks in the Simandou deposit, all of which involve participation from Chinese companies. The SMB-winning consortium—including one Singaporean company, one Guinean company and three Chinese companies—won the tender last year to develop blocks 1 and 2. Rio Tinto, Chinalco and the Guinean government own blocks 3 and 4. Last month, Guinea’s government approved the consortium’s plan to build a railroad and deep-water port to export output from the massive Simandou iron ore deposit to key markets including China. The consortium aims to bring the two blocks into production by 2025, with the first phase of iron ore export targeted at 80 million tons. One estimate is that Guinea’s combined annual iron ore production from blocks 1-4 could be 120 million tons per year (phase 1) by 2026 and may increase to 220 million tons per year (phase 2) by 2030. The 220 million tons of iron ore is equivalent to approximately 15% of the global seaborne iron ore trade in 2019. Investment Implications Chart 15Both Iron Ore And Steel Prices Are Vulnerable To The Downside In 2021 Chinese Commodities Demand: An Unsustainable Boom? Part II: Iron Ore Chinese Commodities Demand: An Unsustainable Boom? Part II: Iron Ore Both iron ore and steel prices are vulnerable to the downside next year. We expect prices of Chinese imported iron ore (62% grade) to decline around 30% from current US$155 per ton to about US$100-110 per ton in 2021 (Chart 15, top panel). We expect the Chinese steel products price index to drop 15% from the current 158 to the range of 130-140 in RMB terms in 2021 (Chart 15, bottom panel).   Ellen JingYuan He  Associate Vice President ellenj@bcaresearch.com   Footnotes 1According to the World Steel Association, crude steel is defined as steel in its first solid (or usable) form, including ingots, semi-finished products (billets, blooms, slabs), and liquid steel for castings. 2For example, there were mandated production cuts during the supply-side reform in the previous several years and frequent output halts aiming to reduce winter pollution. 3Traditional infrastructure is made up of three categories: (1) transport, storage and postal services; (2) water conservancy, environment and utility management; and (3) electricity, gas and water production and supply. 4In November 2020, FMG signed 12 memoranda of understanding (MoU) with major Chinese steel mills, procurement partners and financial institutions on the sidelines of the third China International Import Expo. The MoUs are valued cumulatively in the range of US$3 to $4 billion. Cyclical Investment Stance Equity Sector Recommendations