Russia
Highlights A World Organization of the Petroleum Exporting Countries (WOPEC) looks set to emerge after today’s OPEC 2.0 video conference to discuss production cuts in the wake of the COVID-19 pandemic, and the market-share war between the leaders of the coalition led by the Kingdom of Saudi Arabia (KSA) and Russia. WOPEC will not be memorialized by a Declaration of Cooperation as OPEC 2.0 was. Oil exporters globally will cooperate on harmonizing policy to meet demand. In our latest scenario concentrating on likely supply responses, we show cuts of ~ 8mm b/d will be sufficient to clear the storage overhang caused by COVID-19-induced demand destruction of close to 4mm b/d this year. Based on this modeling, we see Brent prices averaging $36/bbl and $64/bbl this year and next, with WTI trading $2-$6/bbl lower, depending on US Gulf storage availability. This is roughly in line with our previous scenario (Chart of the Week).1 Demand destruction over 4mm b/d would require additional production cuts. Feature The 2020 oil price collapse brought on by COVID-19 – and super-charged by the market-share war declared by Russia following the breakdown of OPEC 2.0’s March 6 meeting – has spurred oil-producing states globally to action. Chart of the WeekExpect A Sharp Oil Price Recovery Chart 2The Oil-Price Collapse Of 2020 WOPEC is bigger than OPEC 3.0 – an unofficial grouping we hypothesized at the end of March to encompass the expected future cooperation of KSA, Russia and the Texas Railroad Commission (RRC) – our shorthand for US oil-producing interests – succeeding OPEC 2.0. Today’s OPEC 2.0 video conference originally was called by KSA for Monday, but was moved to today – presumably – to give member states time to agree production cuts. The conference most likely was delayed by the acrimonious public exchange between its leaders this past weekend.2 On the heels of the OPEC 2.0 video conference comes a hastily called video conference on Friday of G20 energy ministers to discuss energy security. The G20 is led by KSA this year.3 The 2020 oil price collapse brought on by COVID-19 – and super-charged by the market-share war declared by Russia following the breakdown of OPEC 2.0’s March 6 meeting – has spurred oil-producing states globally to action (Chart 2). KSA, Russia and their respective OPEC 2.0 allies all are fully invested in this meeting, as are producers in the US, Canada, Norway and Brazil.4 Supply Destruction Vs.Production Cuts Oil producers face a stark choice: Either cut production voluntarily to counter the global demand destruction of a pandemic, or have the market do it for them by driving prices through cash costs toward zero (i.e., $0.00/bbl), as global crude oil and product storage fills. Prices in some basins have fallen close to zero after accounting for the basis differentials to benchmark prices and transport costs (e.g., WTI-Midland), which, in the US has begun to force shut-ins (Chart 3).5 Continued weak pricing close to zero risks shutting older, high-cost landlocked production in permanently, and many states simply cannot afford to lose the critical revenue provided by oil exports. Chief among these states are the non-Gulf members of OPEC, excluding Russia, US onshore, and Canada, which we identify as “The Other Guys” (Chart 4).6 Chart 3Some Crude Grades Priced Close To $0.00/bbl Chart 4"The Other Guys" Production Declines Would Moderate With OPEC 2.0 Deal We expect The Other Guys in OPEC 2.0 will lose 700k b/d, with 400k b/d of that realized over the course of 2021. The chief contribution of The Other Guys to the OPEC 2.0 coalition’s production-management scheme is their managed production decline. These states were only starting to recover from the Global Financial Crisis (GFC) beginning in 2010 when the OPEC market-share war of 2014-16 was declared. The COVID-19 price collapse, coupled with the knock-on effects of the 2020 KSA-Russia market-share war likely accelerates the rate of production decline for the Other Guys, as capital continues to avoid developing their resources. We expect The Other Guys in OPEC 2.0 will lose 700k b/d, with 400k b/d of that realized over the course of 2021. Core OPEC and Russia can increase (and decrease) production, and we expect they will deliver the largest part of the OPEC 2.0 production cuts. In this week’s simulation, we project KSA will cut 2mm b/d, from their April level of from 12mm b/d; and Russia will cut 1.1mm b/d, down from 11.6mm b/d. We then project Iraq will cut 460k b/d; Kuwait 280k b/d; and the UAE 315k b/d. Outside OPEC 2.0, a lot of the production we expect will be cut is out of necessity. Canada, for example, will be forced to either shut in high-cost tar-sands production or go back to pro-rating production as it did last year, owing to a lack of storage in Alberta and pipeline takeaway capacity to move their crude south to US refiners. We expect Canada to cut 350k b/d this year, as a result. Brazil’s Petrobras already has shut in 100k b/d, and US producers have begun shutting in shale-oil production.7 US Production Cuts Some of the more efficient producers in The Great State of Texas have been calling for pro-rationing of up to 20%, which would push the cuts in Texas’s Permian and Eagle Ford shale basins alone to 1.23mm b/d. Production cuts most likely will be focused on the US, as this is the most easy-to-adjust output in the world. It also still is higher up the global cost curve, although, as we have noted earlier, this will change in the event bankruptcies pick up.8 In the US, production cuts already have begun. They are and will continue to be focused on the shales. We continue to project cuts in the US shales of ~ 1.5 mm b/d this year. However, this number could be higher: If producers respond to the collapse in prices by not sending any new rigs to the field in the next 12 months, production will fall by 2.9mm b/d from production declines alone. Just to keep production flat, the US shales will need an average of ~ 520 rigs per month (assuming no drilled-uncompleted wells are finished). The risk on our rig-count estimates are straightforward: If rig counts go much lower, we could see a large decline in shale production in the coming months (Chart 5). Chart 5US Shale Output Falls This Year And Next Some of the more efficient producers in The Great State of Texas have been calling for pro-rationing of up to 20%, which would push the cuts in Texas’s Permian and Eagle Ford shale basins alone to 1.23mm b/d. Including the Anadarko Basin, most of which is in Oklahoma, which also permits pro-rationing, 20% pro-rationing would push TX-OK cuts to ~ 1.33mm b/d. As we have been writing over the past month, we could see a return of pro-rationing in the states of Texas and Oklahoma. In the Great State, producers have filed a petition before the Texas RRC asking the Commission to reprise its 1928-73 production-management role.9 The Texas RRC will hold a video conference Tuesday, April 14, to consider this petition. We’re expecting this petition to be granted, and for pro-rationing to begin in the near future. On the demand side, we are staying with the scenario we presented March 30, with 2Q20 demand falling ~ 12mm b/d (y/y vs. 2Q19). In 2H20, we project demand to grow at a rate of 800k b/d by 4Q20. For all of 2020, we model average demand losses equal to 3.8mm b/d. For 2021, massive fiscal and monetary stimulus globally will lift demand 5.3mm b/d. With the supply cuts projected above and our demand view, we see balances tightening over the course of the year and moving into a physical deficit in 4Q20 (Chart 6). While near-term oversupply will force inventories to grow sharply, we expect them to draw as sharply beginning by September and continuing into next year (Chart 7). Chart 6Supply-Demand Imbalance Will Tighten Into 2021 Chart 7Inventories Will Build Sharply, Then Draw Sharply in 2021 Investment Implications Our projections for supply presented this week and our demand scenario presented at the end of March are evolving into our base case for oil and gas. We still do not know with certainty the OPEC 2.0 coalition will agree to production cuts today, or whether the Texas RRC will return to the business of pro-rationing. If either or both of these outcomes does not materialize, markets will take over and savagely destroy supply. This will be extremely volatile. For our part, we expect OPEC 2.0, the Other Guys outside the coalition, and the US shales to deliver something that looks like voluntary cuts. This will occur via voluntary cuts, “managed” declines, and pro-rationing and shut-ins. Unlike many of our economist colleagues who argue against such jointly coordinated policies – invoking a free-market, pure-competition paradigm that has not existed for any meaningful period in the modern history of the oil market – we believe producers are intelligently pursuing their interests by jointly coordinating the boom-bust mayhem of unfettered oil markets. Similarly, we believe consumers are better served by diversified sources of energy vs. an over-reliance on large concentrated supplies who can use their low-cost endowment to monopolize supply and set up barrier to entry to competition. Given our view, we remain constructive to the oil market, expecting a rally that will look a lot like the Chart of the Week and the balances we show in Chart 7. As a result, we are getting long 2H21 Brent vs. short 2H22 Brent futures. Robert P. Ryan Chief Commodity & Energy Strategist rryan@bcaresearch.com Hugo Bélanger Associate Editor Commodity & Energy Strategy HugoB@bcaresearch.com Fernando Crupi Research Associate Commodity & Energy Strategy FernandoC@bcaresearch.com Commodities Round-Up Energy: Overweight Defying the global rush to cut oil production, Mexico apparently is moving toward increasing production. Petroleos Mexicanos (PEMEX) is looking to drill 423 wells this year, according to Bloomberg. A March 26 Journal of Petroleum Technology survey suggests capex by E&P companies will fall by up to 35% this year. Base Metals: Neutral This week Japan’s Nippon Steel became the latest producer to idle blast furnaces, halting about 15% of the company’s total capacity. More generally an iron ore surplus in other parts of Asia and in Europe is expected as steel mills idle furnaces amidst lower demand for their output. However, diminished activities in mines – severely impacted by lockdowns – will offset some of the demand loss. COVID-19 induced shutdown in South Africa, Iran, India and Canada have curtailed exports from those countries until late April. Additionally, bad weather in Brazil led iron ore exports to fall on a yoy basis for the third month in a row in March. A decline of ~ 2% vs. last year’s already depressed – following the Vale dam incident – levels. China’s anticipated infrastructure stimulus will support iron ore demand, drawing down inventories and pushing up prices, but it, too, will be tempered by the pace of the recovery in its export markets. Precious Metals: Neutral A strong US dollar remains an important risk for precious metals. The dollar rose 1.6% since March 28 despite the Fed’s actions to calm the global dollar liquidity squeeze. This signals the funding crisis has not been thoroughly controlled and that swap lines will have to be extended to additional EM central banks. However, a large share of outstanding foreign exchange swaps/forwards resides in non-bank financial corporations and institutions with limited access to dollar funding via central bank swap lines. Over the short-term, our gold price recommendation remains vulnerable to deterioration, due to uncertain liquidity conditions (Chart 8). Ags/Softs: Underweight This week we begin tracking the lumber market. Lumber consumption fell sharply as the coronavirus spread in the United States, pushing front-month futures down 44% from February highs. With housing starts already weak in February – down 1.5% month on month – and expected to be even weaker in March (Chart 9), continued lumber supply curtailments will stabilize prices in the short term and eventually push prices up once lower interest rates kick in and demand resumes. Chart 8 Chart 9 1 Please see OPEC 3.0 In the Offing?, published March 30, 2020, which focused on demand destruction. 2 Please see OPEC+ meeting delayed as Saudi Arabia and Russia row over oil price collapse: sources, and G20 energy ministers to hold video conference on Friday: document published by reuters.com April 4 and April 7, 2020. 3 The G20 consists of Argentina, Australia, Brazil, Canada, China, Germany, France, India, Indonesia, Italy, Japan, Mexico, the Russian Federation, Saudi Arabia, South Africa, South Korea, Turkey, the UK, the US and the EU. 4 Please see A look at the major players in this week’s “OPEC++” meeting, a Bloomberg analysis published by worldoil.com April 7, 2020. 5 Please see Can the world agree a deal to boost oil prices? Published by Wood MacKenzie April 3, 2020. 6 The Other Guys is our moniker for all producers excluding core-OPEC, US shale, Russia and Canada. Production from this group of producers has been falling as a share of global production for years, due to a lack of domestic and foreign direct investment in their energy sectors. 7 In its latest Short-Term Energy Forecast, the EIA estimates US crude oil production will fall 500k b/d this year and 700k b/d next year, driven by market forces. 8 For a discussion, please see How Long Will The Oil-Price Rout Last?, a Special Report we published with BCA Research’s Geopolitical Strategy March 9, 2020. It is available at ces.bcaresearch.com. 9 Please see Oil Prorationing in the Spotlight at Texas Railroad Commission, published by Baker Botts, a Texas law firm, on March 30, 2020. Investment Views and Themes Recommendations Strategic Recommendations Tactical Trades Trade Recommendation Performance In 2019 Q4 Commodity Prices and Plays Reference Table Trades Closed in 2020 Summary of Closed Trades
