Gold

Highlights The dollar is fighting a tug of war between two diverging forces: an economic slowdown around the world but plunging real interest rates in the US. The litmus test for determining which force will gain the upper hand is if the DXY fails to break above the 93-94 level that marked the March highs. So far that appears to be the case. In the interim, investors can capitalize on a few themes that will ultimately unfold: an end to the China slowdown, a bet on real rates staying low for longer, and a play on the Olympics. The expressions of these themes are long AUD/MXN, long silver and long the yen, respectively. Natural disasters are also rising in frequency globally. Historically, this has coincided with rising currency volatility. Long CHF/NZD positions can be a potent play on this trend. We ultimately expect the dollar lower 9-12 months from now. The best currencies to express this view today are NOK and SEK. Feature We are a month into the second half of year, and it is instructive to revisit the dollar view and our roadmap towards year-end. As a starting point, two key themes are propping the dollar on a tactical basis: The first is a global economic slowdown, one that could be exacerbated by increased infections of the COVID-19 Delta variant. The dollar tends to rise in an environment where global growth is weak. This is especially the case when US growth is relatively resilient, like now (Chart I-1). The second is the resilience of the US equity market, not only due to superior earnings, but also as regulatory crackdowns hit shares in China specifically, and emerging markets in general. Equity inflows into the US were a key reason the dollar did not collapse in 2020. Renewed inflows into US equities will be particularly beneficial for the dollar (Chart I-2). This will especially be the case if technology and healthcare earnings keep surprising to the upside. Chart I-1The Dollar And Relative Economic Momentum The Dollar And Relative Economic Momentum The Dollar And Relative Economic Momentum Chart I-2The US Is Leading The Earnings ##br##Cycle The US Is Leading The Earnings Cycle The US Is Leading The Earnings Cycle At the same time, real interest rates in the US are very depressed. In its latest meeting, the Federal Reserve reiterated that it will keep running the economy hot, a thesis central to our bearish dollar view. This puts the dollar in a tug of war between two diverging forces: an economic slowdown around the world but plunging real interest rates in the US. Arbitrating The Tug Of War Historically, unless the world economy experiences a recession, the interest rate story has dominated currency market action. Our report last week showed that real interest rates matter for currencies both short term and longer term. Given our bias that global growth will moderate rather than contract, the future path of interest rates will once again become important for currency market action. In this light, lower real rates are negative for the US dollar. How long the outperformance of US equities will last is a tougher call. What we do know is that in a rising interest rate environment, the US equity market has tended to derate relative to the rest of the world. Our base case is that bond yields will be higher globally on a cyclical horizon, suggesting investors should fade the current outperformance of US equities. Scandinavian Currencies As A Strategic Dollar Play The best currencies to express a cyclically lower dollar are the NOK and SEK, for a few reasons other than the strong correlation with the DXY index (Chart I-3): Chart I-3NOK And SEK Are A Play On DXY NOK and SEK Are A Play On DXY NOK and SEK Are A Play On DXY Economic momentum in both Norway and Sweden is picking up steam. In Norway, high oil prices will be a cyclical boost to the currency, as has been the case historically. Meanwhile, Sweden is benefiting from a strong manufacturing landscape, especially in autos where pricing has skyrocketed due to shortages. While the Swedish manufacturing PMI has moderated recently, it still sits at 65.8, the highest level since the mid-1990s. Both currencies remain very cheap according to our models. Our favored PPP model shows that NOK and SEK are trading at a discount of 20% and 17% respectively, amongst the cheapest in the G10 (Chart I-4). Chart I-4The Dollar Is Expensive Trade Themes Into Year End Trade Themes Into Year End Norway, Sweden and Canada are among the countries whose output gaps are expected to close relatively fast (Chart I-5). In the case of Norway (and Canada), the central bank has been vocal about curtailing monetary accommodation, as market conditions improve. The upside surprise in Swedish GDP this week lowers the odds of more monetary accommodation from the Riksbank. This will boost real rates in these countries, supporting their currencies. Chart I-5Output Gaps Across The G10 Trade Themes Into Year End Trade Themes Into Year End In a nutshell, if the dollar heads lower 9-12 months from now, this will benefit most procyclical currencies, with the NOK and SEK as winners. The Yen As An Olympian Chart I-6Currencies And The Olympics Trade Themes Into Year End Trade Themes Into Year End We made the case last month that the yen was the most underappreciated G10 currency, and that certainly remains true.  Since then, there has been improvement in the Japanese economy: The vaccination campaign is progressing smoothly, with 27% of the population having been inoculated from almost nil earlier this year. Meanwhile, about 38% have received at least one dose. This should curtail hospitalizations, despite the increase in new cases. Economic momentum remains tepid, but there are green shoots. Real cash earnings are inflecting higher, which is boosting household spending. There was also remarkable improvement in the Eco Watchers Survey, a sign of optimism among small and medium-sized businesses. Global trade remains strong, which is a boost to the Japanese external sector. While this may slow going forward, it will be a benign headwind. Japan is less exposed to China, a key market for exports, compared to its developed market peers like Australia and New Zealand. Meanwhile, China is already easing policy at the margin. The true catalyst for the yen could be the Olympics. Since the 1970s, the median performance of a currency hosting the Olympics is 4% over a year. The performance of the yen today falls well below the 25th percentile of this performance gap (Chart I-6). This year’s games have obviously been unique given the pandemic but given that the yen is the most shorted G10 currency, this is probably already in the price. It also it does raise the prospect that the yen rises from being an underdog to staging a powerful mean reversion rally. While Japan will not get a tourism boost this summer that will buffet discretionary spending, foreigners are likely to return as the pandemic is put behind us. It is remarkable that Japanese shares, even construction and material companies, that should have benefited from the leadup to the Olympics, have massively underperformed (Chart I-7). This suggests that at the margin, many investors have folded hands and sold Japanese equities indiscriminately. Chart I-7Japanese Shares Have Underperformed Japanese Shares Have Underperformed Japanese Shares Have Underperformed Finally, real rates in Japan are among the highest in the G10. This will not only prevent Japanese concerns from deploying yen cash on foreign paper, but could also lead to some repatriation of funds, boosting the yen. Low Real Rates: Buy Silver (And Platinum) The case for buying silver has become compelling, at least on a tactical basis. First, the runup in prices from under $12/oz in March to almost $30/oz in August ushered silver into a well-defined wedge formation, with a series of higher lows. We are now sitting close to the lower bound of this wedge. Given our expectation that any DXY rally will be capped at 93-94, this puts a solid floor under silver prices around the $22-$23/oz level (Chart I-8). This makes for an attractive risk/reward since silver could overtake its 2011 highs near $50/oz, once strong resistance at $30/oz is breached. Second, similar to gold, silver benefits from low interest rates, plentiful liquidity, and the incentive for fiat money debasement. But unlike gold or even cryptocurrencies, physical use for silver is quite elevated. Silver fabrication demand benefits from electronic production (whereby there is a shortage, so it is bound to eventually increase), as well as new green industries such as solar power that are dominating the manufacturing landscape (Chart I-9). Meanwhile, our Commodity & Energy Strategists have flagged that the surplus of silver is expected to shrink significantly this year, driven by both industrial and investment demand (Chart I-10). Chart I-8Buy Some Silver Buy Some Silver Buy Some Silver Chart I-9Silver Demand Is Picking Up Trade Themes Into Year End Trade Themes Into Year End Chart I-10The Silver Surplus Is Shrinking Trade Themes Into Year End Trade Themes Into Year End Third, silver is also a more potent play on a lower dollar. This is because the silver market is thinner and more volatile, with futures open interest at about one-third that of gold. Put another way, volatility in silver has always been historically higher than gold, which is why silver tends to outperform gold when the dollar is falling (Chart I-11). Chart I-11Silver Is A More Potent Play On The Dollar Silver Is A More Potent Play On The Dollar Silver Is A More Potent Play On The Dollar It is worth pointing out that the velocity of money between the US and China is slowing again, suggesting growth is likely to start outperforming outside the US, beyond the current slowdown. The US benefits less from a pickup in Chinese growth, compared to other countries. This has generally pushed the dollar lower and set fire under the silver/gold ratio (Chart I-12). Finally, there is also a case to be made for platinum. It has lagged both gold and palladium prices (Chart I-13). Meanwhile, breakthroughs are being made in substituting palladium for platinum in gasoline catalytic converters. Chart I-12Money Velocity And The GSR Money Velocity And The GSR Money Velocity And The GSR Chart I-13Platinum And Silver Have Lagged Gold Platinum And Silver Have Lagged Gold Platinum And Silver Have Lagged Gold China Slowdown Almost Over: Buy AUD/MXN Soon We highlighted in February that a tactical opportunity had opened to go short the AUD/MXN cross. With the cross down 11% from its recent highs, an opportunity to go long will soon open up. China has started easing policy at the margin. The AUD/MXN cross correlates quite strongly with the Chinese credit cycle, as Australia is economically tied to China while Mexico depends more on the US (Chart I-14). The Australian PMI has remained quite firm, despite a slowdown in the Chinese credit impulse. Strong commodity prices have been a factor, but it also points to endogenous strength in the Aussie economy. Relative terms of trade favor the Aussie. We had expected terms of trade between Australia and Mexico to relapse on the basis of destocking in China, but that has not been the case (Chart I-15). With oil prices structurally challenged by EVs, while metal prices benefit from the buildout of green infrastructure, terms of trade will remain favorable for the cross longer term. Australian stocks have been underperforming the more defensive Mexican bourse (Chart I-16). This should reverse as cyclicals start to regain the upper hand. Chart I-14AUD/MXN Tracks Chinese Credit AUD/MXN Tracks Chinese Credit AUD/MXN Tracks Chinese Credit Chart I-15AUD/MXN And Terms Of Trade AUD/MXN And Terms Of Trade AUD/MXN And Terms Of Trade Chart I-16AUD/MXN And Relative Equity Prices AUD/MXN And Relative Equity Prices AUD/MXN And Relative Equity Prices The timing for a long position is tricky as Chinese economic activity is likely to slow in the coming months, and cyclical equities could remain under pressure. Meanwhile, as value investors, we are also uncomfortable with AUD/MXN valuations. This suggests that in the very near term, short positions still make sense. That said, the 13-14 zone should provide formidable support to go long, an opportunity likely to unfold in the next 3 months (Chart 17).  