Latest Energy Transition Materials ETF Monthly Report | HANetf

Energy Transition Materials ETF Key Takeaways | September

The underlying index of the Energy Transition Materials ETF fell -9.73% in August. Weakening economic data and deteriorating liquidity in China's shadow banking system weighed heavily on most commodities except energy-related commodities. Among stocks, mining indices most exposed to China, such as lithium and copper miners, experienced the sharpest selloff. After five straight months of increases, the broad equity market had its first down month since February as bond yields and the U.S. dollar (USD) continued to rally. The U.S. 10-year Treasury yield reached a 15-year high as real yields rose quicker than breakeven yields following the recently announced massive Treasury issuance and the Fitch downgrade of U.S. government debt. This was despite several countervailing factors, including headline inflation falling to 3.2% from the 9.1% peak, the U.S. Federal Reserve likely near the end of its rate hiking cycle, deflationary conditions in China and record bond inflows.

The lithium carbonate spot price experienced extreme volatility in August and fell -25.04% over the month to $12.59 per pound. The fall came from short-term bearish sentiment largely in reaction to China’s economic concerns. The lithium market is currently very tightly balanced, causing the spot price to become extremely sensitive to small shifts in supply and demand. However, despite the steep decline in the spot price since the November 2022 high, lithium prices are still many times higher than their historical levels (e.g., in late 2020, the lithium spot price was below $3 per pound).

As of this writing, the recently launched lithium carbonate futures contract on the Guangzhou Futures Exchange was $11.91. Though this still puts the market in backwardation, the extent has lessened since last month, and we believe this may imply a slowdown in lithium’s price descent. CEO Paul Graves of lithium producer Livent Inc. echoed our viewpoint when he stated in August that the company believes prices have reached a floor “above $30 per kilo in China based on public data points and ... expect this to be the case through the rest of this year and into 2024.” 

The lithium market is being bolstered by long-term demand for electric vehicles (EVs). In 2020, the average lithium carbonate spot price was $2.90, while global EV sales were 3.2 million. In 2021, the average spot price was $8.53, while EV sales were 6.5 million. In 2022, the average spot price was $32.64, while EV sales were 10.5 million. EV sales at this level now put 23 countries above the 5% adoption point said to trigger mass adoption.   Bloomberg has forecast that annual global EV sales are likely to nearly triple by 2026 to 27 million.  Lithium miners are pushing to develop projects as quickly as possible, but the scale of the increase in supply needed is unprecedented and may lead to future market imbalances.

In August, lithium miners fell by -12.27% as many mining equities sold off and the lithium spot price fell. That said, YTD the miners have fared much better than the lithium spot market and are nearly flat, with a -0.67% return. Although the drop in the lithium spot price has reduced miners’ margins, they are still profitable at current price levels.

Lithium mining equities have been a more attractive investment than the physical commodity because of the rise in announced offtake agreements, direct equity investments by original equipment manufacturers (OEMs) into lithium miners, and merger and acquisition (M&A) activity. Most recently, on September 4, 2023, Liontown Resources Ltd's share price jumped 11.50% as its board backed a refreshed A$6.6 billion takeover bid from Albemarle Corporation, the largest lithium producer in the world.  The acquisition would expand Albemarle’s presence in Australia, where that company already has significant exposure. This is the fourth offer Albemarle has made for Liontown. The previous offer, A$5.2 billion in March 2023, sent Liontown’s stock price up more than 70%.

The copper spot price fell -4.49% to $3.81 per pound in August, and shares of copper miners fell -9.20% as USD strength prevailed and China’s weakening economy dampened markets.  China has been the source of swings in the copper price, which generally falls on disappointing economic data from China and rises on news of a potential stimulus from the Chinese government.

In August, the U.S. Department of Energy (DOE) named copper a critical mineral for the first time, following the example of the EU, Canada, China, Japan and India. Copper joins lithium, nickel, cobalt, some rare earths such as neodymium and praseodymium, and others on the list. 

Copper met the DOE’s criteria as a critical mineral:

•          Has a high risk of supply chain disruption

•          Serves an essential function in one or more energy technologies, including technologies that produce, transmit, store and conserve energy

In copper’s case, supply chain risks include declining ore grades, fewer meaningful discoveries, reduced production guidance due to operational challenges and long lead times. With regard to energy technologies, copper’s role in transmission has made it essential in the electricity grid (see our August commentary), and it plays a critical role in wind and solar energy as well as EVs. An EV requires 4x the copper of an internal combustion engine (ICE) vehicle. Offshore wind energy requires 7x the copper per megawatt (MW) of traditional coal and natural gas sources. Onshore wind and solar require 3x the copper per MW of conventional sources.  Energy transition represents a significant area of growth for critical minerals, and renewable energy installations are likely to experience strong growth in 2023.

The nickel spot price fell -9.01% in August as China’s negative economic data slowed demand for nickel and stainless steel. Nickel is generally split into Class I, a higher grade for batteries, and Class II, a lower grade for stainless steel.  A surplus in the supply of Class II nickel has weighed down the nickel price. Further, processing innovations have allowed lower-grade nickel to be refined into a higher-grade intermediate product (NPI-to-matte production). These developments have contributed to nickel’s year-to-date decline despite low global inventories and longer-term increasing battery demand.

In the recently released 2023 Critical Materials Assessment from the U.S. Department of Energy, while copper made big headlines, the DOE expects nickel and lithium to become the most critical minerals globally between 2025 and 2035. Tailwinds supporting nickel are the fleet penetration of EVs and the nickel intensity of battery chemistries within those EVs. It is important to note that nickel intensities in battery chemistries are generally expected to increase to meet consumer demand for longer driving distances.

Source of all performance data: Bloomberg / HANetf as of 31.08.2023. All performance figures are showing net data. Past performance is not indicative of future performance and when you invest in ETFs your capital is at risk.

Macro Outlook

We believe the post-pandemic era marks the beginning of a new supercycle for commodities, especially for the critical minerals covered in this report. The clean energy transition is just one trend driving demand higher. Geopolitical tensions and conflict are prompting global powers to reshore their supply chains and production to ensure industrial security—an about-face after many decades of offshoring.

These trends are commodity- and capital-intensive, creating a demand shock for commodities. They are also inflationary in nature. We expect a steady increase in demand to drive commodities in the medium term. Meanwhile, the commodity demand shock is colliding with a supply situation that is woefully inadequate. Miners and production facilities have faced a decade of underinvestment caused by the low commodity prices that prevailed during an era of record-low interest rates and the long lead times required—often a decade or longer— to bring new production online. Sanctions on Russia, the world’s largest producers of many commodities, only aggravate the situation—while also fanning the flames of rising “resource nationalism.”

The commodity supercycles of the past arose from varied conditions. In the 1970s, an energy supply shock drove the distress, rooted in OPEC embargoes. In the early 2000s, it was demand shock from an aggressively growing China that underpinned commodity inflation. The emerging supercycle has both supply and demand shocks, prompting heated global competition to secure commodities.

Please remember that when you invest in ETFs, your capital is at risk.

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