Highlights The pandemic has a negative impact on households and has not peaked in the US. But a depression is likely to be averted. Our market-based geopolitical risk indicators point toward a period of rising political turbulence across the world. We are selectively adding risk to our strategic portfolio, but remain tactically defensive. Stay long gold on a strategic time horizon. Feature I'm going where there's no depression, To the lovely land that's free from care. I'll leave this world of toil and trouble My home's in Heaven, I'm going there. - “No Depression In Heaven,” The Carter Family (1936) Chart 1The Pandemic Stimulus Versus The Great Recession Stimulus Markets bounced this week on the back of a gargantuan rollout of government spending that is the long-awaited counterpart to the already ultra-dovish monetary policy of global central banks (Chart 1). Just when the investment community began to worry about a full-fledged economic depression and the prospect for bank runs, food shortages, and martial law in the United States, the market rallied. Yet extreme uncertainty persists over how long one third of the world’s population will remain hidden away in their homes for fear of a dangerous virus (Chart 2). Chart 2Crisis Has Not Verifiably Peaked, Uncertainty Over Timing Of Lockdowns Chart 3The Pandemic Shock To The Labor Market While an important and growing trickle of expert opinion suggests that COVID-19 is not as deadly as once thought, especially for those under the age of 50, consumer activity will not return to normal anytime soon.1 Moreover political and geopolitical risks are skyrocketing and have yet to register in investors’ psyche. Consider: American initial unemployment claims came in at a record-breaking 3.3 million (Chart 3), while China International Capital Corporation estimates that China’s GDP will grow by 2.6% for the year. These are powerful blows against global political as well as economic stability. This should convince investors to exercise caution even as they re-enter the equity market. We are selectively putting some cash to work on a strategic time frame (12 months and beyond) to take advantage of some extraordinary opportunities in equities and commodities. But we maintain the cautious and defensive tactical posture that we initiated on January 24. No Depression In Heaven The US Congress agreed with the White House on an eye-popping $2.2 trillion or 10% of GDP fiscal stimulus. At least 46% of the package consists of direct funds for households and small businesses (Chart 4). This includes $290 billion in direct cash handouts to every middle-class household – essentially “helicopter money,” as it is financed by bonds purchased by the central bank (Table 1). The purpose is to plug the gap left by the near complete halt to daily life and business as isolation measures are taken. A depression is averted, but we still have a recession. Go long consumer staples. Chart 4The US Stimulus Package Breakdown Table 1Distribution Of Cash Handouts Under US Coronavirus Response Act China, the origin of the virus that triggered the global pandemic and recession, is resorting to its time-tried playbook of infrastructure spending, with 3% of GDP in new spending projected. This number is probably heavily understated. It does not include the increase in new credit that will accompany official fiscal measures, which could easily amount to 3% of GDP or more, putting the total new spending at 6%. Germany and the EU have also launched a total fiscal response. The traditionally tight-fisted Berlin has launched an 11% of GDP stimulus, opening the way for other member states to surge their own spending. The EU Commission has announced it will suspend deficit restrictions for all member states. The ECB’s Pandemic Emergency Purchase Program (PEPP) enables direct lending without having to tap the European Stability Mechanism (ESM) or negotiate the loosening of its requirements. It also enables the ECB to bypass the debate over issuing Eurobonds (though incidentally Germany is softening its stance on the latter idea). The cumulative impact of all this fiscal stimulus is 5% of global GDP – and rising (Table 2). Governments will be forced to provide more cash on a rolling basis to households and businesses as long as the pandemic is raging and isolation measures are in place. Table 2The Global Fiscal Stimulus In Response To COVID-19 President Trump has signaled that he wants economic life to begin resuming after Easter Sunday, April 12. But he also said that he will listen to the advice of the White House’s public health advisors. State governors are the ones who implement tough “shelter in place” orders and other restrictions, so the hardest hit states will not resume activity until their governors believe that the impact on their medical systems can be managed. Authorities will likely extend the social distancing measures in April until they have a better handle on the best ways to enable economic activity while preserving the health system. Needless to say, economic activity will have to resume gradually as the government cannot replace activity forever and the working age population can operate even with the threat of contracting the disease (social distancing policies would become more fine-tuned for types of activity, age groups, and health risk profiles). The tipping point from recession to depression would be the point at which the government’s promises of total fiscal and monetary support for households and businesses become incapable of reassuring either the financial markets or citizens. The largest deficit the US government has ever run was 30% of GDP during World War II (Chart 5). Today’s deficit is likely to go well beyond 15% (5% existing plus 10% stimulus package plus falling revenue). If authorities were forced to triple the lockdown period and hence the fiscal response the country would be in uncharted territory. But this is unlikely as the incubation period of the virus is two weeks and China has already shown that a total lockdown can sharply reduce transmission. Chart 5The US's Largest Peacetime Budget Deficit Any tipping point into depression would become evident in behavior: e.g. a return to panic selling, followed by the closure of financial market trading by authorities, bank runs, shortages of staples across regions, and possibly the use of martial law and curfews. While near-term selloffs can occur, the rest seems very unlikely – if only because, again, the much simpler solution is to reduce the restrictions on economic activity gradually for the low-risk, healthy, working age population. Bottom Line: Granting that the healthy working age population can and will eventually return to work due to its lower risk profile, unlimited policy support suggests that a depression or “L-shaped” recovery is unlikely. The Dark Hour Of Midnight Nearing While the US looks to avoid a depression, there will still be a recession with an unprecedented Q2 contraction. The recovery could be a lot slower than bullish investors expect. Global manufacturing was contracting well before households got hit with a sickness that will suppress consumption for the rest of the year. There is another disease to worry about: the dollar disease. The world is heavily indebted and holds $12 trillion in US dollar-denominated debt. Yet the dollar is hitting the highest levels in years and global dollar liquidity is drying up. The greenback has rallied even against major safe haven currencies like the Japanese yen and Swiss franc (Chart 6). Of course, the Fed is intervening to ensure highly indebted US corporates have access to loans and extending emergency dollar swap lines to a total of 14 central banks. But in the near term global growth is collapsing and the dollar is overshooting. This can create a self-reinforcing dynamic. The same goes for any relapse in Chinese growth. Unlike in 2008 – but like 2015 – China is the epicenter of the global slowdown. China has much larger economic and financial imbalances today than it did in 2003 when the SARS outbreak occurred, and it will increase these imbalances going forward as it abandons its attempt to deleverage the corporate sector (Chart 7). Chart 6The Greenback Surge Deprives The World Of Liquidity Chart 7China's Financial Imbalances Are A Worry The rest of emerging markets face their own problems, including poor governance and productivity, as well as the dollar disease and the China fallout. They are unlikely to lift themselves out of this crisis, but they could become the source for credit events and market riots that prolong the global risk-off phase. Bottom Line: It is too soon to sound the all-clear. If the dollar continues on its rampage, then the gigantic stimulus will not be enough, markets will relapse, and fears of deflation will grow. World Of Toil And Trouble Political risk is the next shoe to drop. The pandemic and recession are setting in motion a political earthquake that will unfold over the next decade. Almost all of our 12 market-based geopolitical risk indicators have exploded upward since the beginning of the year. Chart 8China's Political Risk Is Rising These indicators show that developed market equities and emerging market currencies are collapsing far more than is justified by underlying fundamentals. This risk premium reflects the uncertainty of the pandemic, but the recession will destabilize regimes and fuel fears about national security. So the risk premium will not immediately decline in several important cases. China’s political risk is shooting up, as one would expect given that the pandemic began in Hubei (Chart 8). The stress within the Communist Party can be measured by the shrill tone of the Chinese propaganda machine, which is firing on all cylinders to convince the world that Chinese President Xi Jinping did a great job handling the virus while the western nations are failing states that cannot handle it. The western nations are indeed mishandling it, but that does not solve China’s domestic economic and social troubles, which will grow from here. Of course, our political risk indicator will fall if Chinese equities rally more enthusiastically than Chinese state banks expand credit as the economy normalizes. But this would suggest that markets have gotten ahead of themselves. By contrast, if China surges credit, yet equity investors are unenthusiastic, then the market will be correctly responding to the fact that a credit surge will increase economic imbalances and intensify the tug-of-war between authorities and the financial system, particularly over the effort to prevent the property sector bubble from ballooning. China needs to stimulate to recover from the downturn. Obviously it does not want instability for the 100th birthday of the Communist Party in 2021. An even more important reason for stimulus is the 2022 leadership reshuffle – the twentieth National Party Congress. This is the date when Xi Jinping would originally have stepped down and the leading member of the rival faction (Hu Chunhua?) would have taken over the party, the presidency, and the military commission. Today Xi is not at risk of losing power, but with a trade war and recession to his name, he will have to work hard to tighten control over the party and secure his ability to stay in power. An ongoing domestic political crackdown will frighten local governments and private businesses, who are already scarred by the past decade and whose animal spirits are important to the overall economic rebound. It is still possible that Beijing will have to depreciate the renminbi against the dollar. This is the linchpin of the trade deal with President Trump – especially since other aspects of the deal will be set back by the recession. As long as Trump’s approval rating continues to benefit from his crisis response and stimulus deals, he is more likely to cut tariffs on China than to reignite the trade war. This approach will be reinforced by the bump in his approval rating upon signing the $2 trillion Families First Coronavirus Response Act into law (Chart 9). He will try to salvage the economy and his displays of strength will be reserved for market-irrelevant players like Venezuela. But if the virus outbreak and the surge in unemployment turn him into a “lame duck” later this year, then he may adopt aggressive trade policy and seek the domestic political upside of confronting China. He may need to look tough on trade on the campaign trail. Diplomacy with North Korea could also break down. This is not our base case, but we note that investors are pricing crisis levels into the South Korean won despite its successful handling of the coronavirus (Chart 10). Pyongyang has an incentive to play nice to assist the government in the South while avoiding antagonizing President Trump. But Kim Jong Un may also feel that he has an opportunity to demonstrate strength. This would be relevant not because of North Korea’s bad behavior but because a lame duck President Trump could respond belligerently. Chart 9Trump’s Approval Gets Bump From Crisis Response And Stimulus Chart 10South Korean Political Risk Rising We highlighted Russia as a “black swan” candidate for 2020. This view stemmed from President Vladimir Putin’s domestic machinations to stay in power and tamp down on domestic instability in the wake of domestic economic austerity policies. For the same reason we did not expect Moscow to engage in a market share war with Saudi Arabia that devastated oil prices, the Russian ruble, and economy. At any rate, Russia will remain a source of political surprises going forward (Chart 11). Go long oil. Putin cannot add an oil collapse to a plague and recession and expect a popular referendum to keep him in power till 2036. The coronavirus is hitting Russia, forcing Putin to delay the April 22 nationwide referendum that would allow him to rule until 2036. It is also likely forcing a rethink on a budget-busting oil market share war, since more than the $4 billion anti-crisis fund (0.2% of GDP) will be needed to stimulate the economy and boost the health system. Russia faces a budget shortfall of 3 trillion rubles ($39 billion) this year from the oil price collapse. It is no good compounding the economic shock if one intends to hold a popular referendum – even if one is Putin. For all these reasons we agree with BCA Research Commodity & Energy Strategy that a return to negotiations is likely sooner rather than later. Chart 11Russia: A Lake Of Black Swans However, we would not recommend buying the ruble, as tensions with the US are set to escalate. Instead we recommend going long Brent crude oil. Political risk in the European states is hitting highs unseen since the peak of the European sovereign debt crisis (Chart 12). Some of this risk will subside as the European authorities did not delay this time around in instituting dramatic emergency measures. Chart 12Europe: No Delay In Offering 'Whatever It Takes' Chart 13Political Risk Understated In Taiwan And Turkey However, we do not expect political risk to fall back to the low levels seen at the end of last year because the recession will affect important elections between now and 2022 in Italy, the Netherlands, Germany, and France. Only the UK has the advantage of a single-party parliamentary majority with a five-year term in office – this implies policy coherence, notwithstanding the fact that Prime Minister Boris Johnson has contracted the coronavirus. The revolution in German and EU fiscal policy is an essential step in cementing the peripheral countries’ adherence to the monetary union over the long run. But it may not prevent a clash in the coming years between Italy and Germany and Brussels. Italy is one of the countries most likely to see a change in government as a result of the pandemic. It is hard to see voters rewarding this government, ultimately, for its handling of the crisis, even though at the moment popular opinion is tentatively having that effect. The Italian opposition consists of the most popular party, the right-wing League, and the party with the fastest rising popular support, which is the right-wing Brothers of Italy. So the likely anti-incumbent effect stemming from large unemployment would favor the rise of an anti-establishment government over the next year or two. The result would be a clash with Brussels