Chart I-17AUD/MXN And Momentum AUD/MXN And Momentum AUD/MXN And Momentum A Final Thought On Rising Catastrophes We have been watching with obvious trepidation the rising incidence of catastrophes globally. The occurrence of weather events such as droughts, floods, storms, cyclones, and wildfires has been skyrocketing (Chart I-18). Chart I-18Disasters And Volatility Trade Themes Into Year End Trade Themes Into Year End The direct play is to buy global construction and machinery stocks that are likely to benefit from increased reconstruction activity. It also favors agricultural futures. As for currency markets, the one observation is rising volatility with the VIX having spiked significantly in the years with numerous weather events.  We are already long CHF/NZD and the yen as a play on rising currency volatility, and we will be exploring this thesis more deeply in future publications.    Chester Ntonifor Foreign Exchange Strategist chestern@bcaresearch.com Currencies U.S. Dollar Chart II-1USD Technicals 1 USD Technicals 1 USD Technicals 1 Chart II-2USD Technicals 2 USD Technicals 2 USD Technicals 2 Data out of the US this week was relatively robust: The Markit manufacturing PMI for July edged up from 62.1 to 63.1. That said, the services PMI fell from 64.6 to 59.8. Durable goods orders were rather weak, rising 0.8% year on year in June, versus a consensus of a 2.2% increase. Admittedly, the core non-defense measure, excluding aircraft and parts, rose by 0.5% from 0.1%. Consumer confidence remains resilient, rising from 127.3 to 129.1 in July, well above expectations. Q2 GDP came in at 6.5% quarter on quarter, versus an 8.4% consensus. The US dollar DXY index fell this week. The Fed meeting highlighted that the authorities are in no rush to tighten monetary policy, despite what has been a robust recovery in labor market conditions and inflation. The aftermath of the meeting saw a drop in US real yields and the dollar. The Fed’s dovish stance has been a central theme to our bearish dollar view. Report Links: Arbitrating Between Dollar Bulls And Bears - March 19, 2021 The Dollar Bull Case Will Soon Fade - March 5, 2021 Are Rising Bond Yields Bullish For The Dollar? - February 19, 2021 The Euro Chart II-3EUR Technicals 1 EUR Technicals 1 EUR Technicals 1 Chart II-4EUR Technicals 2 EUR Technicals 2 EUR Technicals 2 Data out of the eurozone this week softened: The manufacturing PMI fell to 62.6 in July from 63.4. The services PMI surprisingly improved, rising from 58.3 to 60.4 in July. Economic confidence rose from 117.9 to 119 in July. The German IFO survey was below consensus in July, but the expectations component did rise from 99.6 to 100.4. The euro rose by 1% this week. We went long the euro at 1.18 on expectations that at the margin, monetary policy in the euro area will shift in a more hawkish fashion. Since then, the ECB has adopted a symmetric inflation target, promising to keep interest rates low for longer. The euro’s indifference to this dovish development suggests a strong floor under the currency, and upside should euro area growth beat consensus. Report Links: Relative Growth, The Euro, And The Loonie - April 16, 2021 The Euro Dance: One Step Back, Two Steps Forward - April 2, 2021 On Japanese Inflation And The Yen - January 29, 2021 The Japanese Yen Chart II-5JPY Technicals 1 JPY Technicals 1 JPY Technicals 1 Chart II-6JPY Technicals 2 JPY Technicals 2 JPY Technicals 2 Japanese data was rather mixed this week: The Jibun manufacturing PMI eased slightly in July, to 52.2 from 52.4. The services component also fell to 46.4. Department store sales came in at 3.7% year on year in June. We highlighted last week that supermarket sales also remain strong. The yen was up 0.4% against the dollar this week. In the history of the Olympics, the incumbent currency has tended to rise over the course of the year. Given the yen is the most shorted developed-market currency currently, this sets it up for a coiled spring rebound. Report Links: The Case For Japan - June 11, 2021 The Dollar Bull Case Will Soon Fade - March 5, 2021 On Japanese Inflation And The Yen - January 29, 2021 British Pound Chart II-7GBP Technicals 1 GBP Technicals 1 GBP Technicals 1 Chart II-8GBP Technicals 2 GBP Technicals 2 GBP Technicals 2 There were some mixed data out of the UK this week: Retail sales in the UK were in line with expectations. The measure excluding automobiles and fuel rose by 7.4% year on year in June. The PMIs generally slowed from very strong levels. The manufacturing print for July was 60.4, while the services component came in at 57.8. House price inflation remains strong, with the nationwide measure coming in at 10.5% year on year in July. Mortgage approvals fell slightly in June but remain at a robust 81.3K. The pound rose by 1.5% this week. The big surprise in the UK has been a reversal in the COVID-19 infection rate, despite an economy that is reopening quite briskly. This sets cable up for a volatile few weeks and months, given a poor technical picture (speculations are cutting long positions from very aggressive levels). We like GBP long term but will stand aside for now. Report Links: Why Are UK Interest Rates Still So Low? - March 10, 2021 Portfolio And Model Review - February 5, 2021 Thoughts On The British Pound - December 18, 2020 Australian Dollar Chart II-9AUD Technicals 1 AUD Technicals 1 AUD Technicals 1 Chart II-10AUD Technicals 2 AUD Technicals 2 AUD Technicals 2 The inflation report in Australia was in line with expectations for Q2: Headline CPI rose from 1.1% to 3.8%. The trimmed mean and median measure came in at 1.6% and 1.7% respectively. The AUD was flat this week, the worst performing G10 currency. The dominant story remains the renewed restrictions from a resurgence in COVID-19, particularly in Sydney. That said, weakness in AUD is starting to create an attractive reward/risk profile. Speculators are net short the Australian dollar, and our bias is that there has been spillover pressure from the recent turmoil in Asian/Chinese markets. In the end, this only makes for a coiled spring rebound in the AUD. Report Links: The Dollar Bull Case Will Soon Fade - March 5, 2021 Portfolio And Model Review - February 5, 2021 Australia: Regime Change For Bond Yields & The Currency? - January 20, 2021 New Zealand Dollar Chart II-11NZD Technicals 1 NZD Technicals 1 NZD Technicals 1 Chart II-12NZD Technicals 2 NZD Technicals 2 NZD Technicals 2 The was scant data out of New Zealand this week: The trade balance came in at NZ$261 million, even with stronger imports in June. The ANZ activity outlook index fell in July, to 26.3 from 31.6. The NZD was up 0.5% this week. The strong rally in NZD after a hawkish RBNZ a fortnight ago continues to fade. This week, we highlighted a new theme, which is the rising incidence of natural disasters. Historically, this has been great for agricultural prices, benefiting NZD. But it has also been accompanied by a tremendous rise in currency volatility, which hurts the NZD vis-à-vis safe-haven currencies. We are currently long CHF/NZD and will be exploring this theme in future publications. Report Links: How High Can The Kiwi Rise? - April 30, 2021 Portfolio And Model Review - February 5, 2021 Currencies And The Value-Versus-Growth Debate - July 10, 2020 Canadian Dollar Chart II-13CAD Technicals 1 CAD Technicals 1 CAD Technicals 1 Chart II-14CAD Technicals 2 CAD Technicals 2 CAD Technicals 2 Data out of Canada this week has been mixed: Retail sales fell month on month in May by 2.1% but this was above expectations. Inflation remains robust. Headline CPI was 3.1%, while the core trim, median and common measures came in at 2.6%, 2.4% and 1.7% respectively. The CAD rose by 0.8% this week. The backdrop for the loonie remains positive as the Bank of Canada is leaning against monetary accommodation by tapering asset purchases, and signaling interest rate increases, while the Fed remains on hold. These pin real interest rate differentials in favor of the loonie. Report Links: Relative Growth, The Euro, And The Loonie - April 16, 2021 Will The Canadian Recovery Lead Or Lag The Global Cycle? - February 12, 2021 The Outlook For The Canadian Dollar - October 9, 2020 Swiss Franc Chart II-15CHF Technicals 1 CHF Technicals 1 CHF Technicals 1 Chart II-16CHF Technicals 2 CHF Technicals 2 CHF Technicals 2 There was scant data out of Switzerland this week: Investor confidence from the Credit Suisse survey fell in July, from 51.3 to 42.8. Total sight deposits were unchanged at CHF 712 bn for the week of July 23. The Swiss franc was up 1.3% this week. Incoming Swiss inflation data next week will dictate whether the SNB steps up the pace of FX intervention. So far, there have been no big moves in the CHF exchange rate to implore central bank attention. A rebound in global bond yields will be a welcome relief since the franc tends to weaken in that environment. For the time being, we believe volatility can continue to rise. As such, the franc will benefit, justifying long CHF/NZD bets. Report Links: An Update On The Swiss Franc - April 9, 2021 Portfolio And Model Review - February 5, 2021 The Dollar Conundrum And Protection - November 6, 2020 Norwegian Krone Chart II-17NOK Technicals 1 NOK Technicals 1 NOK Technicals 1 Chart II-18NOK Technicals 2 NOK Technicals 2 NOK Technicals 2 There was scant data out of Norway this week: Retail sales were flat month on month in June. The NOK was up 1% this week. Our limit buy on Scandinavian currencies was triggered a fortnight ago, nudging us in the money with this week’s currency moves. We are not fighting the Norges Bank, which has signaled they will increase interest rates this year, ahead of both the Federal Reserve and the ECB. As such, we are short EUR/NOK and USD/NOK. Report Links: The Norwegian Method - June 4, 2021 Portfolio And Model Review - February 5, 2021 Revisiting Our High-Conviction Trades - September 11, 2020 Swedish Krona Chart II-19SEK Technicals 1 SEK Technicals 1 SEK Technicals 1 Chart II-20SEK Technicals 2 SEK Technicals 2 SEK Technicals 2 Recent data from Sweden have been improving: The PPI for July came in at 9.6%, up from 7.9%. The June trade balance showed a healthy surplus of SEK 10.3 billion. The economic tendency survey for July came in at 122.4 from 119.8. Manufacturing confidence continues to inflect higher, rising from 125.2 to 129.2 in July. The SEK was the strongest performing G10 currency this week, rising 1.5%. Swedish Q2 GDP was a welcome positive surprise, up by 10.5% year on year and 0.9% quarter on quarter. This is paring back expectations of more stimulus from the Riksbank. We have been highlighting that SEK remains one of our most potent plays on a global growth recovery. As such, we are short EUR/SEK and USD/SEK. Report Links: Revisiting Our High-Conviction Trades - September 11, 2020 More On Competitive Devaluations, The CAD And The SEK - May 1, 2020 Sweden Beyond The Pandemic: Poised To Re-leverage - March 19, 2020 Trades & Forecasts Forecast Summary Core Portfolio Tactical Trades Limit Orders Closed Trades

Highlights Global oil demand will remain betwixt and between recovery and relapse through 3Q21, as stronger DM consumer spending and increasing mobility wrestles with persistent concerns over COVID-19-induced lockdowns in Latin America and Asia. These concerns will be allayed as vaccines become more widely distributed, and fears of renewed lockdowns – and their associated demand destruction – recede.  Going by US experience – which can be tracked on a weekly basis – as consumer spending rises in the wake of relaxed restrictions on once-routine social interactions, fuel demand will follow suit (Chart of the Week). OPEC 2.0 likely will agree to return ~ 400k b/d monthly to the market over the course of the next year and a hal. For 2021, we raised our average forecast to $70/bbl, and our 2H21 expectation to $74/bbl. For 2022 and 2023, we expect Brent to average $75 and $78/bbl. These estimates are highly sensitive to demand expectations, particularly re containment of COVID-19. Feature For every bit of good news related to the economic recovery from the COVID-19 pandemic, there is a cautionary note. Most prominently, reports of increasing demand for refined oil products like diesel fuel and gasoline in re-opening DM economies are almost immediately offset by fresh news of renewed lockdowns, re-infections in highly vaccinated populations, and fears a new mutant strain of the coronavirus will emerge (Chart 2).1 In this latter grouping, EM economies feature prominently, although Australia this week extended its lockdown following a flare-up in COVID-19 cases. Chart of the WeekUS Product Demand Revives As Economy Reopens US Product Demand Revives As Economy Reopens US Product Demand Revives As Economy Reopens Chart 2COVID-19 Infection And Death Rates Keep Markets On Edge Demand Dictates Oil Price Expectations Demand Dictates Oil Price Expectations Our expectation on the demand side is unchanged from last month – 2021 oil demand will grow ~ 5.4mm b/d vs. 2020 levels, while 2022 and 2023 consumption will grow 4.1 and 1.6mm b/d, respectively (Chart 3). These estimates reflect the slowing of global GDP growth over the 2021-23 interval, which can be seen in the IMF's and World Bank's GDP estimates, which we use to drive our demand forecasts.2 Weekly data from the US seen in the Chart of the Week provide a hint of what can be expected as DM and EM economies re-open in the wake of relaxed restrictions on once-routine social interactions. Demand for refined products – e.g., gasoline, diesel fuel and jet fuel – will recover, but at uneven rates over the next 2-3 years. The US EIA notes the recovery in diesel demand, which is included in "Distillates" in the chart above, has been faster and stronger than that of gasoline and jet fuel. This is largely because it reflects the lesser damage done to freight movement and activities like mining and manufacturing. The EIA expects 4Q21 US distillate demand to come in 100k b/d above 4Q19 levels at 4.2mm b/d, and to hit an all-time record of 4.3mm b/d next year. US gasoline demand is not expected to surpass 2019 levels this year or next, in the EIA's forecast. This is partly due to improved fuel efficiencies in automobiles – vehicle-miles travelled are expected to rise to ~ 9mm miles/day in the US, which will be slightly higher than 2019's level. Jet fuel demand in the US is expected to return to 2019 levels next year, coming in at 1.7mm b/d. Chart 3Global Oil Demand Forecast Remains Steady Global Oil Demand Forecast Remains Steady Global Oil Demand Forecast Remains Steady Quantifying Demand Risks We use the recent uptick in COVID-19 cases as the backdrop for modelling demand-destruction scenarios in this month’s oil balances (Chart 2). We consider different scenarios of potential demand destruction caused by the resurgence in the pandemic (Table 1). Last year, demand fell by 9% on average, which we take to be the extreme down move over an entire year. In our simulations, we do not expect demand to fall as drastically this time. Table 1Demand-Destruction Scenario Outcomes Demand Dictates Oil Price Expectations Demand Dictates Oil Price Expectations We modelled two scenarios – a 5% drop in demand (our low-demand-destruction scenario) and an 8% drop in demand (our high-demand-destruction scenario). A demand drop of a maximum of 2% made nearly no difference to prices, and so, we did not include it in our analysis. In both cases, demand starts to fall by September and reaches its lowest point in October 2021. We adjusted changes to demand in the same proportion as changes in demand in 2020, before making estimates converge to our base-case by end-2022. The estimates of price series are noticeably distinct during the period of the simulation (Chart 4). Starting in 2023, the low-demand-destruction prices and base-case prices nearly converge, as do their inventory levels. Prices and inventory levels in the high-demand-destruction case remain lower than the base-case during the rest of the forecast sample. OPEC 2.0 and world oil supply were kept constant in these scenarios. World oil supply is calculated as the sum of OPEC 2.0 and Non-OPEC 2.0 supply. Non-OPEC 2.0 can be broken down into the US, and Non-OPEC 2.0, Ex-US countries. Examples of these suppliers are the UK, Canada, China, and Brazil. OPEC 2.0 can be broken down into Core-OPEC 2.0 and the cohort we call "The Other Guys," which cannot increase production. Core-OPEC 2.0 includes suppliers we believe have excess spare capacity and can inexpensively increase supply quickly. Chart 4Brent Forecasts Rise As Global Economy Recovers COVID-19 Demand Destruction Scenarios Brent Forecasts Rise As Global Economy Recovers COVID-19 Demand Destruction Scenarios Brent Forecasts Rise As Global Economy Recovers COVID-19 Demand Destruction Scenarios OPEC 2.0 Remains In Control We continue to expect the OPEC 2.0 producer coalition led by the Kingdom of Saudi Arabia (KSA) and Russia to maintain its so-far-successful production policy, which has kept the level of supply below demand through most of the COVID-19 pandemic (Chart 5). This allowed OECD inventories to fall below their pre-COVID range, despite a 9% loss of global demand last year (Chart 6). We expect this discipline to continue and for OPEC 2.0 to continue restoring its market share (Table 2). Chart 5OPEC 2.0 Production Policy Kept Supply Below Demand OPEC 2.0 Production Policy Kept Supply Below Demand OPEC 2.0 Production Policy Kept Supply Below Demand Chart 6...And Drove OECD Inventories Down ...And Drove OECD Inventories Down ...And Drove OECD Inventories Down Table 2BCA Global Oil Supply - Demand Balances (MMb/d, Base Case Balances) Demand Dictates Oil Price Expectations Demand Dictates Oil Price Expectations Our expectation last week the KSA-UAE production-baseline impasse will be short-lived remains intact. We expect supply to be increased after this month at a rate of 400k b/d a month into 2022, per the deal most members of the coalition signed on to prior to the disagreement between the longtime GCC allies. This would, as the IEA notes, largely restore OPEC 2.0's spare capacity accumulated via production cutbacks during the pandemic of ~ 6-7mm b/d by the end of 2022 (Chart 7). It should be remembered that most of OPEC 2.0's spare capacity is held by Gulf Cooperation Council (GCC) states, which includes the UAE. The UAE's official baseline production number (i.e., its October 2018 production level) likely will be increased to 3.65mm b/d from 3.2mm b/d, and its output in 2H21 and 2022 likely will be adjusted upwards. As one of the few OPEC 2.0 members that actually has invested in higher production and can increase output meaningfully, it would, like KSA, benefit from providing barrels out of this spare capacity.3 Chart 7OPEC 2.0 Spare Capacity Will Return Demand Dictates Oil Price Expectations Demand Dictates Oil Price Expectations As we noted last week, we do not think this impasse was a harbinger of a breakdown in OPEC 2.0's so-far-successful production-management strategy. In our view, this impasse was a preview of how negotiations among states with the capacity to raise production will agree to allocate supply in a market starved for capital in the future. This is particularly relevant as US shale producers continue to focus on providing competitive returns to their shareholders, which will limit supply growth to that which can be done profitably. We see the "price-taking cohort" – i.e., those producers outside OPEC 2.0 exemplified by the US shale-oil producers – remaining focused on maintaining competitive margins and shareholder priorities. This means maintaining and growing dividends, and returning capital to shareholders will have priority as the world transitions to a low-carbon business model (Chart 8).4 For 2021, we raised our average forecast to $70/bbl on the back of higher prices lifting the year-to-date average so far, and our 2H21 expectation to $74/bbl. For 2022 and 2023, we expect Brent to average $75 and $78/bbl (Chart 9). These estimates are highly sensitive to demand expectations, which, in turn, depend on the global success in containing and minimizing COVID-19 demand destruction, as we have shown above. Chart 8US Shale Producers Focus On Margins US Shale Producers Focus On Margins US Shale Producers Focus On Margins Chart 9Raising Our Forecast Slightly Raising Our Forecast Slightly Raising Our Forecast Slightly Investment Implications In our assessment of the risks to our views in last week's report, we noted one of the unintended consequences of the unplanned and uncoordinated rush to a so-called net-zero future will be an improvement in the competitive position of oil and gas. This is somewhat counterintuitive, but the logic goes like this: The accelerated phase-out of conventional hydrocarbon energy sources brought about policy, regulatory and legal imperatives already is reducing oil and gas capex allocations within the price-taking cohort exemplified by US shale-oil producers. This also will restrict capital flows to EM states with heavy resource endowments and little capital to develop them. Our strong-conviction call on oil, gas and base metals is premised on our view that renewables and their supporting grids cannot be developed and deployed quickly enough to make up for the energy that will be foregone as a result of these policies. Capex for the metals miners has been parsimonious, and brownfield projects continue to dominate. Greenfield projects can take more than a decade to develop, and there are few in the pipeline now as the world heads into its all-out renewables push. In a world where conventional energy production is being forced lower via legislation, regulation, shareholder and legal decisions, higher prices will ensue even if demand stays flat or falls: If supply is falling, market forces will lift oil and gas prices – and the equities of the firms producing them – higher. As for metals like copper and their producers, if supply is unable to keep up with demand, prices of the commodities and the equities of the firms producing them will be forced to go higher.5 This call underpins our long S&P GSCI and COMT ETF commodity recommendations, and our long MSCI Global Metals & Mining Producers ETF (PICK) recommendation. We will look for opportunities to get long oil and gas producer exposure via ETFs as well, given our view on oil and metals spans the next 5-10 years.   