even in the context of Brussels taking on a more permissive attitude toward budget deficits. This will be all the worse if Brussels tries to climb down from stimulus too abruptly. Our political risk indicators have fallen for two countries over the past month: Taiwan and Turkey (Chart 13). This is not because political risk is falling in reality, but because these two markets have not seen their currencies depreciate as much as one would expect relative to underlying drivers of their economy: In Taiwan’s case the reason is the US dollar’s unusual strength relative to the Japanese yen amidst the crisis. Ultimately the yen is a safe-haven currency and it will eventually strengthen if global growth continues to weaken. Moreover we continue to believe that real world politics will lead to a higher risk premium in the Taiwanese dollar and equities. Taiwan faces conflicts with mainland China that will increase with China’s recession and domestic instability. In Turkey’s case, the Turkish lira has depreciated but not as much as one would expect relative to European equities, which have utterly collapsed. Therefore Turkey’s risk indicator shows its domestic political risk falling rather than rising. Turkey’s populist mismanagement will ensure that the lira continues depreciating after European equities recover, and then our risk indicator will shoot up. Chart 14Brazilian Political Risk Is No Longer Contained Prior to the pandemic, Brazilian political risk had remained contained, despite Brazilian President Jair Bolsonaro’s extreme and unorthodox leadership. Since the outbreak, however, this indicator has skyrocketed as the currency has collapsed (Chart 14). To make matters worse, Bolsonaro is taking a page from President Trump and diminishing the danger of the coronavirus in his public comments to try to prevent a sharp economic slowdown. This lackadaisical attitude will backfire since, unlike the US, Brazil does not have anywhere near the capacity to manage a major outbreak, as government ministers have warned. This autumn’s local elections present an opportunity for the opposition to stage a comeback. Brazilian stocks won’t be driven by politics in the near term – the effectiveness of China’s stimulus is critical for Brazil and other emerging markets – but political risk will remain elevated for the foreseeable future. Bottom Line: Geopolitical risk is exploding everywhere. This marks the beginning of a period of political turbulence for most of the major nation-states. Domestic economic stresses can be dealt with in various ways but in the event that China’s instability conflicts with President Trump’s election, the result could be a historic geopolitical incident and more downside in equity markets. In Russia’s case this has already occurred, via the oil shock’s effect on US shale producers, so there is potential for relations to heat up – and that is even more true if Joe Biden wins the presidency and initiates Democratic Party revenge for Russian election meddling. The confluence of volatile political elements informs our cautious tactical positioning. Investment Conclusions If the historic, worldwide monetary and fiscal stimulus taking place today is successful in rebooting global growth, then there will be “no depression.” The world will learn to cope with COVID-19 while the “dollar disease” will subside on the back of massive injections of liquidity from central banks and governments. Gold: The above is ultimately inflationary and therefore our strategic long gold trade will be reinforced. The geopolitical instability we expect to emerge from the pandemic and recession will add to the demand for gold in such a reflationary environment. No depression means stay long gold! US Equities: Equities will ultimately outperform government bonds in this environment as well. Our chief US equity strategist Anastasios Avgeriou has tallied up the reasons to go long US stocks in an excellent recent report, “20 Reasons To Buy Equities.” We agree with this view assuming investors are thinking in terms of 12 months and beyond. Chart 15Oil/Gold Ratio Extreme But Wait To Go Long Tactically, however, we maintain the cautious positioning that we adopted on January 24. We have misgivings about the past week’s equity rally. Investors need a clear sense of when the US and European households will start resuming activity. The COVID-19 outbreak is still capable of bringing negative surprises, extending lockdowns, and frightening consumers. Hence we recommend defensive plays that have suffered from indiscriminate selling, rather than cyclical sectors. Go tactically long S&P consumer staples. US Bonds: Over the long run, the Fed’s decision to backstop investment grade corporate bonds also presents a major opportunity to go long on a strategic basis relative to long-dated Treasuries, following our US bond strategists. Global Equities: We prefer global ex-US equities on the basis of relative valuations and US election uncertainty. Shifting policy winds in the United States favor higher taxes and regulation in the coming years. This is true unless President Trump is reelected, which we assess as a 35% chance. Emerging Markets: We are booking gains on our short TRY-USD trade for a gain of 6%. This is a tactical trade that remains fundamentally supported. Book 6% gain on short TRY-USD. Oil: For a more contrarian trade, we recommend going long oil. Our tactical long oil / short gold trade was stopped out at 5% last week. While we expect mean reversion in this relationship, the basis for gold to rally is strong. Therefore we are going long Brent crude spot prices on Russia’s and Saudi Arabia’s political constraints and global stimulus (Chart 15). We will reconsider the oil/gold ratio at a later date. Matt Gertken Vice President Geopolitical Strategist mattg@bcaresearch.com Footnotes 1 See Joseph T. Wu et al, "Estimating clinical severity of COVID-19 from the transmission dynamics in Wuhan, China," Nature Medicine, March 19, 2020, and Wei-jie Guan et al, "Clinical Characteristics of Coronavirus Disease 2019 in China," The New England Journal Of Medicine, February 28, 2020. Section II: Appendix : GeoRisk Indicator China Russia UK Germany France Italy Canada Spain Taiwan Korea Turkey Brazil Section III: Geopolitical Calendar
Highlights Rapidly changing news flows are forcing oil markets to recalibrate supply-demand fundamentals continuously. This will keep volatility at or close to recent record highs (Chart of the Week). The demand shock from COVID-19 accounts for ~ 65% of the oil price collapse, based on our modeling. USD demand is fueling record dollar strength, which could suppress commodity consumption after the COVID-19 shock dissipates. If the Fed’s epic monetary policy response sates USD demand, commodity demand will rebound strongly. Highly uncertain expectations on the supply side – fueled by the market-share war between the Kingdom of Saudi Arabia (KSA) and Russia set to begin in earnest April 1 – will keep global policy uncertainty elevated post-COVID-19. Texas regulators are debating the efficacy of re-establishing a long-dormant policy mandating the state’s Railroad Commission (RRC) pro-rate production. The chairman of the RRC and the CEO of Russia’s state oil champion Rosneft both oppose production-management schemes, arguing they allow other producers to steal market share. The Trump administration, however, sees potential in working with KSA to stabilize markets. Feature Sparse information available to markets makes it extremely difficult to estimate the impact of the COVID-19 shock to demand. Oil options’ implied volatility reached record levels following unprecedented price changes – down and up – in the underlying futures markets over the past month, as the Chart of the Week shows.1 This reflects the markets’ profound uncertainty regarding supply, demand and near-term policy outcomes that will affect these fundamentals in the short-, medium- and long-term. Sparse information available to markets makes it extremely difficult to estimate the impact of the COVID-19 shock to demand. The ever-changing evolution of supply dynamics presents its own – unprecedented – difficulties. The usual lags in information on supply and demand are compounded by the near-certain substantial revisions that will accompany these data as a better picture of the fundamentals emerges. Chart of the WeekOil Price Volatility At Record Level That said, we are attempting to develop models and an intuition for likely turning points on both sides of the fundamentals. We stress up front that these estimates are tentative, particularly on the demand side, as they use commodity prices and financial variables that are difficult to track closely even in the best of times, and are themselves continuously adjusting to highly uncertain fundamentals. COVID-19 Crushes Commodity Demand Oil prices fell 60% YTD after being struck by simultaneous demand and supply exogenous shocks (Chart 2). We capture the effect of the demand shock with a combination of multivariate regressions using various cyclical commodities, the US trade-weighted dollar, and 10-year treasury yields. Global demand for cyclical commodities – including oil – is fundamentally related to global economic activity. By extracting the common information from these commodity prices, we can estimate the proportion of the oil price decline associated with the ongoing demand shock.2 Chart 2Oil-Price Collapse Of 2020 We estimate roughly 60% of the crude oil price drop so far this year can be explained by the sharp contraction in global demand caused by the COVID-19 pandemic. To estimate the impact of the demand shock from the COVID-19 pandemic on crude oil prices, we expanded a model developed by James Hamilton in the last market-share war of 2014-16.3 Hamilton’s model uses market-cleared prices outside of oil – copper, the USD and 10-year nominal US treasurys – to estimate the extent of the global aggregate demand shock. We estimate roughly 60% of the crude oil price drop so far this year can be explained by the sharp contraction in global demand caused by the COVID-19 pandemic (Chart 3). Some specific refined-product demand (i.e., air and car travel, marine-fuel consumption) was hit harder, meaning the demand shock would be higher in those sectors. For transportation-related refined products, COVID-19-related impacts could account for as much as 70% of the decline in prices. Chart 3COVID-19 Crushes Oil Demand Chinese Demand May Be Recovering News reports suggesting a tentative recovery from the COVID-19 demand shock are emerging in China, where the virus originated late last year. Weekly data indicate inventories in bellwether commodity markets – copper and steel – should begin to fall as demand slowly recovers. While encouraging, this may not be sufficient to offset the massive losses in copper demand that likely will be posted this year as a result of the lockdown imposed in China – and globally – to contain the spread of COVID-19. China accounts for ~ 50% of global demand and ~ 40% of refined copper supply.4 Global copper inventories will be useful indicators of the state of China’s recovery, as they will be sourced early as mining and refining operations are ramped up in response to increasing demand (Chart 4). Chart 4Copper Inventories Will Track Aggregate Demand Recovery Chart 5China Expected To Roll Infrastructure Investment Into 2020 China is set to roll a large portion of its multi-year 34-trillion-yuan (~ $5 trillion) investment plan into this year, to secure economic recovery from the COVID-19 pandemic. For example, our colleagues at BCA Research’s China Investment Service expect a near 10% increase in infrastructure investments this year, which would take such investment to 198 billion yuan (Chart 5). Local governments already have ramped up their expenditures, frontloading 1.2 trillion yuan of bond issuance in the first two months of 2020, a 53% jump versus the same period last year. This includes 1 trillion yuan of special government bonds (SPBs), which is expected to rise to 3-3.5 trillion yuan by the end of 2020, up 30% from 2019 levels. Additional funding channels likely will be opened to support public spending this year. Aggressive policy easing by the Peoples Bank of China (PBOC) in recent weeks, coupled with likely additional debt issuance and infrastructure spending this year will support revived aggregate demand in China. China’s policy responses will be additive to those of the US, where more than $2.2 trillion of fiscal stimulus could be deployed following Congressional agreement on a massive fiscal package that likely will be endorsed by the White House. For its part, the Fed has gone all-in on fighting the economic, liquidity and credit shocks unleashed by the COVID-19 pandemic.5 The EU also is expected to roll out large fiscal-stimulus packages, led by Germany, which is lining up a 150-billion-euro (~ $162 billion) bond issue this year, and a 156 billion-euro supplementary budget.6 Texas Railroad Commission To The Rescue? Another possible element of a global oil-production-regulation scheme emerged in recent days from America’s Lone Star state: The Texas Railroad Commission (RRC). Based on our modeling, 30% to 40% of the decline in oil prices this year is explained by the expectation of higher supply in the coming months (Chart 6).7 It is worthwhile remembering this is anticipatory, given statements and actions from KSA and Russia regarding steps both are taking to sharply increase future production. KSA, for example, provisionally chartered transport to move close to ~ 38mm barrels of crude to refining centers, 12mm barrels of which will be pointed toward the US.8 This was part of the Kingdom’s plan to boost supplies to the market to 12.3mm b/d beginning in April, most of which will come from higher production, augmented by storage drawdowns. If we get a rapprochement between OPEC 2.0’s leaders – KSA and Russia – and the coalition’s production-management scheme is rebuilt, oil prices could outperform other cyclical commodities post-COVID-19, as a large component of supply uncertainty is removed. However, before that can happen, markets will have to absorb the surge in exports from KSA that are being priced in for April and May. Chart 6Expected Supply Increase From KSA, Russia Accounts For 30-40% Of Oil Price Collapse Another possible element of a global oil-production-regulation scheme emerged in recent days from America’s Lone Star state: The Texas Railroad Commission (RRC). Texas regulators are openly debating the efficacy of re-establishing a long-dormant policy mandating the RRC pro-rate production. The idea was floated by outgoing RRC Commissioner Ryan Sitton, who earlier this month in an op-ed proposed KSA, Russia and the US could jointly agree to 10% reductions in output to stabilize global oil markets. This would expand the management of oil production and spare capacity globally, a profound shift from earlier eras when the RRC then OPEC took on that role.9 While RRC staff are studying the idea, Sitton’s proposal has not received the endorsement of fellow commissioners, particularly Wayne Christian, the chairman of the RRC.10 Christian’s argument against the scheme is similar to that of Rosneft CEO Igor Sechin’s: Both argue such schemes allow other producers to steal market share. Russian government officials continue to signal they are open to returning to the negotiating table with KSA. The Trump administration, however, sees potential in working with KSA and to stabilize markets. Earlier this month, the administration sent a “senior Energy Department official” to Riyadh to support the State Department and the US’s energy attache.11 For its part, Russian government officials continue to signal they are open to returning to the negotiating table with KSA. The “Russian position was never about triggering an oil prices fall. This is purely our Arab partners initiative,” according to a Reuters report quoting Andrei Belousov, Russia’s first deputy prime minister, in an interview with state news agency TASS. “Even oil companies who are obviously interested to maintain their markets, did not have a stance that the deal (OPEC+) should be dissolved.” According to Reuters, Russia proposed an extension of existing production cuts of 1.7mm b/d, perhaps to the end of this year, but “(our) Arab partners took a different stance.” 