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 US EIA expects growth in large-scale solar capacity will exceed the increase in wind generation for the first time ever in 2021-22. The EIA forecasts 33 GW of solar PV capacity will be added to the US grid this year and next, with small-scale solar PV increasing ~ 5 GW/yr. The EIA expects wind generation to increase 23 GW in 2021-22. The EIA attributed the slow-down in wind development to the expiration of a $0.025/kWH production tax credit at the end of 2020. Taken together, solar and wind generation will account for 15% of total US electricity output by the end of 2022, according to the EIA. Nuclear power will account for slightly less than 20% of US generation in 2021-22, while hydro will fall to less than 7% owing to severe drought in the western US. At the other end of the generation spectrum, coal will account for ~ 24% of generation this year, as it takes back incremental market share from natural gas, and ~ 22% of generation in 2022. Base Metals: Bullish Iron ore prices continue to trade above $215/MT in China, even as demand is expected to slow in 2H21. Supply additions from Brazil, which ships higher quality 65% Fe ore, have been slower than expected, which is supporting prices (Chart 10). Separately, the Chinese government's auction of refined copper earlier this month cleared the market at $10,500/MT, or ~ $4.76/lb. Spot copper has been trading on either side of $4.30/lb this month, which indicates the Chinese market remains well bid. Precious Metals: Bullish The 13-year record jump in the US Consumer Price Index reported this week for the month of June is bullish for gold, as it produced weaker real rates and sparked demand for inflation hedges. Fed Chair Powell continued to stick to the view that the recent rise in inflation is transitory. The Fed’s dovish outlook will support gold prices and likely will lead to a weaker US dollar, as it reduces the possibility that US interest rates will rise soon. A falling USD will further bolster gold prices (Chart 11). Chart 10 BENCHMARK IRON ORE 62% FE, CFR CHINA (TSI)RECOVERING BENCHMARK IRON ORE 62% FE, CFR CHINA (TSI)RECOVERING Chart 11 Gold Prices Going Down Gold Prices Going Down     Footnotes 1     We highlighted this risk in last week's report, Assessing Risks To Our Commodity Views, which is available at ces.bcaresearch.com. Two events – in the Seychelles and Chile, where the majority of the populations were inoculated – highlight re-infection risk. Re-infections in Indonesia along with lockdowns following the spread of the so-called COVID-19 Delta variant also are drawing attention. Please see Euro 2020 final in UK stokes fears of spread of Delta variant, published by The Straits Times on July 11, 2021. The news service notes that in addition to the threats super-spreader sporting events in Europe present, "The rapid spread of the Delta variant across Asia, Africa and Latin America is exposing crucial vaccine supply shortages for some of the world's poorest and most vulnerable populations. Those two factors are also threatening the global economic recovery from the pandemic, Group of 20 finance ministers warned on Saturday." 2     Please see the recently published IMF World Economic Outlook Reports and the World Bank Global Economic Prospects. 3    If, as we suspect, KSA and the UAE are playing a long game – i.e., a 20-30-year game – this spare capacity will become more valuable as investment capex into oil production globally slows. Please see The $200 billion annual value of OPEC’s spare capacity to the global economy published by kapsarc.org on July 17, 2018. 4    Please see Bloomberg's interview with bp's CEO Bernard Looney at Banks Need ‘Radical Transparency,’ Citi Exec Says: Summit Update, which aired on July 13, 2021. In addition to focusing on margins and returns, the company – like its peers among the majors – also is aiming to reduce oil production by 20% by 2025 and 40% by 2030. 5    This turn of events is being dramatically played out in the coal markets, where the supply of metallurgical coals is falling as demand increases. Please see Coal Prices Hit Decade High Despite Efforts to Wean the World Off Carbon published by wsj.com on June 25, 2021.   Investment Views and Themes Strategic Recommendations Tactical Trades Commodity Prices and Plays Reference Table Trades Closed in 2021 Summary of Closed Trades Image

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 Assessing Risks To Our Commodity Views Assessing Risks To Our Commodity Views 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 US Pushing For Resolution of KSA-UAE Spat US 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 Assessing Risks To Our Commodity Views Assessing Risks To Our Commodity Views 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 Assessing Risks To Our Commodity Views Assessing Risks To Our Commodity Views 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 Assessing Risks To Our Commodity Views Assessing Risks To Our Commodity Views Chart 6Call On Base Metals Supply Will Be Massive Out To 2050 Assessing Risks To Our Commodity Views Assessing Risks To Our Commodity Views 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 Copper Prices Remains Parsimonious Copper Prices Remains Parsimonious Chart 8Shareholder Interests Predominate Metals Agendas Assessing Risks To Our Commodity Views Assessing Risks To Our Commodity Views 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 Assessing Risks To Our Commodity Views Assessing Risks To Our Commodity Views 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 Our Oil Price View Remains Intact Our 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 BENCHMARK IRON ORE 62% FE, CFR CHINA (TSI) GOING DOWN BENCHMARK IRON ORE 62% FE, CFR CHINA (TSI) GOING DOWN Chart 12 Sentiment Supports Oil Prices Sentiment Supports Oil Prices     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 Image

Highlights Gold is – and always will be – exquisitely sensitive to Fed policy and forward guidance, as last month's "Dot Shock" showed (Chart of the Week). Its price will continue to twitch – sometimes violently – as the widening dispersion of views evident in the Fed dots keeps markets on edge and pushes forward rate expectations in different directions. Fed policy is important but will remain secondary to fundamentals in oil markets. Increasingly inelastic supply will force refiners to draw down inventories, which will keep forward curves backwardated. OPEC 2.0's production-management policy is the key driver here, followed closely by shale-oil's capital discipline. Between these market bookends are base metals, which will remain sensitive to Fed policy, but increasingly will be more responsive to tightening supply-demand fundamentals, as the pace of the global renewables and EV buildout challenges supply. The one thing these markets will share going forward is increasing volatility. Gold volatility will remain elevated as markets are forced to parse sometimes-cacophonous Fed forward guidance; oil volatility will increase with steeper backwardation; and base metals volatility will rise as fundamentals continue to tighten. We remain long commodity-index exposure (S&P GSCI and COMT ETF) and equity exposure (PICK ETF). Feature Gold markets still are processing last month's "Dot Shock" – occasioned by the mid-June move of three more Fed bankers' dots into the raise-rates-in-2022 camp at the Fed – and the sometimes-cacophonous forward guidance of post-FOMC meetings accompanying these projections. Following last month's meeting, seven of the 18 central bankers at the June meeting now favor an earlier rate hike. This dot dispersion fuels policy uncertainty. When policy uncertainty is stoked, demand for the USD typically rises, which generally – but not always – contributes to liquidation of dollar-sensitive positions in assets like commodities. This typically leads to higher price volatility.1 This is most apparent in gold, which is and always will be exquisitely sensitive to Fed guidance and the slightest hint of a change in course (or momentum building internally for such a change). This is what markets got immediately after the June meeting. When this guidance reflects a wide dispersion of views inside the Fed, it should come as no surprise that price volatility increases among assets that are most responsive to monetary policy. This dispersion of market expectations – as a matter of course – is intensified by discordant central-bank forward guidance.2 Fundamentals Reduce Oil's Sensitivity To Fed Policy Fed policy will always be important for the evolution of the USD through time, which makes it extremely important for commodities, since the most widely traded commodities are priced in USD. All else equal, an increase in the value of the USD raises the cost of commodities ex-US, and vice versa. Chart of the WeekGold Still Processing Dot Shock Gold Still Processing Dot Shock Gold Still Processing Dot Shock Chart 2Oil Market Remains Tight... Oil Market Remains Tight... Oil Market Remains Tight... The USD's impact is dampened when markets are fundamentally tight – e.g., when the level of demand exceeds supply, as is the case presently for oil (Chart 2).3 When this occurs, refiner inventories have to be drawn down to make up for supply deficits (Chart 3). This leads to a backwardation in the oil forward curves – i.e., prices of prompt-delivery oil are higher than deferred-delivery oil – reflecting the fact that the supply curve is becoming increasingly inelastic (Chart 4). This backwardation benefits OPEC 2.0 member states, as most of them have long-term supply contracts with customers indexed to spot prices, and investors who are long commodity-index exposure, as it is the source of the roll yield for these products.4 Chart 3Forcing Inventories To Draw... Forcing Inventories To Draw... Forcing Inventories To Draw... Chart 4...And Backwardating Forward Curves ...And Backwardating Forward Curves ...And Backwardating Forward Curves Copper's Sensitivity To Fed Policy Declining Supply-demand fundamentals in base metals – particularly in the bellwether copper market – are tightening, which, as the oil market illustrates, will make prices in these markets less sensitive to USD pressures going forward (Chart 5). We expect the copper forward curve to remain backwardated for an extended period (Chart 6), which will distance the evolution of copper prices from Fed policy variables (e.g., interest rates and the USD). Chart 5Copper USD Sensitivity Will Diminish As Balances Tighten Copper USD Sensitivity Will Diminish As Balances Tighten Copper USD Sensitivity Will Diminish As Balances Tighten Chart 6Expect Persistent Backwardation In Copper Expect Persistent Backwardation In Copper Expect Persistent Backwardation In Copper Indeed, our modeling suggests this already is occurring in the metals markets, as can be seen from the resilience of copper prices during 1H21, when China's fiscal and monetary stimulus was waning and, recently, during the USD's recent rally, which was an unexpected headwind generated by the Fed's June meeting. If, as appears likely, China re-engages in fiscal and monetary stimulus in 2H21, the global demand resurgence for metals, copper in particular, will receive an additional fillip. Like oil, copper inventories will have to be drawn down over the next two years to make up for physical deficits, which have been a persistent problem for years (Chart 7). Capex in copper markets has yet to be incentivized by higher prices, which means these physical deficits likely will widen as the world gears up for expanded renewables generation and the grids required to support them, not to mention higher electric vehicle (EV) demand. If, as we expect, copper miners do not invest in new greenfield mine projects – choosing instead to stay with their brownfield expansion strategies – the market will tighten significantly as the world ramps up its demand for renewable energy. This means copper's supply curve will, like oil's, become increasingly inelastic. At the limit – i.e., if new mining capex is not incentivized – price will be forced to allocate limited supply, and may even have to get to the point of destroying demand to accommodate the renewables buildout. Chart 7Supply-Demand Balance Tightening In Copper Supply-Demand Balance Tightening In Copper Supply-Demand Balance Tightening In Copper A Word On Spec Positioning We revisited our modeling of speculative influence on these markets over the past couple of weeks, in anticipation of the volatility we expect and the almost-certain outcry from public officials that will ensue. Our modeling continues to support our earlier work, which found fundamentals are determinant to the evolution of industrial commodity prices. Using Granger-Causality and econometric analysis, we find prices mostly explain spec positioning in oil and copper, and not the other way around.5 We do find spec positioning – via Working's T Index – to be important to the evolution of volatility in WTI crude oil options, along with other key variables (Chart 8).6 That said, other variables are equally important to this evolution, including the St. Louis Fed's Financial Stress Index, EM equity volatility, VIX volatility and USD volatility. These variables are not useful in modeling copper volatility, where it appears fundamental and financial variables are driving the evolution of prices and, by extension, price volatility. We will continue to research this issue, and will continue to subject our results to repeated trials in an attempt to disprove them, as any researcher would do. Chart 8Oil Volatility Drivers Oil Volatility Drivers Oil Volatility Drivers Investment Implications Gold will remain hostage to Fed policy, but oil and base metals increasingly will be charting a path that is independent of policy-related variables, chiefly the USD. There is no escaping the fact that gold volatility will increasingly be in the thrall of US monetary policy – particularly during the next two years as the Fed attempts to guide markets toward something resembling normalization of that policy.7 However, as the events of the most recent FOMC meeting illustrate, gold price volatility will remain elevated as markets are forced to parse oftentimes-cacophonous Fed forward guidance. This would argue in favor of using low-volatility episodes as buying opportunities in gold options – particularly calls, as we continue to expect gold prices to end the year at $2,000/oz. We also favor silver exposure via calls, expecting price to go to $30/oz this year. In oil and base metals, we continue to expect supply-demand fundamentals in these markets to tighten, which predisposes us to favor commodity index products. For this reason, we remain long commodity-index exposure – specifically the S&P GSCI index, which is up 6.8% since inception, and the COMT ETF, which is up 8.7% since inception. We expect the base metals markets to remain very well bid going forward, and remain long equity exposure in these markets via the PICK ETF, which we re-entered after a trailing stop was elected that left us with a 24% gain since inception at the end of last year.   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 US crude oil stocks (ex SPR) fell 6.7mm barrels in the week ended 25 June 2021, according to the US EIA. Total crude and product stocks were down 4.6mm barrels. Domestic crude oil production was unchanged at 11.1mm b/d over the reporting week. Total refined-product demand surpassed the comparable 2019 reporting period, led by higher distillate consumption (4.2mm b/d vs 3.8mm b/d). Gasoline consumption remains a laggard (9.2mm b/d vs 9.5mm b/d), as does jet fuel (1.4mm b/d vs 1.9mm b/d). Propane and propylene demand surged over the period, likely on the back of petchem demand (993k b/d vs 863k b/d). Base Metals: Bullish Base metals prices are moving higher in anticipation of tariffs being imposed by Russia to discourage exports beyond the Eurasian Economic Union, according to argusmedia.com. In addition to export tariffs on copper, aluminum and nickel, steel exports also will face levies to discourage material from leaving the EAEU (Chart 9). The tariffs are expected to remain in place from August through December 2021. Separately, premiums paid for high-quality iron ore in China (65% Fe) reached record highs earlier this week, as steelmakers scramble for supply, according to reuters.com. The premium iron ore traded close to $36/MT over benchmark material (62% Fe) this week. Precious Metals: Bullish Gold prices continue to move lower following the FOMC meeting on June 16. The yellow metal was down 0.6% y-o-y at $1762.80/oz as of Tuesday’s close after being up a little more than 13% y-o-y before the FOMC meeting earlier this month (Chart 10). We believe the USD rally, which, based on earlier research we have done, could be benefitting from safe-haven demand arising from global concern over the so-called Delta variant of COVID-19, which has spread to at least 85 countries. Public-health officials are fearful this could cause a resurgence in COVID-19 cases and additional mutations in the virus if vaccine distribution in EM states is not increased. Ags/Softs: Neutral Widely disparate weather conditions in the US west and east crop regions – drought vs cooler and wetter weather – appear to be on track to produce average crop yields for corn and beans this year, according to agriculture.com's Successful Farming. In regions where hard red spring wheat is grown, states experiencing low rainfall likely will have poor crops this year. Chart 9 "Dot Shock" Continues To Roil Gold; Oil … Not So Much "Dot Shock" Continues To Roil Gold; Oil … Not So Much Chart 10 US Dollar To Keep Gold Prices Well Bid US Dollar To Keep Gold Prices Well Bid   Footnotes 1     We model gold prices as a function of financial variables sensitive to Fed policy – e.g., real rates and the broad trade-weighted USD – and uncertainty, which is conveyed via the Global Economic Policy Uncertainty (GEPU) index published by Baker, Bloom & Davis.  2     Please see Lustenberger, Thomas and Enzo Rossib (2017), "Does Central Bank Transparency and Communication Affect Financial and Macroeconomic Forecasts?" SNB Working Papers, 12/2017. The Swiss central bank researchers find "… the verdict about the frequency of central bank communication is unambiguous. More communication produces forecast errors and increases their dispersion. … Stated differently, a central bank that speaks with a cacophony of voices may, in effect, have no voice at all. Thus, speaking less may be beneficial for central banks that want to raise predictability and homogeneity among financial and macroeconomic forecasts. We provide some evidence that this may be particularly true for central banks whose transparency level is already high." (p. 26) 3    Please see OPEC 2.0 Vs. The Fed, published on February 8, 2018, for additional discussion. 4    Please see The Case For A Strategic Allocation To Commodities As An Asset Class, a Special Report we published on March 11, 2021 on commodity-index investing.  It is available at ces.bcaresearch.com. 5    The one outlier we found was Brent prices, for which non-commercial short positioning does Granger-Cause price.  Otherwise, price was found to Granger-Cause spec positioning on the long and short sides of the market. 6   Please see BCA Research's Commodity & Energy Strategy Weekly Report, "Specs Back Up The Truck For Oil," published on April 26, 2018, in which we introduce Holbrook Working's "T Index," a measure of speculative concentration in futures and options markets. It is available at ces.bcaresearch.com. Briefly, Working's T Index shows how much speculative positioning exceeds the net demand for hedging from commercial participants in the market. 7     Please see How To Re-Shape The Yield Curve Without Really Trying published by our US Bond Strategy group on June 22 for a deeper discussion of the outlook for Fed policy.   Investment Views and Themes Strategic Recommendations Tactical Trades Commodity Prices and Plays Reference Table Trades Closed in 2021 Summary of Closed Trades Image

Highlights Entering 2H21, oil and metals' price volatility will rise as inventories are drawn down to cover physical supply deficits brought about by the re-opening of major economies ex-China. As demand increases and oil and metals supply become more inelastic, forward curves will backwardate further.  This will weaken commodity-price correlations with the USD and boost commodity-index returns. Going into next week's OPEC 2.0 meeting, the Kingdom of Saudi Arabia (KSA) and Russia likely will hold off on further production increases, until greater clarity around US-Iran negotiations and the return of Iran as a bona fide exporter is available. Chinese authorities will release 100k MT of copper, aluminum and zinc into tight domestic markets in July.  A two-day rally followed the news. Since bottoming in March 2020, the XOP and XME ETFs covering oil and gas producers and metals miners are up ~ 218% and ~ 196%, respectively, following the ~ 230% move in crude oil and the ~ 100% rise copper prices.  Higher volatility will present buying opportunities for these ETFs  (Chart of the Week). We remain long commodity index exposure – S&P GSCI and COMT ETF – expecting steeper backwardations. We will go long the PICK ETF at tonight's close again, after being stopped out last week with a 23.9% return. Feature Heading into 2H21, industrial commodity markets will continue to tighten.  In the case of oil, this is caused by OPEC 2.0's production-management strategy – i.e., keeping supply below demand – and capital discipline among producers in the price-taking cohort.1 Base metals, on the other hand, are tightening because demand is recovering much faster than supply.2 Re-opening of major economies will boost refined-product demand in oil markets – e.g., gasoline and jet fuel – which will leave refiners little choice but to continue drawing on inventories to cover supply shortfalls in the near term (Chart 2). Chart of the WeekResources ETFs Follow Prices Higher Resources ETFs Follow Prices Higher Resources ETFs Follow Prices Higher Chart 2Refiners Will Continue Drawing Crude Investments Refiners Will Continue Drawing Crude Investments Refiners Will Continue Drawing Crude Investments Base metals – particularly copper and aluminum – will remain well bid in the face of constrained supply and higher consumption ex-China.  Despite China's widely anticipated decision to release strategic stockpiles of copper, aluminum and zinc next month into a tight domestic market – which we flagged last month – continued inventory draws will be required to cover physical deficits in these markets, particularly in copper (Chart 3).3 Chart 3Copper Inventories Will Draw As Demand Ex-China Rises Copper Inventories Will Draw As Demand Ex-China Rises Copper Inventories Will Draw As Demand Ex-China Rises Chart 4Steeper Backwardation, Higher Volatility Oil, Metals Vol Creates Buying Opportunities Oil, Metals Vol Creates Buying Opportunities Higher Vol On The Way As demand for industrial commodities increases and inventories continue to draw, forward curves will become more backwardated – i.e., material delivered promptly (next day or next week) will command a higher price than commodities delivered next month or next year: Consumers value current supply above deferred supply, and producers and merchants have to charge more to cover inventory replacement costs, which increase when prompt demand outstrips supply. The steepening of forward curves for industrial commodities will lead to higher price volatility in oil and metals markets, particularly copper: Demand will confront increasingly inelastic supply.  In this evolution, prices will be forced to allocate inelastic supply as demand increases.  Sometimes-sharp changes in price are required to equilibrate available supply with demand when this happens.  This can be seen clearly in oil markets, but it holds true for all storable commodities (Chart 4).4 Investment Implications Industrial commodity markets are entering a more volatile phase, which will be characterized by sharp price movements up and down over the short term, as demand continues to outpace supply. Our analysis suggests this is the beginning of a more volatile phase in industrial commodity markets.  The balance of risk in industrial commodity prices will remain to the upside as volatility increases. In the short term, fundamental imbalances can be addressed over a relatively short months-long horizon – i.e., OPEC 2.0 can release spare capacity over a 3-4 month interval to accommodate rising demand – so that price increases do not destroy demand as oil-exporters are rebuilding their fiscal balance sheets. Base metals markets will have a tougher time in the short run finding the supply to meet surging demand, but it can be done over the next year or so without prices getting to the point where demand-destruction sets in. Over the medium to long term, investor-owned oil and gas producers literally are being directed by policymakers, shareholders and courts toward an extended wind-down of production and investment in future production.  