12 Investment Implications The big uncertainty at present is the extent of demand destruction that will be caused by COVID-19. At this point, the diplomatic maneuvering among states on the oil-supply side is a distraction. Any substantive action will require drawn-out negotiation, particularly to reconstitute and expand OPEC 2.0 to include the Texas RRC in the management of global oil production and spare capacity. In the here and now, markets are forcing sharp reductions in oil output, particularly in the US shales – e.g., Chevron announced it will be cutting capex and exploratory spending 20% this year on Tuesday.13 This is occurring throughout the industry in the US and around the world. Reuters compiled announcements by oil producers that have indicated they will cut an average 30% reduction in capex in response to the oil-price collapse.14 We are expecting US shale output to grow ~ 650k b/d this year, and to fall by ~ 1.35mm b/d next year on the back of the price collapse this year (Chart 7).15 We do not expect a resurgent shale-producing sector in the short- to medium-term, given the capital markets’ demonstrated aversion to funding this sector until it can demonstrate long-term profitability. The big uncertainty at present is the extent of demand destruction that will be caused by COVID-19, and the effectiveness of fiscal and monetary policy in supporting national economies during the pandemic. Equally important will be policy responsiveness post-COVID-19, and how quickly economies worldwide return to normal. Chart 7US Shale Output Will Fall Sharply Bottom Line: We expect a re-building of OPEC 2.0, with KSA and Russia restoring their production-management scheme before global storage facilities are filled and markets push prices below cash costs to force production to shut in. The revenue gains from this course of action far exceed any benefit derived from increasing production and prolonging a market-share war.16 Any agreement to include the Texas RRC will occur after demand is bottoming and moving up – i.e., once the outlook for demand is more stable – as happened when OPEC 2.0 was formed. Robert P. Ryan Chief Commodity & Energy Strategist rryan@bcaresearch.com Hugo Bélanger Associate Editor Commodity & Energy Strategy HugoB@bcaresearch.com Fernando Crupi Research Associate Commodity & Energy Strategy FernandoC@bcaresearch.com Commodities Round-Up Energy: Overweight The COVID-19 pandemic produced one undisputed winner: the environment. Limits on movement and factory shutdowns have massively reduced air pollution in countries hit by the pandemic early on (e.g. China and Italy). We expect similar declines elsewhere in Europe. This already is reflected in the ~ 30% drop in Carbon Emission Allowances (EUA) futures this year (Chart 8). Following the GFC, worldwide CO2 emissions dropped by 2.2%, but rapidly rebounded in 2010 – surpassing pre-crisis levels. We expect a similar recovery in global emissions as record stimulus measures kick in and normal traffic resumes post-COVID-19. Therefore, we are going long December 2020 ICE EUA futures. Base Metals: Neutral The LME base metal index is down 20% YTD. Downside risks remain large as lockdowns globally continue to intensify in the wake of the COVID-19 pandemic. These drastic measures also threaten mine operations for some metals. Copper supply is reportedly reduced in Peru and Chile. Nonetheless, weak economic growth along with a strong US dollar remain the dominant factors. Base metals prices gained from a lower USD on Tuesday, signaling market participants welcomed the Fed’s actions to relieve global liquidity fears. Still, it is too early to confirm these measures will be sufficient to circumvent further deterioration in the global economy. Precious Metals: Neutral Gold, silver, platinum, and palladium rose 12%, 15%, 14%, and 16% from the start of the week, recovering part of the sharp losses from the COVID-19 shock. Metals – especially Gold – were supported by the Fed’s resolve to provide much-needed liquidity to markets. Platinum and palladium were pushed higher following South Africa’s government decision to halt metal and mining operations as part of a 21-day nationwide shutdown to prevent the spread of the virus. Silver prices remain disconnected from their main drivers – i.e. safe-haven and industrial demand – and should rise along with gold once liquidity concerns dissipate (Chart 9). Ags/Softs: Underweight After being under pressure for the last three sessions, CBOT May Corn futures rose this week, trading above $3.50/bu, as expectations of stronger demand for ethanol were revived by increasing oil prices. Wheat and beans also put in strong showings this week, as demand starts to lift. US grain exports are holding up relatively well versus the competition – chiefly the South America powerhouses Argentina and Brazil – as COVID-19 hampers their exports. Wheat futures remain firm on the back of stronger demand as consumers stockpile during the pandemic. Chart 8 Chart 9 Footnotes 1 The Chart of the Week shows prompt volatility at the end of last week, when it stood at a record 183.22%, and a sharply backwardated volatility forward curve. Implied volatility is a parameter in option-pricing models, which equates the premium paid for options with the principal factors determining its value (i.e., the underlying futures price, the option’s strike price, time to expiry, interest rates and the expected volatility, or standard deviation of expected returns on the underlying). All of the factors other than volatility can be observed in the underlying market and interest rate markets, leaving volatility to be determined using an iterative search. Please see Ryan, Bob and Tancred Lidderdale (2009), Short-Term Energy Outlook Supplement: Energy Price Volatility and Forecast Uncertainty, published by the US Energy Information Administration, for a discussion of volatility as a market-cleared parameter. 2 We estimate our model both in (1) levels given that base metals, the US dollar and oil prices are cointegrated – i.e. these variable follow a common long-term stochastic trend – and (2) log-difference. We include the US dollar and 10-year treasury yields as explanatory variables. These series are closely linked to global growth trends, weakness in global economic activity is associated with a rising dollar and falling treasury yields. We only include treasury yields in the first difference model given that it is not cointegrated with oil and metal prices in levels. 3 Please see Oil prices as an indicator of global economic conditions, posted by Prof. Hamilton on his Econbrowser blog December 14, 2014. Our model uses monthly market inputs – non-oil commodities, the trade-weighted USD, US 10-year treasurys from January 2000 to February 2020, and the last daily close for March 2020. We extend Brian Prest’s 2018 model, which is based on Hamilton but uses monthly data instead of weekly data as in Hamilton. Please see Prest, C. Brian, 2018. "Explanation for the 2014 Oil Price Decline: Supply or Demand?" Energy Economics 74, 63-75. 4 Please see China steel, copper inventories dip as demand recovers from virus and Rupture of copper demand to fuel surplus as industry hit by virus, published March 20 and March 23, 2020, by reuters.com. 5 For an in-depth discussion, please see Life At The Zero Bound published March 24, 2020, by BCA Research’s US Bond Strategy. It is available at usbs.bcaresearch.com. 6 Please see Germany expected to announce fiscal stimulus as European death toll rises published by thehill.com March 23, 2020. 7 We estimate the share of the price collapse explained by the supply shock using the residuals from our demand-only Brent price model presented in Chart 3. The difference between actual Brent prices and our demand-only estimates captures oil-specific factors unexplained by global economic growth – mainly supply dynamics. 8 Please see Saudi provisionally charters 19 supertankers, six to U.S. as global oil price war heats up published by reuters.com March 11, 2020. 9 Please see Texas regulator considers oil output cuts for the first time in decades published by worldoil.com on March 20, 2020. We discussed the historic role of the RCC during the 2014-16 OPEC-led market-share war in End Of An Era For Oil And The Middle East, a Special Report published April 9, 2014, with BCA Research’s Geopolitical Strategy. We noted, “In March of 1972, the (RRC) effectively relinquished control of Texas oil production, when it allowed wells in the state to produce at 100% of their capacity. This signaled the exhaustion of U.S. spare capacity – production no longer had to be pro-rated to maintain prices above marginal costs – and the ascendance OPEC to global prominence in the oil market.” 10 Please see Texas Railroad Commission chairman opposes OPEC-style oil production cuts published by S&P Global Platts March 20, 2020. 11 Please see U.S. to send envoy to Saudi Arabia; Texas suggests oil output cuts published by reuters.com March 20, 2020. 12 Please see Russia: Gulf nations, not us, to blame for oil prices fall -TASS published by reuters.com March 22, 2020. 13 Please see Chevron cuts spending by $4 billion, suspends share buybacks published by worldoil.com March 24, 2020. 14 Please see Factbox: Global oil, gas producers cut spending after crude price crash, published by reuters.com March 23, 2020. Refiners also are cutting runs – particularly in the US and Europe – in the wake of collapsing demand for gasoline and distillates (jet, diesel and marine fuels), as S&P Global Platts reported March 23, 2020: Refinery margin tracker: Global refining margins take a severe hit on falling gasoline demand. 15 This extends to oil-services companies as well, which are anticipating a deeper crash in their businesses than occurred in the 2014-16 market-share war. Please see Shale service leaders warn of a bigger crash this time around published by worldoil.com March 24, 2020. 16 We argued this outcome was more likely than not – given the economic and welfare stakes – in last week’s report, KSA, Russia Will Be Forced To Quit Market-Share War. Investment Views and Themes Recommendations Strategic Recommendations Tactical Trades TRADE RECOMMENDATION PERFORMANCE IN 2019 Q4 Commodity Prices and Plays Reference Table Trades Closed in Summary of Closed Trades
Highlights As the global economy moves toward shut-down, the Kingdom of Saudi Arabia (KSA) and Russia will be forced to end their market-share war and focus on shoring up their economies and tending to their populations’ welfare. Governments worldwide are rolling out fiscal- and monetary-policy responses to the COVID-19 pandemic. They also are imposing seldom-seen freedom-of-movement and -gathering restrictions on their populations to contain the spread of the virus. A surge in bankruptcies among US shale-oil companies is expected as demand and supply shocks push Brent and WTI below producers’ breakeven prices. In our base case, benchmark prices are pushed toward $20/bbl this year, which will keep volatility elevated. Prices recover in 4Q20 and 2021, as the pandemic recedes, and economies respond to fiscal and monetary stimulus. We have reduced our oil-price forecasts in the wake of the deterioration in fundamentals, expecting Brent to average $36/bbl in 2020, and $55/bbl in 2021. WTI will trade ~ $3-$4/bbl lower. COVID-19 is transitory. Therefore price risk is to the upside in 2021, given the global stimulus being deployed. Feature Brent and WTI prices are down 61.4% and 66.6% since the start of the year (Chart of the Week), taking front-month futures to their lowest levels since 2002. Oil markets are in a fundamental disequilibrium – the expected global supply curve is moving further to the right with each passing day, as the KSA and Russia market-share rhetoric escalates. Global demand curves are moving further to the left on an hourly basis, as governments worldwide impose freedom-of-movement restrictions and lock-downs to contain the spread of COVID-19 seen only during times of war and natural devastation. These effects combine to swell inventories globally, as rising supply fails to be absorbed by demand. The collapse in crude oil prices since the beginning of this year is lifting volatility to levels not seen since the Gulf War of 1990-91. Chart of the WeekBenchmark Crude Prices Collapse Toward Cash Costs Chart 2Oil-Price Volatility Surges To Wartime Levels Prices, as can be expected under such circumstances, are plunging toward cash costs – i.e., the level at which only operating costs are covered – which are below $20/bbl. The collapse in crude oil prices since the beginning of this year is lifting volatility to levels not seen since the Gulf War of 1990-91 launched by the US and its allies following Iraq’s invasion of Kuwait (Chart 2). As inventories rise, the supply of storage globally falls, and prices are forced below cash costs to drive surplus crude oil production from the market. The rapid evolution from backwardation (prompt prices exceed deferred prices) to steep contango (prompt prices at a discount) in the benchmark crudes is how markets signal the supply of storage is falling (Chart 3). Chart 3Markets' Violent Move From Backwardation To Contango Chart 4Storage Constraints Drive Price Volatility This strain on global inventory capacity will keep volatility elevated: As physical constraints on storage intensify, only price can adjust to clear the market, which results in massive price moves as markets respond in real time to supply-demand imbalance (Chart 4). Shales Lead US Output Lower At this point, massive increases in supply are not required to keep benchmark oil prices below $30/bbl. Markets are seeing and anticipating a sharp contraction in demand in the near term, with storage building as consumers “shelter in place” around the world. Production is set to increase in April, in