Markets have been pricing through just such a situation in the post-COVID-19 world, with OPEC 2.0 managing supply against falling demand and still managing to reduce inventories significantly.  If the world follows the IEA's pathway to a decarbonized future – in which no investment in new oil or gas production is required after 2025 – this will become the status quo for these markets going forward.5 Metals producers, on the other hand, are being encouraged to increase marketable supply at a rapid pace to accommodate demand driven by the build-out of renewable energy – chiefly wind and solar – and the grids that will be required to move this energy. Producers, however, remain reluctant to do so, fearing their capex investment to build out supply will produce physical surpluses that depress returns, similar to the last China-led commodity super-cycle. Supplying the necessary base metals to make this happen will be difficult at best, according to Ivan Glasenberg, CEO at Glencore.  At this week's Qatar Economic Forum, he said copper supply will have to double between now and 2050 to meet expected demand for this critical metal.  “Today, the world consumes 30 million tonnes of copper per year and by the year 2050, following this trajectory, we’ve got to produce 60 million tonnes of copper per year,” he said.  “If you look at the historical past 10 years, we’ve only added 500,000 tonnes per year … Do we have the projects? I don’t think so. I think it will be extremely difficult.”6 The volatility we are expecting in oil, gas and base metals prices, will present buy-the-dip opportunities in related equities vehicles.  Since bottoming in March 2020, the XOP and XME ETFs covering oil and gas producers and metals miners are up ~ 218% and ~ 196%, respectively, matching the ~ 230% move in crude oil and the ~ 100% rise in copper prices.  We remain long commodity index exposure – S&P GSCI, which is up 5.9% and the COMT ETF, which is up 7.6% – expecting steeper backwardations.  The trailing stop on our MSCI Global Metals & Mining Producers ETF (PICK) position recommended 10 December 2020 was elected, which stopped us out with a gain of 23.9%.  We are getting long the PICK again at tonight's close.   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 Commercial crude oil stocks in the US (ex-SPR barrels) fell 7.6mm barrels w/w in the week ended 18 June 2021, according to the US EIA. Including products, US crude and product inventories were down 5.8mm barrels. US domestic crude oil production was down 100k b/d, ending the week at 11.1mm b/d. Overall product supplied, the EIA's proxy for refined-product demand, was up 180k b/d at 20.75mm b/d, which is 129k b/d below 2019 demand for the same period. At 9.44mm b/d, gasoline demand was just below comparable 2019 consumption of 9.47mm b/d, while jet-fuel demand remains severely depressed vs. comparable 2019 consumption at 1.58mm b/d (vs. 1.92mm b/d).  Distillate demand (e.g., diesel fuel) for the week ended 18 June 2021 was 3.95mm b/d vs. 3.97mm b/d for the comparable 2019 period. Base Metals: Bullish Benchmark spot iron ore (62% Fe) prices are holding above $210/MT in trading this week, as demand for the steel input remains strong in China (Chart 5). The Chinese Communist Party (CCP) increased its level of intervention in the iron ore market this week, launching investigations into “malicious speculation,” vowing to “severely punish” anyone found to be engaged in such behavior, according to ft.com.7 Benchmark iron ore prices hit $230/MT in May. We continue to expect exports from Brazil to pick up in 2H21, which will push prices lower in 2H21. Precious Metals: Bullish In the aftermath of last Wednesday’s FOMC meeting gold prices lost nearly $86/oz (Chart 6). Our colleagues at BCA Research's USBS believe markets are paying too much attention to the Fed’s dot plots, and not to the central bank’s verbal guidance.8 Originally, the Fed stated that it will only start raising interest rates once a checklist of three conditions have been met. This checklist includes guidance on actual and expected inflation rates and the labor market. Gold prices did not react to Chair Powell's testimony before the House Select Subcommittee on the Coronavirus Crisis. Ags/Softs: Neutral US spring wheat prices are rallying on the back of dry weather in the northern Plains, while forecasts for benign crop weather in the Midwest pressured soybeans lower this week, according to successfulfarming.com. Chart 5 BENCHMARK IRON ORE 62% FE, CFR CHINA (TSI) GOING DOWN BENCHMARK IRON ORE 62% FE, CFR CHINA (TSI) GOING DOWN Chart 6 US Dollar To Keep Gold Prices Well Bid US Dollar To Keep Gold Prices Well Bid     Footnotes 1     Please see our most recent oil price forecasts published last week in Balance Of Risks Tilts To Higher Oil Prices.  It is available at ces.bcaresearch.com. 2     Please see A Perfect Energy Storm On The Way published on June 3, 2021 for further discussion. 3    Please see Less Metal, More Jawboning published on May 27, 2021, which flagged China's likely decision to release strategic stockpiles of base metals. 4    Chart 4 shows implied volatility as a function of the slope of the forward curve, i.e., the difference between the 1st- and 13th-nearby futures divided by the 1st-nearby future vs implied volatilities for Brent and WTI options.  This modeling extends Kogan et al (2009), mapping realized volatilities calculated using historical settlements of crude oil futures against the slope of crude oil futures conditioned on 6th- vs. 3rd-nearby futures returns (in %). Please see Kogan, L., Livdan, D., & Yaron, A. (2009), "Oil Futures Prices in a Production Economy With Investment Constraints." The Journal of Finance, 64:3, pp. 1345-1375. 5    Please see fn 2's discussion of the IEA's Net Zero by 2050, A Roadmap for the Global Energy Sector beginning on p. 5 under The Case For A Carbon Tax. 6    Please see Copper supply needs to double by 2050, Glencore CEO says published on June 23, 2021 by reuters.com.  Of course, being a copper producer with large-scale base-metals projects due to come on line in the next year or so, Mr. Glasenberg could be talking his book, but as Chart 3 shows, copper has been and likely will be in physical deficits for years. 7     Please see China cracks down on iron ore market, published by ft.com on June 21, 2021. 8    Please see How To Re-Shape The Yield Curve Without Really Trying, published on June 22, 2021.   Investment Views and Themes Strategic Recommendations Tactical Trades Commodity Prices and Plays Reference Table Trades Closed in 2021 Summary of Closed Trades Image

Dear Client, Next week, instead of our regular report, we will be sending you a Special Report from BCA Research’s MacroQuant tactical global asset allocation team. Titled “MacroQuant: A Quantitative Solution For Forecasting Macro-Driven Financial Trends,” this white paper will discuss the purpose, coverage, and methodology of the MacroQuant model. I hope you will find the report insightful. We will be back the following week with the GIS Quarterly Strategy Outlook, where we will explore the major trends that are set to drive financial markets for the rest of 2021 and beyond. We will also be holding a webcast on Thursday, July 8 at 10:00 AM EDT (3:00 PM BST, 4:00 PM CEST, 10:00 PM HKT) to discuss the outlook. Best regards, Peter Berezin Chief Global Strategist Highlights Although the Fed delivered a hawkish surprise on Wednesday, monetary policy is likely to remain highly accommodative for the foreseeable future. We continue to see high US inflation as a long-term risk rather than a short-term problem. Outside of a few industries, wage inflation remains well contained. In those industries suffering from labor shortages, the expiration of emergency unemployment benefits, increased immigration, and the opening up of schools should replenish labor supply. Bottlenecks in the global supply chain are starting to ease. Many key input prices have already rolled over, suggesting that producer price inflation has peaked and is heading down. A slowdown in Chinese credit growth could weigh on metals prices during the summer months, which would further temper inflationary pressures. We are downgrading our view on US TIPS from overweight to neutral. Owning bank shares is a cheaper inflation hedge. Look Who’s Talking The Fed jolted markets on Wednesday after the FOMC signaled it may raise rates twice in 2023. Back in March, the Fed projected no hikes until 2024 (Chart 1). Chart 1Fed Forecasts Converge Toward Market Expectations Don’t Sweat US Inflation…Just Yet Don’t Sweat US Inflation…Just Yet Seven of 18 committee members expected lift-off as early as 2022, up from four in March. Only five participants expected the Fed to start raising rates in 2024 or later, down from 11 previously. The Fed acknowledged recent upward inflation surprises by lifting its forecast of core PCE inflation to 3.4% for 2021 compared with the March projection of 2.4%. These forecast revisions bring the Fed closer to market expectations, although the latter are proving to be a moving target. Going into the FOMC meeting, the OIS curve was pricing in 85 bps of rate tightening by the end of 2023. At present, the market is pricing in about 105 bps of tightening. At his press conference, Chair Powell acknowledged that FOMC members had discussed scaling back asset purchases. “You can think of this meeting as the ‘talking about talking about’ meeting,” he said. A rate hike in 2023 would imply the start of tapering early next year. The key question for investors is whether this week’s FOMC meeting marks the first of many hawkish surprises from the Fed. We do not think it does. As Chair Powell himself noted, the dot-plot is “not a great forecaster of future rate moves,” before adding that “Lift-off is well into the future.” Ultimately, a major monetary tightening cycle would require that inflation remain stubbornly high. As we discuss below, while there are good reasons to think that the US economy will eventually overheat, the current bout of inflation is indeed likely to be “transitory.” This implies that bond yields are unlikely to rise into restrictive territory anytime soon, which should provide continued support to stocks. Inflation: A Long-Term Risk Rather Than A Short-Term Problem Chart 2Globalization Plateaued More Than A Decade Ago Globalization Plateaued More Than A Decade Ago Globalization Plateaued More Than A Decade Ago There are plenty of reasons to worry that US inflation will eventually move persistently higher. As we discussed in a recent report, many of the structural factors that have suppressed inflation over the past 40 years are reversing direction: Globalization is in retreat: The ratio of global trade-to-manufacturing output has been flat for over a decade (Chart 2). Looking out, the ratio could even decline as more companies shift production back home in order to gain greater control over unruly global supply chains. Baby boomers are leaving the labor force en masse. As a group, baby boomers control more than half of US wealth (Chart 3). They will continue to run down their wealth once they retire. However, since they will no longer be working, they will no longer contribute to national output. Continued spending against a backdrop of diminished production could be inflationary. Chart 3Baby Boomers Have Accumulated A Lot Of Wealth Don’t Sweat US Inflation…Just Yet Don’t Sweat US Inflation…Just Yet Despite a pandemic-induced bounce, underlying productivity growth remains disappointing (Chart 4). Slow productivity growth could cause aggregate supply to fall short of aggregate demand. Social stability is in peril, as exemplified by the recent dramatic increase in the US