the midst of a global exogenous shock to demand. As these fundamentals are worked into prices volatility will remain high. In our updated forecasts, our base case assumes KSA and its allies, and Russia raise production by 1.3mm b/d in 2Q20 and 3Q20. KSA's and Russia's output increase to ~ 11mm b/d and 11.7mm b/d, respectively. We expect the reality of low prices and a slowing world economy to force these states back to the negotiating table in 2H20, with production cuts being realized in 4Q20 and 2021 (see below). With less capital made available to shale drillers, production growth in the shales literally is forced to slow. While KSA’s and Russia’s budgets almost surely will bear enormous strain in such an environment, we believe it is the US shales that take the hardest hit over the short run, if KSA and Russia maintain their avowed production intensions. The growth in US shale output – Russia’s presumed target – is expected to slow sharply this year under current circumstances, increasing at a rate of just 650k b/d over 2019’s level. Next year, we expect shale production in the US to fall ~ 1.3mm b/d to 7.7mm b/d. Part of this is driven by the on-going reluctance of capital markets to fund shale drillers and hydrocarbon-based energy companies generally, which can be seen in the blowout in high-yield bond spreads dominated by shale issuers (Chart 5). With less capital made available to shale drillers, production growth in the shales literally is forced to slow. Chart 5Low Price Force US Shale Cutbacks With funding limited and domestic oil prices well below breakevens – and cash costs – more shale-oil producers will be pushed into bankruptcy or into sharp slowdowns in drilling activity (Charts 6A and 6B). These constraints will force total US output to contract by 1.3mm b/d next year, based on our modeling. This will take US lower 48 output this year and next to 10.5mm b/d and 9.2mm b/d, respectively (Chart 7). Chart 6ALow Prices Force US Shale CutbacksChart 6BLow Price Force US Shale Cutbacks Capital markets will not tolerate unprofitable production. When the dust settles next year, US shale-oil output is expected to take the biggest supply hit globally, based on our current assumptions and modeling results. Worthwhile remembering, however, shale-oil production is highly likely to emerge a leaner more efficient sector, as they did in the OPEC-led market-share war of 2014-16.1 Also worthwhile remembering, for shale operators, is capital markets will not tolerate unprofitable production. So, net, a stronger, more disciplined shale-oil producer cohort emerges from the wreckage of the COVID-19 demand shock coupled with the KSA-Russia market-share war of 2020. Chart 7US Shale Contraction Leads US Output Lower In 2021 Demand Uncertainty Is Huge We are modeling a shock that reduces global demand – a highly unusual occurrence – by 150k b/d this year versus 2019 levels (Table 1). Most of this shock occurs in 1H20, where a large EM contraction originating in China set the pace. We expect China’s demand to begin recovering in 2Q20. The demand contraction moves into OECD states in 2Q20, which are expected to follow a similar trajectory in demand shedding seen elsewhere (Chart 8). In 2H20, we expect global demand to begin recovering, and, barring another outbreak of COVID-19 (or another novel coronavirus) next winter, for global demand growth to re-accelerate to ~ 1.7mm b/d in 2021. Table 1BCA Global Oil Supply - Demand Balances (MMb/d, Base Case Balances) The uncertainty around our demand modeling is large. Expectations from the large data providers are all over the map: The EIA expects demand to grow 360k b/d this year, while the IEA and OPEC expect -90k and 60k b/d. In addition, some banks and forecasters make a case for demand falling by 1mm b/d or more in 2020, a scenario we do not expect. Sorting through the evolution of demand this year – i.e., tracking the recovery from China and EM through to DM – will be difficult, particularly as Western states go into lock-down mode and the global economy remains moribund. This makes our forecasts for supply-demand balances and prices highly tentative, and subject to revision. Chart 8Demand Shock + Market-Share War = Imbalance Market-Share War: What Is It Good For? As we argue above, the US shale-oil producers will, for a variety of reasons, be forced by capital and trading markets to retrench, and to cut production sharply. They lost favor with markets prior to the breakdown of OPEC 2.0, and this will not change. At this point, it is unlikely KSA and Russia can alter this evolution by increasing or decreasing production – investors already have shown they have little interest in funding their further growth and development. The KSA-Russia market-share war reinforces investors’ predispositions, and decidedly accelerates this retrenchment by the shale producers. As the global economy moves toward shut-down, KSA and Russia will be forced to turn their attention to shoring up their economies and tending to their populations’ welfare. The strain of a global shut-down will absorb governments’ resources worldwide, and self-inflicted wounds – which, at this point, a market-share war amounts to – will only make domestic conditions worse in KSA, Russia and their respective allies. The income elasticity of supply for these producers is such that small adjustments – positive or negative – on the supply side have profound effects on oil producers’ revenues (Table 2). Both KSA and Russia are aware of this. Russia burns through its $150 billion national wealth fund in ~ three years in a market-share war, while KSA burns through ~ 10% of its foreign reserves, when export prices fall $30/bbl and Russia's exports rise 200k b/d and KSA's rise 2mm b/d.2 In a world where demand destruction is accelerating revenue losses, and storage limitations threaten to collapse oil prices below cash costs, production management – even if that means extending the 1Q20 cuts of 1.7mm b/d for the balance of 2020 – is necessary to avoid larger, longer-term economic damage (Chart 9). Table 2Market-Share War Vs. Revenue Chart 9Global Inventories Could Surge We believe the leadership in both of these states have sufficient reason to return to the negotiating table to figure out a way to re-start their production-management accord, if only to preserve funds to cover imports while global demand recovers. It may take a month or two of unchecked production to make this point clear, however, so volatility can be expected to remain elevated. These fundamental and political assessments compel us to reduce our oil-price forecasts in the wake of the deterioration in fundamentals, expecting Brent to average ~ $36/bbl in 2020, and $55/bbl in 2021. WTI will trade ~ $3-$4/bbl lower. Price risk is to the upside in 2021, given the global fiscal and monetary stimulus being deployed. Bottom Line: The confluence of a true global demand shock and a market-share war on the supply side has pushed benchmark crude oil prices close to cash costs for many producers. The damage to states highly dependent on oil revenues is just now becoming apparent. We expect KSA and Russia to return to the negotiating table, to hammer out a production-management accord that allows them to control as much of the economic damage to their economies as is possible. Capital markets already are imposing a harsh discipline on US shales – Russia’s presumptive target in the market-share war. The consequences of the COVID-19 vis-a-vis demand destruction are of far greater moment for KSA and Russia than their market-share war. They need to shore up their economies and get in the best possible position to benefit from a global economic rebound, not destroy themselves seeking a Pyrrhic victory that devastates both of them. Robert P. Ryan Chief Commodity & Energy Strategist rryan@bcaresearch.com Hugo Bélanger Associate Editor Commodity & Energy Strategy HugoB@bcaresearch.com Commodities Round-Up Energy: Overweight Chinese refiner Sinochem International Oil (Singapore) turned down an offer of crude-oil cargoes for May-June deliver from Russian oil company Rosneft PJSC, which is under US sanctions, according to Bloomberg. Sinochem refuses cargoes from Iran, Syria, Venezuela, and Kurdistan, which also are under sanction or are commercially aligned with sanctioned entities. Base Metals: Neutral The downward trend in base metal prices remains, as the spread of the coronavirus intensifies outside of China, and governments worldwide impose freedom-of-movement restrictions on their populations to contain further spread. Persistent US dollar strength – supported by inflows to safe assets amid the elevated global economic uncertainty – pressures EM economies’ base metal demand. As a result, the LME index is down 18% YTD, reaching its 2016 lows. We were stopped out of our long LMEX recommendation on March 17, 2020 for a 12% loss. Precious Metals: Neutral Gold and silver are caught up in a global selloff of assets that have performed well over the past year as safe havens, as market participants raise cash for liquidity reasons or margin calls. We are waiting for an opportunity to go long gold again after being stopped out earlier in the sell-off. Silver will recover with industrial-commodity demand, which we expect to occur in 4Q20, when the COVID-19 threat recedes, and consumers worldwide are responding to the globally fiscal and monetary stimulus being rolled out now. We are staying on the sidelines for now, as volatility is extremely high for metals (Chart 10). Ags/Softs: Underweight CBOT May Corn futures were down 3% Tuesday, reaching 18-month lows, driving mostly by high USD levels, which make US exports less competitive. Supplies from South America, where a large harvest is ongoing in Argentina and Brazil, are taking market share. Furthermore, according to a report from the University of Illinois, lower gasoline consumption resulting from the COVID-19 pandemic will reduce the amount of corn needed for ethanol production; demand could fall 120mm to 170mm bushels. Soybeans and wheat futures ended the day slightly higher on the back of bargain buying, after falling to multi-month lows on Monday. USD strength remains a headwind on ags, encouraging production ex-US at the margin and contributing to stifling demand for US exports (Chart 11). Chart 10Gold Is Experiencing Extremely High Volatility Chart 11USD Strength Remains A Headwind On AGS Footnotes 1 Please see How Long Will The Oil-Price Rout Last?, a Special Report we published March 9, 2020, which discussed US bankruptcy law and the re-cycling of assets. 2 Please see Russia's Supply Shock To Oil Markets and Russia Regrets Market-Share War?, which we published March 6 and March 12, 2020, for additional discussion. Investment Views and Themes Recommendations Strategic Recommendations Tactical Trades TRADE RECOMMENDATION PERFORMANCE IN 2019 Q4 Commodity Prices and Plays Reference Table Trades Closed in 2020 Summary of Closed Trades
Highlights Our short EM equity index recommendation has reached our target and we are booking profits on this trade. The halt to economic activity will produce a global recession that will be worse than the one that took place in late 2008. We continue to recommend short positions in a basket of EM currencies versus the US dollar. In EM fixed-income markets, the duration of the ongoing selloff has been short, and large losses will trigger more outflows ensuring further carnage. Stay defensive for now. Russia is unlikely to make a deal with Saudi Arabia to restrain oil output for now. Feature The global economy is experiencing a sudden, jarring halt. The only comparison for such a sudden stop is the one that occurred in the fall of 2008, following Lehman’s bankruptcy. In our opinion, the global economic impact of the current sudden stop is shaping up to be worse than the one that occurred in 2008. That said, we are taking profits on our short position in EM equities. This position – recommended on January 30, 2020 – has produced a 30% gain. EM share prices have reached the long-term support that acted as the ultimate floor during the bear markets in 1997-‘98, 2001-‘02, 2007-‘08 and 2015. Our decision to take profits reflects investment discipline. The MSCI EM stock index in US dollar terms has reached our target. In addition, this decision is consistent with two important indicators that we follow and respect: 1. EM stocks have become meaningfully cheap. Chart I-1 illustrates that our cyclically-adjusted P/E (CAPE) ratio for EM equities is about one standard deviation below its fair value – the same level when the EM equity market bottomed in 1998, 2008 and 2015. Chart I-1EM Equities Are Cheap According To The Cyclically-Adjusted P/E Ratio For this EM CAPE ratio to reach 1.5 standard deviations below its fair value – the level that is consistent with EM’s 2001-02 lows – EM share prices need to drop another 15%. 2. In term of the next technical support, EM share prices have reached the long-term support that acted as the ultimate floor during the bear markets in 1997-‘98, 2001-‘02, 2007-‘08 and 2015 (Chart I-2). Chart I-2EM Share Prices Are At Their Long-Term Support While share prices are likely to undershoot, it is risky to bet on a further decline amid current extremely elevated uncertainty and market volatility. The Global Downturn Will Be Worse Than In Late 2008 Odds are that the current global downturn is shaping up to be worse than the one that occurred in late 2008. From a global business cycle perspective, the current sudden halt is beginning from a weaker starting point. Global trade growth was positive back in August-September 2008 – just prior to the Lehman bankruptcy – despite the ongoing US recession (Chart I-3A). In comparison, global trade was shrinking in December 2019, before the COVID-19 outbreak (Chart I-3B). Chart I-3AGlobal Trade Growth Was Positive In September 2008… Chart I-3B…But Was Negative In December 2019 This is because growth in EM and Chinese economies was still very robust in the middle of 2008. Moreover, the economies of EM and China were structurally very healthy and were anchored by solid fundamentals. Still, the blow to confidence emanating from the crash in global financial markets and plunge in US domestic demand in the fall of 2008 produced major shockwaves in EM/Chinese financial markets. Provided the ongoing negative confidence shock and lingering uncertainty persist, odds are that the risk premium will initially overshoot before settling down. Consistently, risk markets will undershoot in the interim. This is in contrast with current cyclical growth conditions and structural economic health, both of which are very poor in EM/China going into this sudden stop. In China, economic growth in January-February 2020 was much worse than at the trough of the Lehman crisis in the fourth quarter of 2008. Chart I-4 reveals that industrial production, auto sales and retail sales volumes all contracted in January-February 2020 from a year ago. The same variables held up much better in the fourth quarter of 2008 (Chart I-4). Business activity in China is recovering in March, but from very low levels. Reports and evidence from the ground suggest that many companies are operating well below their ordinary capacity – the level of economic activity remains well below March 2019 levels. US real GDP, consumer spending and capital expenditure shrunk by 4%, 2.5% and 17% at the trough of 2008 recession (Chart I-5). Odds are that these variables will plunge by an even greater magnitude in the coming months as the US reinforces lockdowns and public health safety measures. Chart I-4China Business Cycle Was Much Stronger In Q4 2008 Than Now Chart I-5US Growth At Trough Of 2008 Recession Chart I-6US Small Caps: Overlay Of 2008 And 2020 About 50% of consumer spending in the US is attributed to people over 55 years of age. Provided COVID-19’s fatality rate is high among the elderly, odds are this cohort will not risk going out and spending. How bad will domestic demand in the US be? It is impossible to forecast with any certainty, but our sense is that it will plunge by more than it did in the late 2008-early-2009 period, i.e., by more than 4% (Chart I-5, bottom panel). Interestingly, the crash in US small-cap stocks resembles the one that occurred in the wake of the Lehman bankruptcy (Chart I-6). If US small-cap stocks follow their Q4 2008 - Q1 2009 trajectory, potential declines from current levels will be in the 10%-18% range. Bottom Line: The current halt in economic activity and impending global recession will be worse than the one that took place in late 2008. Reasons Not To Jump Into The Water…Yet Even though EM equities have become cheap and oversold and we are booking profits on our short position in EM stocks, conditions for a sustainable rally do not exist yet: So long as EM corporate US dollar bond yields are rising, EM share prices will remain under selling pressure (Chart I-7). Corporate bond yields are shown inverted in this chart. Chart I-7EM Stocks Fall When EM Corporate Bond Yields Rise Chart I-8Chinese And Emerging Asian Corporate Bond Yields Are Spiking The selloff in both global and EM credit markets began only a few weeks ago from very overbought levels. Many investors have probably not yet trimmed their positions. Hence, EM sovereign and corporate credit spreads and yields will likely rise further as liquidation in the global and EM credit markets persists. Consistently, bond yields for Chinese offshore corporates as well as emerging Asian high-yield and investment-grade corporates are rising (Chart I-8). EM local currency bond yields have also spiked recently as rapidly depreciating EM currencies have triggered an exodus of foreign investors. Rising local currency bond yields are not conducive for EM share prices (Chart I-9). Chart I-9EM Equities Drop When EM Local Bond Yields Rise EM ex-China currencies correlate with commodities prices (Chart I-10). Both industrial commodities and oil prices have broken down and have further downside. The path of least resistance for oil prices is down, given anemic global demand and our expectation that Russia and Saudi Arabia will not reach any oil production cutting agreement for several months (please refer to our discussion on this topic below). Finally, our Risk-On/Safe-Haven currency ratio1 is in free fall and will likely reach its 2015 lows before troughing (Chart I-11). This ratio tightly correlates with EM share prices, and the latter remains vulnerable to further downside as long as this ratio is falling. Chart I-10EM Currencies Move In Tandem With Commodities Prices Chart I-11More Downside In Risk-On/ Safe-Haven Currency Ratio Bottom Line: Although we are taking profits on the short EM equity position, we continue to recommend short positions in a basket of EM currencies – BRL, CLP, ZAR, IDR, PHP and KRW – versus the US dollar. Liquidation in EM fixed-income markets has been sharp, but the duration has been short –only a few weeks. Large losses will trigger more outflows from EM fixed-income markets. Stay defensive for now. What We Do Know And What We Cannot Know Amid such extreme uncertainty, it is critical for investors to distinguish between what we know and what we cannot know. What we cannot know: With regards to COVID-19: The speed of its spread, the ultimate number of victims it claims and – finally – its impact on consumer and business confidence and psyche. Related to lockdowns: Their duration in key economies. These questions will largely determine this year’s economic growth trajectory: Will it be V-, U-, W-, or L-shaped? Unfortunately, no one knows the answers to the above questions to have any certainty in projecting this year’s global growth. The key factor that gives Russia an advantage over Saudi Arabia in terms of its ability to deal with a negative terms-of-trade shock is not only its better fiscal position but also its ability to depreciate its currency. What we do know: Authorities in all countries will stimulate aggressively so long as financial markets are rioting. Nonetheless, these stimulus measures will not boost growth immediately. With entire countries locked down and plunging consumer and business confidence, stimulus will not have much impact on growth in the near term. In brief, all policy stimulus will boost growth only when worries about the pandemic subside and the economy begins to function again. Both are not imminent. Hence, we are looking at an air pocket with respect to near-term global economic growth. As we argued in our March 11 report titled, Unraveling Of The Policy Put, the pre-coronavirus financial market paradigm – where stocks and credit markets were priced to perfection because of the notion that policymakers would not allow asset prices to drop – has unravelled. In recent weeks, policymakers around the world have announced plans to deploy massive amounts of stimulus, yet the reaction of financial markets has been underwhelming. The reason is two-fold: Both demand shrinkage and production shutdowns have just started, and they will run their due course regardless of announced policy stimulus measures. Equity and credit markets were priced for perfection before this selloff, and investors are in the process of recalibrating risk premiums. Provided the ongoing negative confidence shock and lingering uncertainty persist, odds are that the risk premium will initially overshoot before settling down. Consistently, risk markets will undershoot in the interim. Bottom Line: DM’s domestic demand downturn is still in its initial phase, and there is little foresight in terms of the pandemic’s evolution. These are natural forces, and any stimulus policymakers enact are unlikely to preclude them from occurring. Reflecting the economic contraction and heightened uncertainty, the selloff in risk assets will likely continue for now. Do Not Bet On An Early Resuscitation Of OPEC 2.0 As we argued in our March 11 report, Russia is unlikely to make a deal with Saudi Arabia to restrain oil output in the immediate term. Russia may agree to restart negotiations, but it will not agree to reverse its position for some time. Both nations will be increasing crude output (Chart I-12). As a result, a full-fledged oil market share war is underway. Consistently, crude prices have experienced a structural breakdown (Chart I-13). Chart I-12The Largest Oil Producers Are Ramping Up Output Chart I-13Structural Breakdown In Oil Prices The key factor that gives Russia an advantage over Saudi Arabia in terms of its ability to deal with a negative terms-of-trade shock is not only its better fiscal position but also its ability to depreciate its currency. Russia has a flexible exchange rate, which will allow the currency to depreciate in order to soften the blow from lower oil prices on the real economy and fiscal accounts. The Russian economy and financial system have learned to operate with recurring major currency depreciations. Saudi Arabia has been running a fixed exchange rate regime since 1986 and cannot use currency depreciation to mitigate the negative terms-of-trade shock on its end. Even though Russia’s fiscal budget break-even oil price is much lower than that of Saudi Arabia’s, it is not the most important variable to consider in this confrontation. The fiscal situation in both Russia and Saudi Arabia will not be a major problem for now. Both governments can issue local currency and US dollar bonds, and there will be sufficient demand for these bonds from foreign and local investors. This is especially true with DM interest rates sitting at the zero-negative territory. Falling oil prices and downward pressure on exchange rates will trigger capital outflows in both countries. Russia has learned to live with persistent capital flight. In the meantime, capital outflows will stress Saudi Arabia’s financial system and, eventually, its real economy. This is in fact the country’s key vulnerability. We will be publishing a Special Report on Saudi Arabia in the coming weeks. Bottom Line: Do not expect a quick recovery in oil prices. Arthur Budaghyan Chief Emerging Markets Strategist arthurb@bcaresearch.com Footnotes 1 Average of CAD, AUD, NZD, BRL, RUB, CLP, MXN & ZAR total return indices relative to average of CHF & JPY total returns. Equities Recommendations Currencies, Credit And Fixed-Income Recommendations
Highlights Bear markets occur in phases, and their narrative can mutate. What began as a selloff caused by the coronavirus outbreak could well mutate into an oil crash-led selloff, and then mutate again into a selloff due to policy omnipotence, or something else. We are reiterating our short positions in the EM equity index and a basket of EM currencies versus the US dollar as well as our defensive positioning in EM domestic bonds and credit markets. We are taking profits on our long gold/short oil and copper trade. Oil prices may stabilize, but risks are still skewed to the downside. We are also booking gains on our long Russian domestic bonds/short oil position. Feature Chart I-1A Record Low Currency VOL Is Followed By Major Market Disturbances Global financial markets are witnessing the unwinding of the policy put. For the past several years, the consensus in the global investment community was that risk assets could not go down because of policy puts from the Federal Reserve, the US Treasury and President Trump, the European Central Bank and the Chinese authorities. Similarly, crude oil prices had been supported by OPEC 2.0’s put from December 2016 until recently. The latest panic and broad-based liquidation of risk assets has been due not only to fear and uncertainty related to the rapid escalation in COVID-19 cases around the world, but also to investor realization that these policy puts are ineffectual. The Fed’s 50-basis-point intra-meeting rate cut proved incapable of stabilizing global risk assets. Investors have begun to doubt the efficacy of policy puts and have thrown in the proverbial towel. Crucially, the high-speed and intensity of the selloff was due to widespread complacency and overbought conditions in risk assets. In our January 23 report, we quoted Bob Prince, co-CIO of Bridgewater, who stated in Davos that “…we have probably seen the end of the boom-bust cycle.” This comment was consistent with prevalent complacency in global financial markets, reflected in very tight credit spreads worldwide, high US equity multiples and record-low implied volatility in various asset classes. In the same January 23 report, we wrote: “Any time an influential person has made a similar declaration in the past, it marked a major turning point in financial markets. Remarkably, implied volatility for the US dollar has plummeted to a record low, as it has for EM currencies and a wide range of equity markets. Chart I-1 illustrates the implied volatility for EM currencies and the US dollar. Such low levels of implied currency market volatility historically preceded major moves in currency markets and often led to a material selloff in broad EM financial markets.” In that same report , we recommended going long implied EM currency volatility. Since then JP Morgan’s EM currency volatility has risen from 6% to 10%. What began as a selloff caused by the coronavirus outbreak could well mutate into an oil crash-led selloff, and then mutate again into a selloff due to policy omnipotence, or something else. Consistent with this thesis, we reinstated our short EM equity index recommendation in the following week’s report – on January 30. The MSCI EM stock index is down 11% since then. Our target is 800, which is 18% below current levels (Chart I-2, top panel). Chart I-2EM Stocks: A Breakdown In The Making Market Narratives Mutate Chart I-3VIX Surge In Early 2018 Was A Trigger Not Cause Of Selloff Narratives of all large market moves are always expounded in retrospect. Only after a selloff is well-advanced do investors and commentators come up with reasons for it and build a plausible narrative describing it. Critically, bear markets occur in phases, and their narrative can evolve. What began as a selloff caused by the coronavirus outbreak could well mutate into an oil crash-led selloff, and then mutate again into a selloff due to policy omnipotence, or something else. For example, the early 2018 selloff in global equities and industrial commodities was at the time attributed to the spike in US equity volatility (Chart I-3, top and middle panels). In retrospect, January 2018 marked a major top in the global business cycle (Chart I-3, bottom line). Hence, the true reason for the late-January 2018 top in global stocks and industrial commodities was a downturn in global manufacturing and trade and not the surge in the VIX. The key question investors are currently wrestling with is the following: How deep will this selloff be, and how long will it last? Our view is that the selloff in EM and global risk assets is not yet over. As such, we are reiterating our short positions in the EM equity index and a basket of EM currencies versus the US dollar, as well as our defensive positioning in EM domestic bonds and credit markets. Gauging The Downside There is no doubt that global growth will be affected by the spread of COVID-19 and the precautionary measures taken by the authorities, companies and households around the world to contain the outbreak. Further, growth visibility is extremely low, and that uncertainty is raising the risk premiums that investors demand. The latter is weighing on risk assets in general and global share prices in particular. Presently, precise forecasts for GDP growth and a potential trajectory of COVID-19 cases are not credible, and hence cannot be relied upon to formulate a sound investment strategy. If the current bloodbath in risk assets persists, a market bottom could be reached well before bad economic data are released or COVID-19 infection cases peak. Given the uncertainty related to both the global growth trajectory and the Covid-19 epidemic, the only way for investors to gauge a market bottom is to continuously examine valuations, technicals and market internals. With respect to valuations and technicals, we have the following observations: The EM equity index seems to breaking below its major support