homicide rate. In the past, social instability and higher inflation have gone hand in hand (Chart 5). Chart 4Trend Productivity Growth Has Been Disappointing Trend Productivity Growth Has Been Disappointing Trend Productivity Growth Has Been Disappointing Chart 5Historically, Social Unrest And Higher Inflation Move In Lock-Step Historically, Social Unrest And Higher Inflation Move In Lock-Step Historically, Social Unrest And Higher Inflation Move In Lock-Step Perhaps most importantly, policymakers are aiming to run the economy hot. A tight labor market will lift wage growth (Chart 6). Not only could higher wage growth push up inflation through the usual “cost-push” channel, but by boosting labor’s share of income, a tight labor market could spur aggregate demand. Despite these structural inflationary forces, history suggests that it will take a while – perhaps another two-to-four years – for the US economy to overheat to the point that persistently higher inflation becomes a serious risk. Consider the case of the 1960s. While the labor market reached its full employment level in 1962, it was not until 1966 – when the unemployment rate was a full two percentage points below NAIRU – that inflation finally took off (Chart 7). Chart 6A Tight Labor Market Eventually Bolsters Wages A Tight Labor Market Eventually Bolsters Wages A Tight Labor Market Eventually Bolsters Wages Chart 7Inflation Started Accelerating Quickly Only When Unemployment Reached Very Low Levels In The 1960s Inflation Started Accelerating Quickly Only When Unemployment Reached Very Low Levels In The 1960s Inflation Started Accelerating Quickly Only When Unemployment Reached Very Low Levels In The 1960s In May, 4.4% fewer Americans were employed than in January 2020 (Chart 8). The employment-to-population ratio for prime-aged workers stood at 77.1%, 3.4 percentage points below its pre-pandemic level (Chart 9). Chart 8US Employment Still More Than 4% Below Pre-Pandemic Levels Don’t Sweat US Inflation…Just Yet Don’t Sweat US Inflation…Just Yet Chart 9Prime-Age Employment-To-Population Ratio Remains Below Pre-Pandemic Levels Prime-Age Employment-To-Population Ratio Remains Below Pre-Pandemic Levels Prime-Age Employment-To-Population Ratio Remains Below Pre-Pandemic Levels A Labor Market Puzzle Admittedly, if one were to ask most companies if they were finding it easy to hire suitable workers, one would hear a resounding “no.” According to the National Federation of Independent Business (NFIB), 48% of firms reported difficulty in filling vacant positions in May, the highest share in the 46-year history of the survey (Chart 10). Chart 10US Labor Market Shortages (I) US Labor Market Shortages (I) US Labor Market Shortages (I) Chart 11US Labor Market Shortages (II) US Labor Market Shortages (II) US Labor Market Shortages (II)   Nationwide, the job openings rate reached a record high of 6% in April, up from 4.5% in January 2020. The share of workers quitting their jobs voluntarily – a measure of worker confidence – also hit a record of 2.7% (Chart 11). How can we reconcile the apparent tightness in the labor market with the fact that employment is still well below where it was at the outset of the pandemic? Four explanations stand out. First, unemployment benefits remain extremely generous. For most low-wage workers, benefits exceed the pay they received while employed. It is not surprising that labor shortages have been most pronounced in sectors such as leisure and hospitality where average wages are relatively low (Chart 12). The good news for struggling firms is that the disincentive to working will largely evaporate by September when enhanced unemployment benefits expire. Chart 12Labor Scarcity Prevalent In Low-Wage Sectors Don’t Sweat US Inflation…Just Yet Don’t Sweat US Inflation…Just Yet Chart 13School Closures Have Curbed Labor Supply Don’t Sweat US Inflation…Just Yet Don’t Sweat US Inflation…Just Yet Second, lingering fears of the virus and ongoing school closures continue to depress labor force participation. Chart 13 shows that participation rates have recovered less for mothers with young children than for other demographic groups. This problem will also fade away by the fall when schools reopen. Third, the number of foreign workers coming to the US fell dramatically during the pandemic. State Department data show that visas dropped by 88% in the nine months between April and December of last year compared to the same period in 2019 (Chart 14). President Biden revoked President Trump’s visa ban in February, which should pave the way for renewed migration to the US. Chart 14US Migrant Worker Supply Is Depressed Don’t Sweat US Inflation…Just Yet Don’t Sweat US Inflation…Just Yet Chart 15The Pandemic Accelerated Early Retirement The Pandemic Accelerated Early Retirement The Pandemic Accelerated Early Retirement   Fourth, about 1.5 million more workers retired during the pandemic than one would have expected based on the pre-pandemic trend (Chart 15). Most of these workers were near retirement age anyway. Thus, there will likely be a decline in new retirements over the next couple of years before the baby boomer exodus described earlier in this report resumes in earnest. Other Input Prices Set To Ease Just as labor shortages in a number of industries will ease later this year, some of the bottlenecks gripping the global supply chain should also diminish. The prices of various key inputs – ranging from lumber, steel, soybeans, corn, to DRAM prices – have rolled over (Chart 16). This suggests that producer price inflation for manufactured goods, which hit a multi-decade high of 13.5% in May – has peaked and is heading lower. Chart 16Input Prices Have Rolled Over Input Prices Have Rolled Over Input Prices Have Rolled Over The jump in prices largely reflected one-off pandemic effects. For example, rental car companies, desperate to raise cash at the start of the pandemic, liquidated part of their fleets. Now that the US economy is reopening, they have found themselves short of vehicles. With fewer rental vehicles hitting the used car market, households flush with cash, and new vehicle production constrained by the global semiconductor shortage, both new and used car prices have soared. Vehicle prices have essentially moved sideways since the mid-1990s (Chart 17). Thus, it is doubtful that the recent surge in prices represents a structural break. More likely, prices will come down as supply increases. According to a recent report from Goldman Sachs, auto production schedules already imply an almost complete return to January output levels in June. Chart 17Vehicle Prices Have Essentially Moved Sideways Since The Mid-1990s Vehicle Prices Have Essentially Moved Sideways Since The Mid-1990s Vehicle Prices Have Essentially Moved Sideways Since The Mid-1990s Chart 18Rebounding Pandemic-Affected Services Prices Are Pushing Up Overall CPI Don’t Sweat US Inflation…Just Yet Don’t Sweat US Inflation…Just Yet As Chart 18 shows, more than half of the increase in consumer prices in April and May can be explained by higher vehicle prices, along with a rebound in pandemic-affected service prices (airfares, hotels, and event admissions). Outside those sectors, the level of the CPI remains below its pre-pandemic trend (Chart 19). Chart 19Unwinding Of "Base Effects" Unwinding Of "Base Effects" Unwinding Of "Base Effects"   Chart 20"Supercore" Inflation Measures Remain Well Contained "Supercore" Inflation Measures Remain Well Contained "Supercore" Inflation Measures Remain Well Contained More refined measures of underlying inflation such as the trimmed-mean CPI, median CPI, and sticky price CPI are all running well below their official core CPI counterpart (Chart 20). While certain components of the CPI basket, such as residential rental payments, are likely to exhibit higher inflation in the months ahead, others such as vehicle and food prices will see lower inflation, and perhaps even outright deflation. Slower Chinese Credit Growth Should Temper Commodity Inflation Chart 21Chinese Credit Growth And Metal Prices Move Together Chinese Credit Growth And Metal Prices Move Together Chinese Credit Growth And Metal Prices Move Together Chinese credit growth and base metals prices are strongly correlated (Chart 21). We do not expect the Chinese authorities to embark on a new deleveraging campaign. Credit growth has already fallen back to 11%, which is close to the prior bottom reached in late-2018. Nevertheless, to the extent that changes in Chinese credit growth affect commodity prices with a lag of about six months, metals prices could struggle to maintain altitude over the summer months. China’s plan to release metal reserves into the market could further dampen prices. We remain short the global copper ETF (COPX) relative to the global energy ETF (IXC) in our trade recommendations. The trade is up 18.4% since we initiated on May 27, 2021. We will close this trade if it reaches our profit target of 30%. Bank Shares Are A Better Hedge Against Inflation Than TIPS We have been overweight TIPS in our view matrix. However, with 5-year/5-year forward breakevens trading near pre-pandemic levels, any near-term upside for inflation expectations is limited (Chart 22). As such, we are downgrading TIPS from overweight to neutral in our fixed-income recommendations. Investors looking to hedge inflation risk should consider bank shares. Our baseline view is that the 10-year Treasury yield will rise to about 1.9% by the end of the year. If inflation fails to come down as fast as we anticipate, bond yields would increase even more than that. Chart 23 shows that banks almost always outperform the S&P 500 when bond yields are rising. Chart 22Limited Near-Term Upside For Inflation Expectations Limited Near-Term Upside For Inflation Expectations Limited Near-Term Upside For Inflation Expectations Chart 23Bank Shares Thrive in A Rising Yield Environment Bank Shares Thrive in A Rising Yield Environment Bank Shares Thrive in A Rising Yield Environment   Banks are also cheap. US banks trade at 12.2-times forward earnings compared with 21.9-times for the S&P 500. Non-US banks trade at 10-times forward earnings compared to 16.4-times for the MSCI ACW ex-US index. Finally, we like gold as a long-term inflation hedge. We would go long gold in our structural trade recommendations if the price were to fall to $1700/ounce. Peter Berezin Chief Global Strategist pberezin@bcaresearch.com Global Investment Strategy View Matrix Don’t Sweat US Inflation…Just Yet Don’t Sweat US Inflation…Just Yet Special Trade Recommendations Don’t Sweat US Inflation…Just Yet Don’t Sweat US Inflation…Just Yet Current MacroQuant Model Scores Don’t Sweat US Inflation…Just Yet Don’t Sweat US Inflation…Just Yet