lines. If this breakdowns transpires, there is an air pocket until the index reaches its next technical support, which is 18% below its current level (please refer to the top panel of Chart I-2 on page 3). If the EM MSCI equity index drops to this support range, it would be trading at 11 times its trailing earnings (please refer to the bottom panel of Chart I-2 on page 3). At those levels, the EM equity index would be discounting a lot of bad news, making it immune to dismal economic data and general uncertainty. For the S&P 500, if the current defense line – which held been during 2011, 2015 and 2018 selloffs – is violated, the next long-term technical support is around 2400-2500 (Chart I-4). Inflows to EM fixed-income funds were enormous in 2019. Meanwhile, EM corporate and sovereign spreads have broken out (Chart I-5). Provided this selloff commenced from very overbought and expensive levels, the odds are that liquidation forces will not abate right now and that the selloff in EM fixed income has further to go. Chart I-4S&P 500: Where Technical Support Lies? Chart I-5EM Sovereign And Corporate Spreads Have Broken Out In a nutshell, we suspect that EM local currency bonds and credit markets received a lot of inflows from European investors in recent years because yields were negative across European fixed-income markets. A weak euro was a boon for European investors investing in EM. That, however, is reversing. Since the recent sharp appreciation in the euro and the nosedive in EM currencies, EM financial market returns in euros have collapsed. This will likely prompt an exodus of European investors from EM financial markets. Chart I-6A Major Breakdown In This Cyclical Indicator Even though the EM equity index is not expensive or overbought, rising EM USD and local currency bond yields herald lower share prices, as we discussed at length in last week’s report. Our Risk-On/Safe-Haven currency ratio1 has plummeted below its major technical support and the next level is significantly lower. In other words, this indicator is also in an air pocket (Chart I-6). Given it is extremely well-correlated with EM share prices, the latter will not bottom until this indicator stabilizes. Technical configurations of high-beta and cyclical segments of the global equity universe are consistent with failed breakouts. Such a profile is typically not followed by a correction, but by a major drawdown. These include the European aggregate equity index, the Nikkei, global industrials and US high-beta stocks (Chart I-7). Chart I-7AFailed Breakouts Are Often Followed By Large Drawdowns Chart I-7BFailed Breakouts Are Often Followed By Large Drawdowns Chart I-8The Global Stocks-To-Bonds Ratio Is Back To 2011 Levels Finally, the global stock-to-bond ratio has decisively broken below the upward sloping channel that has been in place since 2009 (Chart I-8). Typically, when a market or ratio experiences such a major breakdown, the recovery does not occur quickly and is unlikely to be V-shaped. In short, the structural breakdown in the global stocks-to-bond ratio suggests that global share prices will likely stay under downward pressure for some time. Bottom Line: Odds are that risk assets remain in a liquidation phase and investors should avoid catching a falling knife. The odds are also high that EM share prices in US dollar terms have another 18% downside. We reckon at those levels – where the MSCI EM equity index is around 800 – it would be safe to start accumulating EM equities, even if the global growth outlook remains mired in uncertainty. For now, we recommend playing EM on the short side. What To Do With Oil Plays Despite periodic spikes in crude prices over the past few years, we have held our conviction that oil is in a structural bear market. We doubted the sustainability of the OPEC 2.0 arrangement, arguing that Russia would not cooperate with Saudi Arabia in the long term. Russia did cooperate much longer than we had expected, temporarily supporting oil prices. Ultimately, Russian President Vladimir Putin abandoned the cartel late last week, and the Saudis have hit back with massive price discounts amid large output increases. Consequently, oil prices have crashed and are presently oversold (Chart I-9). Given the uncertainty related to both the global growth trajectory and the Covid-19 epidemic, the only way for investors to gauge a market bottom is to continuously examine valuations, technicals and market internals. However, there will be no rapprochement between the Saudis and the Russians for some time. Given the drop in demand amid sharp increases in supply, crude oil prices may well slide further. Since July 11, 2019, we have been recommending a long gold/short oil and copper trade (Chart I-10). This position has generated a large 40% gain. Today, we are taking profits on this trade. Instead, we are replacing it with a new position: long gold/short copper. Chart I-9A Long-Term Profile Of Oil Prices Chart I-10Book Profits On Long Gold / Short Oil And Copper Trade Among oil plays, we have been overweight Mexico and Russia within EM, both in fixed income and equity universes. That said, for absolute return investors, we have not been recommending unhedged long positions in either Mexico or Russia because of our expectation of a drop in oil prices and the ensuing broad-based EM selloff. Regarding Russia, for investors who were looking to gain exposure to local currency bonds, we have been recommending that they hedge this position by shorting oil since November 14, 2019. This recommendation has paid off well, and we are closing this position with a 26% gain. We will be looking to buy Russian local bonds unhedged in the weeks ahead. Chart I-11Relative Performance Of Russian And Mexican Domestic Bonds Is Facing Near-Term Headwinds In Mexico, we have also been reluctant to recommend naked exposure to local currency or US dollar bonds because of our bearish view on oil and the risk of large outflows from EM that would hurt the peso. Indeed, the oil crash and outflows from EM have led to a plunge in the Mexican currency. Instead, in Mexico we have been recommending betting on yield curve steepening. The proposition has been that short rates are anchored by a disinflationary backdrop and tight fiscal policy in Mexico while the long end of the curve could sell off in a scenario of capital outflows from EM. As with Russia, we are monitoring Mexican markets and are looking to recommend buying domestic bonds without hedging the currency risk in the weeks or months ahead. Bottom Line: We are taking profits on our long gold/short oil and copper trade. Oil prices may stabilize, but risks are still skewed to the downside. In the near term, the relative performance of Mexican and Russian stocks and local currency bonds versus their respective EM benchmarks could be undermined by capital outflows from EM in general and these countries in particular (Chart I-11). Nevertheless, both nations’ macro fundamentals remain benign, and their fixed-income and equity markets will outperform their EM peers in the medium term. Arthur Budaghyan Chief Emerging Markets Strategist arthurb@bcaresearch.com Footnotes 1 Calculated as ratio of equal-weighted average of total return indices of cad, aud, nzd, brl, idr, mxn, rub, clp & zar relative to average of jpy & chf total returns (including carry); rebased to 100 at January 2000. Equities Recommendations Currencies, Credit And Fixed-Income Recommendations
Highlights Supply constraints and unstoppable demand growth – the result of stricter regulations requiring higher loadings in autocatalysts to treat toxic pollution in automobile-engine emissions – will continue to push palladium’s price higher, despite a near-vertical move higher that began in 2H19. South Africa’s power grid is in a state of near-collapse, which will add volatility to mining operations focused on platinum-group metals – chiefly palladium, platinum and rhodium. South Africa accounts for 36% of global palladium production and 73% of platinum production, which makes it difficult to make the case that platinum could be substituted for palladium as its price rises. Palladium stocks are at risk of being further depleted globally as demand from automobile manufacturers in China, the US and Europe remains robust. This will keep palladium forward curves backwardated for the foreseeable future. While pressure to find alternatives for palladium will grow as prices rise, in absolute terms the additional cost resulting from higher prices for the metal – ~ $400 per vehicle – is not yet enough to draw significant investment to this effort. Feature Palladium markets are fundamentally tight and unresponsive to macroeconomic uncertainty. Table 1Top 5 Best Performing Commodities In 2019, for the third year in a row, palladium prices outperformed other major commodities, returning an impressive 54% over the year (Table 1). This is the result of a massive 13% increase in demand for the metal – powered by strong autocatalyst demand for gasoline-powered cars in China and Europe, even as collapsing auto production globally and elevated trade uncertainty continue to dog automobile sales (Chart 1). This apparent contradiction is explained by stricter vehicle emissions regulations in major consuming markets – chiefly the Euro 6d, China 6 and US Tier 3 regimes – and power shortages in South Africa, which are introducing considerable volatility on the supply side in the second-largest producing country for the metal. Chart of the WeekSurging Autocatalyst Palladium Demand Again this year, palladium markets are fundamentally tight and unresponsive to macroeconomic uncertainty. Palladium prices soared 39% YTD, its fastest 40-day increase since 2010. Unlike other commodity markets, palladium is completely disregarding the COVID-19 outbreak that originated in China late last year. Favorable supply-side fundamentals continue to drive the palladium rally: The metal’s decade-long physical supply deficit intensified in 2019 and we expect it to widen this year (Chart 2, panel 1). On the demand side, Chinese consumption is at risk. China is the world’s largest auto manufacturing market. Hubei Province – COVID-19’s epicenter – is a large car manufacturing hub, accounting for ~ 10% of the country’s annual automobile output. In the wake of COVID-19, the country’s car production is expected to fall 10% in 1Q20. In addition, the virus had infected more than 80,000 people globally, and has spread rapidly outside Hubei into Asia, Europe, the Middle East, Africa, and North America, raising the odds of a pandemic. Interestingly, speculative positioning and ETF investment demand is subdued, and is not inflating prices (Chart 2, panel 2). Chart 2Palladium Deficit To Widen This Year Palladium Demand Soars As Auto Production Collapses Strong global automobile catalyst demand drove the rally in palladium prices last year. This occurred as car production fell by 9%, 8%, and 15% in US, China, and India – an unusual divergence in fundamentals. The culprit: Technical changes to autocatalysts from stricter emissions regulations. In China, the latest phase of car emissions regulations – China 6 – was gradually introduced in high-population centers, which also suffer from high levels of pollution. These centers accounted for ~ 60% of annual Chinese car sales in 2019. China 6 represents a major shift in emissions regulations and will make the Chinese auto fleet compliant with Europe’s best practices. As a result, palladium loadings in conforming light-duty gasoline vehicles reportedly increased by ~20% in 2019. This pushed China’s autocatalyst consumption up by 570k oz despite the drop in annual car sales, which created the rare dislocation between the country’s car production and palladium prices (Chart 3). We expect this trend to continue this year: China 6 is on track to be enforced countrywide – i.e., the remaining 40% of car sales – by mid-year, providing an additional ~ 10% boost in loadings of the metal. Chart 3Stricter Regulations Support Prices Amid Falling Car Production In Europe, the introduction of Euro 6c legislation in September 2018 and the extension to all new vehicles of Euro 6d-TEMP regulations in September 2019 – mainly the real driving emissions (RDE) testing procedure adopted in the wake of the Volkswagen “dieselgate” scandal in 2015 – pushed palladium loading in autocatalysts up by ~ 25% from 2017 to 2019.1 The regulations became stricter in January 2020, putting additional stress on manufacturers to comply with the new standards, which will continue to support higher palladium loadings. We expect the COVID-19 outbreak to delay the recovery in global gasoline-powered vehicle production and consumption to 2H20. Lastly, in the US – which remains an important market for autocatalyst palladium demand (Chart 4) – the ongoing implementation of the Tier 3 legislation will continue to gradually increase palladium content in autocatalysts until 2025. For 2020, we do not expect this to significantly boost loadings per vehicle and are factoring in 2% growth. These legislative changes in major automotive markets produced a structural break in our palladium demand model (Chart 5). After adjusting our estimates for greater palladium content in gasoline aftertreatment systems, our model suggests that demand provides strong support to palladium prices, but also suggests other factors – i.e. supply and inventory – are at play. Chart 4North America's Auto Sector Remains A Large Share Of Palladium Demand Chart 5Higher Palladium Loadings Largely Explains Last Year's Price Surge In the US and Europe, consumers can absorb higher vehicle sales despite being close to saturated in terms of vehicle ownership. We expect the COVID-19 outbreak to delay the recovery in global gasoline-powered vehicle production and consumption to 2H20. In China, we expect the government will overstimulate its economy to meet its long-term goal of doubling its GDP and per capita income by 2020.2 Automobile ownership and vehicle sales there are low vs. DM economies, suggesting more upside for sales in China (Chart 6). In the US and Europe, consumers can absorb higher vehicle sales despite being close to saturated in terms of vehicle ownership. Car sales move in cycles around long-term demographic trends: The longer the current economic expansion, the further above-trend car sales can rise (Chart 7). Chart 6China: Structural Outlook For Autos Is Bright China Car Consumption Will Rebound In 2H20... Chart 7... Likewise For Europe And US Bottom Line: The combination of stricter environmental regulations in key gasoline-powered automobile markets and the post-coronavirus rebound in global auto consumption will push the palladium market further in deficit this year as it faces an inelastic supply, critically low inventories and low substitutability over the short-term (more on this below). Palladium Supply In 2020: Weak growth And Low Price-Elasticity Palladium supply is highly constrained. The largest supplies are concentrated in Russia (42%), South Africa (36%) and North America (14%). From 2015 to 2019, supply and capex grew by a very subdued 7% and 15.2% respectively, completely disregarding the 200% rise in prices (Chart 8, panel 1). This illustrates palladium supply’s extremely low price-elasticity.3 Palladium supply growth will remain muted for the foreseeable future, as Eskom begins long-delayed maintenance to refurbish its derelict generation fleet. Primary supplies declined by close to 2% last year on falling shipments from Russia and record electricity load-shedding – i.e. blackouts – in South Africa (Chart 8, panel 2).4 As tight as palladium markets are fundamentally, South Africa’s crippled power grid – long in need of upgrading and repair – has been, and remains, a key driver of short-term platinum-group metals (PGM) prices.5 Following the breakdown of close to 25% of the country’s generating capacity, Eskom – the nation’s utility monopoly responsible for ~ 90% of its electricity generation – has been forced to implement rolling blackouts to balance power supply and demand and prevent permanent damage to the country’s power grid. Palladium supply growth will remain muted for the foreseeable future, as Eskom begins long-delayed maintenance to refurbish its derelict generation fleet. Consequently, Stage 6 load-shedding events likely will become more frequent. These efforts are complicated by massive debt – ~ $30 billion – which has required government bailouts and forced the company to take loans from a Chinese industrial bank. Chart 8Top Palladium Producers' Capex Price-Elasticity Is Low This is playing havoc with PGM supplies. During the unmatched Stage 6 load-shedding in December 2019 – cutting power to 37% of grid users – PGM supplies were reduced by 50%. Stockpiles covered the loss, but persistent blackouts lasting years could push markets into an actual shortage of palladium as inventories would rapidly be depleted. This is a significant risk: Eskom itself warned rolling blackouts will persist for the next 18 months.6 Elevated local currency PGM prices are postponing announced shafts closures, as miners seek to profit from the favorable pricing environment (Chart 9). But insufficient electricity capacity will weigh on mine supply growth over the next few years as companies hold-back on much-needed long-term investments. The final units of Eskom’s Medupi and Kusile projects are expected to be completed over the next two years – adding 4800MW to its installed capacity. This can partially alleviate South Africa’s electricity difficulties, but these units are not enough to support a rebound in economic and mine production growth. South Africa is in profound need of large-scale investments in its power sector. Close to 5000MW of power capacity is scheduled to shut down over the next five years (Chart 10). Chart 9Favorable Domestic Metal Prices For South African Miners Chart 10South Africa Needs Additional Power Generation Capacity After years of pressure from mining companies, South Africa’s minister of Mineral Resources and Energy announced it would allow companies to generate unlimited electricity for their own activities. The current political and economic climate is not constructive for meeting this challenge. The World Bank recently slashed South Africa’s 2020 GDP growth forecast to 0.9% from 1.5% previously on the back of electricity and infrastructure constraints impeding domestic growth and weak external demand. Likewise, rating agency Moody's signaled – ahead of its review of South Africa’s Baa3 credit rating in March – it could downgrade the country to speculative grade, citing the detrimental impact of recurring power outages on manufacturing and mining output. After years of pressure from mining companies, South Africa’s minister of Mineral Resources and Energy announced it would allow companies to generate unlimited electricity for their own activities. This will provide much-needed help to the country’s power sector. According to the Minerals Council South Africa, mining companies could bring an additional ~ 1500MW capacity online in the next 9 to 36 months. But doubts remain with regard to the timeline for companies to obtain the necessary licenses and if these can easily be acquired. Johnson Matthey expects supply growth in Russia – the largest producer – will be capped this year as Nornickel’s processing of old mines' copper concentrate – which boosted the company’s palladium supply over the past few years – is finalized. Still, a paltry 1% gain is possible from expected efficiency gains at existing mines, according to Nornickel. The company also announced it will increase production at its Talnakh and South Cluster mines, but this additional supply will only reach markets gradually as processing capacity constraints won’t be resolved until 2023, according to Johnson Matthey. Bottom Line: Growth prospects in the top two palladium-producing countries are weak in 2020. This will not suffice to meet the soaring autocatalyst demand. Higher recycling and inventory releases – both incentivized by higher prices – will be needed to balance the market. Palladium Stockpiles Are Dangerously Low We expect palladium prices will move higher on the expanding deficit, and backwardation in the forward curve will persist to incentivize the release of inventories to market (Chart 11). Yet, global palladium stockpiles have been declining since 2014 and are now at critically low levels, raising the risk of a disrupting shortage of the metal:7 ETF and exchange inventories now stand at a paltry 600k oz (Chart 12). These are the most price-elastic stocks and will get close to zero as prices increase. Chart 10Expect Backwardation To Persist Chart 12Price-Sensitive Stockpiles Are Dangerously Low Exhaustion of inventory would spike prices until demand destruction or additional supply – both inelastic in the short-run – are able to balance the market. The Russian Ministry of Finance’s reserves – a state secret – are now almost exhausted, according to Russia’s Norilsk Nickel, the largest supplier of physical palladium in the world. Last year, Norilsk Nickel held an estimated 1mm oz of the metal in its Global Palladium Fund, and signaled it is increasingly using its reserves to balance markets and provide needed liquidity. Earlier this year, the company released 3 MT of palladium to the market from stocks. Complete exhaustion of inventory would spike prices until demand destruction or additional supply – both inelastic in the short-run – are able to balance the market. Don’t Count On Substitution, Yet Switching to platinum requires significant capital- and resource-intensive R&D and appears to be beyond the current capabilities of automakers. We expect platinum prices to rise in 2020 supported by improving fundamentals, growing safe-haven demand, and markets pricing in increasing anticipation of substitution from palladium to platinum. Unlike palladium, platinum is also affected by safe-haven demand and gets bid up with gold and silver prices in periods of high uncertainty (Chart 13). With gold prices now above $1,600/oz, platinum will benefit from safe-haven flows due to its relative price advantage (Chart 14). Chart 13Safe-Haven Flows Support Platinum Prices Chart 14Platinum Is Cheap Relative To Gold We believe substitution will commence over the coming years, but this is a gradual process. Substitution from expensive palladium to low-priced platinum in industrial applications is the largest risk to our positive view on the palladium-to-platinum (Pd-to-Pt) ratio (Chart 15). This started in smaller and more price-elastic segments (e.g. dental, jewelry and diesel autocatalyst). However, to have a real impact on overall demand and thus the price ratio, substitution needs to take place in gasoline autocatalyst technology. The discount has been at a level consistent with substitution for more than a year, but the urgency to upgrade current designs to meet new environmental legislation and RDE regulations in China, Europe, and the US is the main focus of automakers this year. Switching to platinum requires significant capital- and resource-intensive R&D and appears to be beyond the current capabilities of automakers scrambling to meet the latest anti-pollution regulations globally. Moreover, large-scale substitution will take place only if automakers’ cost-benefit analysis points to significant long-term profits from switching. That said, platinum’s supply security remains a risk in the long-term: South Africa accounts for 73% of global production and our analysis suggests output growth there likely will remain weak over the next few years, especially as Eskom rebuilds its failing power grid. This lack of diversity increases sourcing risks for automakers, who, not without reason, would not want to switch over to platinum only to find that supply is also in doubt down the road. The overall platinum market is 26% smaller than that of palladium. Assuming a one-for-one substitution of Pd to Pt in gasoline catalyzers, a 1.2mm oz reduction in Pd demand – the amount required to reduce palladium’s deficit to zero – would send platinum markets to a 1.4mm oz deficit.8 Without substantial production growth, platinum prices would spike, reducing the profitability of investing in these new catalysts. Thus, substitution will eventually impact the price ratio, but will not be large enough to overturn absolute price level trends. In addition, the amount of PGMs in the typical autocatalyst – ~ 5 grams – adds $400 to the cost of the average automobile (Chart 15, lower panel). We do not believe this cost drives automakers' decisions, which is another reason the substitution of Pt for Pd likely will remain a topic of discussion more than action. Chart 15Palladium's Price Surge Adds ~0 Per Gasoline Car Bottom Line: We believe substitution will commence over the coming years, but this is a gradual process and it will not happen on a meaningful scale this year. Thus, we expect the continuation of relative demand and inventory trends will provide a favorable setting for the Pd-to-Pt ratio this year (Chart 16). Chart 16Pd-to-Pt Price Ratio Will Increase Again in 2020 Hugo Bélanger Associate Editor Commodity & Energy Strategy HugoB@bcaresearch.com Robert P. Ryan Chief Commodity & Energy Strategist rryan@bcaresearch.com Commodities Round-Up Energy: Overweight Brent and WTI crude oil lost 5% and 4% this week, as fears of a global pandemic in the wake of the COVID-19 outbreak gripped markets. Reports of outbreaks in Asia ex-China, the Middle East and Europe fueled these concerns. Against this backdrop, OPEC 2.0 will be meeting in Vienna March 5 and 6 to consider cuts of 600k b/d recommended by its technical committee earlier this month. We continue to expect the full coalition to approve these cuts at the upcoming meetings. Saudi Arabia, Kuwait and the United Arab Emirates reportedly are considering an additional 300k b/d of cuts to offset the global demand hit delivered by COVID-19. The IEA estimates the COVID-19 outbreak will reduce Chinese refining throughput by 1.1mm b/d, and will reduce the call on OPEC crude by 1.7mm b/d in 1Q20. Base Metals: Neutral Iron ore prices weakened, following global equities lower, as the COVID-19 outbreak spread around the world. However, traders continue to report lower stocks of iron ore, which should keep prices supported, according to MB Fastmarkets (Chart 17). We remain long December 2020 high-grade iron ore (65% Fe) vs. short the benchmark 62% Fe contract on the Singapore Commodity Exchange, which we initiated November 7, 2019. This recommendation was up 5.3% as of Tuesday’s close, when we mark to market. Precious Metals: Neutral After retreating slightly from its run toward $1,700/oz earlier this week, gold remains well supported by safe-haven demand (Chart 18). In addition, actual and expected policy stimulus – e.g., Hong Kong's “helicopter money” drop of USD 1,200 to all permanent residents over the age of 18 – and expectations of additional central bank easing globally to offset the global spread of COVID0-19 will keep gold and precious metals generally supported. Markets should start pricing in higher inflation expectations as additional stimulus starts to roll in. Ags/Softs: Underweight Global grain markets could be set to rally sharply, as unusually wet weather in the Middle East and East Africa spawned by higher-than-usual cyclone activity produces perfect breeding conditions for desert locusts in the region over the next two months. According to National Geographic, by June the locusts could increase their populations “400-fold compared with today, triggering widespread devastation to crops and pastures in a region that’s already extremely vulnerable to famine.” This could put more than 13mm people in East Africa at risk of “severe acute food insecurity,” and imperil millions more. Chart 17China's Iron Ore Stocks Tight Chart 18Safe Havens Gold, USD Well Bid Footnotes 1 Please see New legislation planned in response to dieselgate, published by Autocar June 9, 2016. See also Johnson Matthey’s February 2020 Pgm Market Report. 2 Our view of strong Chinese fiscal and monetary stimulus was discussed in detail in our February 13, 2020 weekly report titled Iron Ore, Steel Poised For Rally. 3 Historically produced as an inferior byproduct from nickel, gold, and platinum mines, the price incentive from palladium alone isn’t enough to generate the needed investments in new mine production. According to Nornickel, this is slowly changing, palladium is an increasingly large part of mining companies’ revenues, making the metal a valuable co-product. This could improve mines investments’ responsiveness to movement in palladium prices over the medium term. 4 According to Eskom, “Load shedding is aimed at removing load from the power system when there is an imbalance between the electricity available and the demand for electricity. If we did not shed load, then the whole national power system would switch off and no one would have electricity.” The company’s load-shedding program includes 8 stages, where each stage represents the removal of 1000MW of demand – e.g., stage 5 removes 5000MW. This is done by shutting down specific sections of the grid. 5 The PGMs are ruthenium, rhodium, palladium, osmium, iridium, and platinum. 6 Things got worse after the December load-shedding event. Less than a month later, Reuters noted more than two times the power shed in December went “offline because of plant breakdowns. 7 This can be seen in the close to 12mm oz. decline in UK and Switzerland – home of the largest secured vaults of Palladium and Platinum – net imports. 8 Technological improvement in palladium catalysts has made the metal more efficient in for gasoline-powered engines vs. platinum. It has superior properties in terms of thermal durability and NOx reduction. Thus, the conversion could be greater than 1-to-1 and would imply a smaller share of palladium autocatalyst substitution could be absorbed by existing platinum supplies. Investment Views and Themes Recommendations Strategic Recommendations Tactical Trades TRADE RECOMMENDATION PERFORMANCE IN 2019 Q4 Commodity Prices and Plays Reference Table Trades Closed in 2020 Summary of Closed Trades