Highlights Oil demand expectations remain high. Realized demand continues to disappoint. This means OPEC 2.0's production-management strategy – i.e., keeping the level of supply below demand – will continue to dictate oil-price levels. US producers will remain focused on consolidation via M&A and on returning capital to shareholders, in line with the Kingdom of Saudi Arabia's (KSA) expectation. Going forward, shale producers will focus on protecting and growing profit margins. The durability of OPEC 2.0's tactical advantage arising from its enormous spare capacity – ~ 7mm b/d – is difficult to gauge: Tightening global oil markets now in anticipation of Iran's return as a bona fide exporter benefits producers globally, and could accelerate the return of US shales if that return is delayed or re-opening boosts demand more than expected. We are raising our average Brent forecast for 2021 to $66.50 vs. $63/bbl earlier, with 2H21 prices averaging $70/bbl. We are moving our 2022 and 2023 forecasts up slightly to $74 and $81/bbl (Chart of the Week). WTI will trade $2-$3/bbl lower. We remain long the S&P GSCI Dynamic Roll Index ETF (COMT) and the S&P GSCI, expecting tight supply-demand balances to further steepen backwardations in forward curves. Feature While the forecasted rebound in global oil demand continues to drive expectations for higher prices, it is the production discipline of OPEC 2.0 and capital discipline imposed on US shale producers that has and will continue to super-charge the recovery of prices. Continued monetary accommodation and fiscal stimulus notwithstanding, realized global oil demand has mostly flatlined at ~ 96mm b/d following its surge in February, as uncertainty over COVID-19 containment keeps governments hesitant about reopening their economies too quickly. Stronger demand in Asia, led by China, has been offset by weaker demand in India and Japan, where COVID-19 remains a deterrent to re-opening and recovery. The recovery in DM demand generally stalled over this period even as vaccine availability increased (Chart 2). Chart of the WeekOPEC 2.0 Comfortable With Higher Prices Balance Of Risks Tilts To Higher Oil Prices Balance Of Risks Tilts To Higher Oil Prices Chart 2Global Demand Recovery Stalled Balance Of Risks Tilts To Higher Oil Prices Balance Of Risks Tilts To Higher Oil Prices That likely will change in 2H21, but it is not a given: The UK, which has been among the world leaders in COVID-19 containment and vaccinations, delayed its full reopening by a month – to July 19 – in an effort to gain more time to bolster its efforts against the Delta variant first identified in India. In the US, New York state lifted all COVID-19-induced restrictions and fully re-opened this week. Still, even in the US, unintended inventory accumulation in the gasoline market – just as the summer driving season should be kicking into high gear – suggests consumers remain cautious (Chart 3). Chart 3Unintended Inventory Accumulation in US Gasoline Market Balance Of Risks Tilts To Higher Oil Prices Balance Of Risks Tilts To Higher Oil Prices We continue to expect the re-opening of the US and Europe (including the UK) will boost DM demand in 2H21, and wider vaccine availability will boost EM oil demand later in the year and in 2022. For all of 2021, we have lifted our demand-growth estimate slightly to 5.3mm b/d from 5.2mm b/d last month. We expect global demand to grow 4.1mm b/d next year and 1.6mm b/d in 2023. Our 2021 estimates are in line with those of the US EIA and the IEA. OPEC is more bullish on demand recovery this year, expecting growth of 6mm b/d. We continue to believe the risk on the demand side remains to the upside; however, given continued uncertainty around global COVID-19 containment, we remain circumspect. Supply-Side Discipline Drives Oil Prices OPEC 2.0 remains committed to its production-management strategy that is keeping the level of supply below demand. Compliance with production cuts in May reportedly was at 115%, following a 114% rate in April.1 Core OPEC 2.0 – i.e., states with the capacity to increase production – is holding ~ 7mm b/d of spare capacity, according to the IEA, which will allow it to continue to perform its role as the dominant supplier in our modeling (Chart 4). Earlier this year, KSA's Energy Minister Abdulaziz bin Salman correctly recognized the turn in the market that likely ensures OPEC 2.0's dominance for the foreseeable future – i.e., the shift in focus of the US shale-oil producers from production for the sake of production to profitability.2 This is a trend that has been apparent for years as capital markets all but abandoned US shale-oil producers. Chart 4OPEC 2.0 Remains Dominant Balance Of Risks Tilts To Higher Oil Prices Balance Of Risks Tilts To Higher Oil Prices Producers outside OPEC 2.0 – what we refer to as the "price-taking cohort" – have prioritized shareholder interests as a result of this market pressure, and remain focused on sometimes-forced consolidation via M&A, which we have been expecting.3 The significance of this evolution of shale-oil production is difficult to overstate, particularly as the survivors of this consolidation will be firms with strong balance sheets and a focus on profitability, as is the case with any well-run manufacturing firm. We also expect large producers to opportunistically shed production assets to reduce their carbon footprints, so as to come into compliance with court-ordered emission reductions and shareholder demands to reduce pollution.4 With the oil majors like Shell, Equinor and Oxy divesting themselves of shale properties, production increasingly will be in the hands of firms driven by profitability.5 We expect US shale-oil production to end the year at 9.86mm b/d and to average 9.57mm b/d next year; however, as the shales become the marginal global supply, production could become more volatile (Chart 5). The consolidation of US production also will alter the profitability of firms continuing to operate in the shales. We expect breakeven costs to fall as acquired production by stronger firms results in high-grading of assets – only the most profitable will be produced given market-pricing dynamics – while less profitable acreage will be mothballed until prices support development(Chart 6). Chart 5US Producers Focus On Profitability Balance Of Risks Tilts To Higher Oil Prices Balance Of Risks Tilts To Higher Oil Prices Chart 6Shale Breakevens Likely Fall As Consolidation Picks Up Balance Of Risks Tilts To Higher Oil Prices Balance Of Risks Tilts To Higher Oil Prices Supply-Demand Balances Tightening The current round of M&A consolidation and OPEC 2.0's continued discipline lead us to expect continued tightening of global oil supply-demand balances this year and next (Chart 7). This will allow inventories to continue to draw, which will keep forward oil curves backwardated (Chart 8). Chart 7Supply-Demand Balances Will Continue To Tighten Balance Of Risks Tilts To Higher Oil Prices Balance Of Risks Tilts To Higher Oil Prices Chart 8Tighter Markets, Lower Stocks Balance Of Risks Tilts To Higher Oil Prices Balance Of Risks Tilts To Higher Oil Prices The critical factor here will be OPEC 2.0's continued calibration of supply in line with realized demand and the return of Iran as a bona fide exporter, which we expect later this year. OPEC 2.0's restoration of ~ 2mm b/d of supply will be done by the beginning of 3Q21, when we expect Iran to begin restoring production and visible exports (i.e., in addition to its under-the-radar sales presently). The return of Iranian supply – and a possible increase in Libyan output – will present some timing difficulties for OPEC 2.0's overall strategy, but they will be short-lived. We continue to monitor output to assess the evolution of balances (Table 1). Table 1BCA Global Oil Supply - Demand Balances (MMb/d, Base Case Balances) Balance Of Risks Tilts To Higher Oil Prices Balance Of Risks Tilts To Higher Oil Prices Investment Implications Oil demand will increase over the course of 2H21, as vaccines become more widely distributed globally, and the massive fiscal and monetary stimulus deployed worldwide kicks economic activity into high gear. On the supply side, markets will tighten on the back of continued restraint until Iranian barrels return to the market. The balance of risk is to the upside, particularly if the US and Iran are unable to agree terms that restore Iran as a bona fide exporter. In that case, the market tightening now under way will result in sharply higher prices. That said, realized demand growth has stalled over the past three months, which can be seen in unintended inventory accumulation in the US gasoline markets just as the summer driving season opens. We are raising our average Brent forecast for 2021 to $66.50 vs. $63/bbl earlier, with 2H21 prices averaging $70/bbl. We are moving our 2022 and 2023 forecasts up slightly as well to $74 and $81/bbl (Chart of the Week). WTI will trade $2-$3/bbl lower. We remain long the S&P GSCI Dynamic Roll Index ETF (COMT) and the S&P GSCI, expecting tight supply-demand balances to further steepen backwardations in forward curves. The big risk, as highlighted above, remains an acceleration of COVID-19 infections, hospitalizations and deaths, which force governments to delay re-opening or impose localized lockdowns once again. In this regard, KSA's strategy of calibrating its output to realized – vice forecasted – demand likely will remain in place.   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 China's refinery throughput surged 4.4% to 14.3mm b/d in May, a record high that surpassed November 2020's previous record of 14.26mm b/d, according to S&P Platts Global. The increased runs were not unexpected, and were largely accounted for by state-owned refiners, which operated at 80% of capacity after coming out of turnaround season. Turnarounds will fully end in July. In addition, taxes on niche refined-product imports are due to increase, which will bolster refinery margins as inventories are worked down. China's domestic crude oil production was just slightly more than 4mm b/d. Base Metals: Bullish China's Standing Committee approved the release an undisclosed amount of its copper, aluminum and zinc stockpiles via an auction process in the near future, according to reuters.com. The government disclosed its intent on the website of National Food and Strategic Reserves Administration on Wednesday; however, specifics of the auction – volumes and auction schedule, in particular – were not disclosed. Prices had fallen ~ 9% from recent record highs in the lead-up to the announcement, which we flagged last month.6 Prices rallied from lows close to $4.34/lb on the COMEX Wednesday (Chart 9). Precious Metals: Bullish After a worse-than-expected US employment report, we do not expect the Federal Reserve to lift nominal interest rates in Wednesday’s Federal Open Market Committee (FOMC) meeting. The Fed will only raise rates once the US economy reaches a level consistent with its definition of "maximum employment." Wednesday’s interest rate decision will be crucial to gold prices. If the Fed does not mention asset tapering or an interest-rate hike, citing current inflation as a transitory phenomenon, gold demand and prices will rise. On the other hand, if the Fed indicates an interest rate hike sooner than the previously stated 2024, this will weigh on gold prices (Chart 10). Ags/Softs: Neutral As of June 13, 96% of the US corn crop had emerged vs. the five-year average of 91%, according to the USDA. 68% of the crop was rated in good to excellent condition, slightly below the five-year average. In the bean market, 94% of the crop was planted as of 13 June, vs. the five-year average of 88%. The Department reported 86% of the crop had emerged vs. the five-year average of 74%. According to the USDA, 52% of the bean crop was in good-to-excellent condition vs the five-year average of 72%. Chart 9 Balance Of Risks Tilts To Higher Oil Prices Balance Of Risks Tilts To Higher Oil Prices Chart 10 Balance Of Risks Tilts To Higher Oil Prices Balance Of Risks Tilts To Higher Oil Prices   Footnotes 1     Please see OPEC+ complies with 115% of agreed oil curbs in May - source published by reuters.com on June 11, 2021. 2     Please see Saudis raise U.S. and Asian crude prices for April delivery published by worldoil.com on March 8, 2021. 3    Please see US shale consolidation continues as Independence scoops up Contango Oil & Gas published by S&P Global Platts on June 8, 2021. 4    We discuss this in A Perfect Energy Storm On The Way, published on June 3, 2021.  Climate activism will become increasingly important to the evolution of oil and natural gas production, and likely will lead to greater concentration of supply in the hands of OPEC 2.0 and privately held producers that do not answer to shareholders. 5    Please see Interest in Shell's Permian assets seen as a bellwether for shale demand published by reuters.com on June 15, 2021. 6    Please see Less Metal, More Jawboning, which we published on May 27, 2021.  It is available at ces.bcaresearch.com. 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