Energy Transition Material ETF Report | Apr 2024

Energy Transition Materials ETF Key Takeaways

The Sprott Energy Transition Materials UCITS ETF rose 9.97% in March. Global central banks—including the Swiss National Bank, the Bank of England, the U.S. Federal Reserve (Fed), the European Central Bank and the People’s Bank of China—have recently taken a dovish stance, either reducing interest rates or indicating imminent cuts. This pivot marks the most significant wave of monetary easing since the COVID-19 crisis, as over 50 rate cuts were announced globally in the last three months. The shift signals a broader adoption of policies aimed at stimulating economic growth as concerns over inflation diminish, especially from the Fed, paving the way for more rate cuts and looser financial conditions.

As a result, there has been a recovery in commodities and cyclical sectors like mining and energy. This expansion is expected to support the entire energy transition sector, which is now positioned more favorably than it has been for two years. Several contributing factors have set a promising macroeconomic backdrop for the energy transition group, including: 1) the resurgence of the global reflation trade, signaling a bullish outlook for commodities and cyclical sectors as central banks initiate an easing cycle; 2) uranium nearing the end of its initial correction phase and gearing up for its next expected rise; 3) an overall broadening of market breadth and risk-taking; 4) improved economic data from China; and 5) energy transition equities approaching the conclusion of its two-year consolidation phase.

The broad market has been moving higher as the Fed maintains its outlook for three rate cuts in 2024, the economic growth outlook improves, inflation (though bumpy) keeps tracking lower, and the U.S. Treasury continues to place more bond issuance into the short end of the yield curve. In equities, the growth outlook for artificial intelligence has sparked higher earnings revisions, while financial conditions remain highly accommodative, allowing ample scope for expansion in price multiples. The prospect of a soft landing, moderating inflation, accommodative central banks, ample system liquidity, the secular AI growth engine and easy financial conditions have fueled this “everything rally.”

The lithium carbonate spot price rose by almost 15% in the first half of March before retreating, ending the month up 5.35%, making its overall year-to-date rally 9.46%. Lithium has begun recovering as its precipitous decline from previous unsustainable highs appears to have ended.

However, even with lithium’s recent increase, the current price remains below a sustainable level and will need to rise to incentivize supply in the longer term. In the meantime, the lithium supply is shrinking, with project curtailments and cuts to lithium growth plans likely to exacerbate significant supply deficits anticipated later this decade. Chinese supply has become susceptible to disruption. Much of China’s lower-grade and higher-cost source of lithium, lepidolite, is no longer economical. Further, China’s recent environmental probe in a top production hub may spur further disruptions.

Bloomberg reports that, as a result of these factors, “UBS Group AG and Goldman Sachs Group Inc. have trimmed their 2024 supply estimates by 33% and 26%, respectively, while Morgan Stanley warned about the growing risk of lower inventories in China.”  Given the thinning market, investors with short positions may need to consider unwinding positions due to a potential market bottoming. There are significant short positions in several top lithium producers which, due to these supply cuts, may be under threat. Short positions in Albemarle Corp. and Pilbara Minerals Ltd., for example, account for more than 20% of their outstanding shares.

Demand for electric vehicles (EVs) continues to increase, additionally bolstered by a stringent new rule in the U.S. that further limits auto emissions, thus compelling automakers to rapidly boost EV sales.  There is no real alternative for lithium in EVs. Despite a perceived slowdown, global EV sales increased from 10.5 million in 2022 to 14 million in 2023 and are forecast to increase to 16.7 million in 2024. Ultimately, we believe EV penetration rates will continue to rise, potentially increasing demand for lithium and benefitting lithium miners.

National interests in the lithium market continue to develop. The industry is being transformed by the growing importance of reshoring and friendshoring, as well as new industrial policies and fresh investment. Lithium Americas received a record $2.26 billion loan from the U.S. Department of Energy to develop a Nevada lithium deposit.  It came in the wake of General Motors’ $650 million equity investment in Lithium Americas, the largest investment by an automaker in a raw materials producer disclosed to date. The loan and investment together give Lithium Americas most of the capital it needs to fund an initial 40,000 tonnes per year of battery-grade lithium carbonate production (Phase 1) at its Thacker Pass mine in Nevada. The investment gives GM exclusive rights to 100% of Lithium Americas’ lithium production from Phase 1 for up to 15 years, and a right of first offer on Phase 2 production.

Similarly, in March, Australian producer Liontown Resources secured a A$550 million loan from Australian banks and government agencies as it aims to begin production this year.

These loans represent a substantial step in strengthening various countries’ critical materials supply chains, and we expect the trend to continue to bolster critical mineral miners.

The nickel spot price fell -6.23% in March to end the month at $7.52 per pound. Nickel miner stocks fared better over the same period, gaining 3.07%. Nickel fell after Indonesia, the world’s largest nickel producer, announced that it is expediting approvals of production quotas known as RKABs (work plan and budget approvals). Nickel supply has increased rapidly in recent years, with Indonesia producing 1.8 million metric tons in 2023 compared to 760,000 in 2020. Indonesia now accounts for half of global supply, and some estimates predict that the country will produce more than 75% of global supply during the 2022–2029 period.  The winner of the recent Indonesia election, Prabowo Subianto, has publicly stated that he will continue the resource nationalism policies of his predecessor, Joko Widodo. These policies aim to turn Indonesia into a global nickel powerhouse to meet the growing demand from the EV battery and stainless-steel industries.

Several European car makers are in the process of establishing EV plants in Indonesia, including Citroen, Renault and Volkswagen, following in the footsteps of Chinese automakers. Both China and Europe view Indonesia as a production base for EVs, particularly entry-level cars. China continues to dominate investment in Indonesia’s EV industry, led by companies like BYD, Wuling, Chery and Great Wall Motors.

Like lithium, closures of higher-cost mines, most recently in New Caledonia, are reducing the current nickel surplus that resulted from increased low-cost Indonesian production. In a move to bail out its nickel industry, the French government approved a $152 million bridge loan to nickel miner Prony Resources in New Caledonia, which has suffered because of the fall in nickel prices and the boom in Indonesian nickel production. New Caledonia continues to struggle with low-cost output from Indonesia but has long been a major source of nickel production.

Despite the current supply glut, nickel’s long-term fundamentals are strong. Significant amounts of nickel will be needed in future years for companies and governments to reach net-zero emissions targets. Many big economies, including Australia, have listed nickel as a critical mineral. Stricter emission mandates are also helping to boost the nickel industry, particularly in the U.S., where the Environmental Protection Agency is imposing mandates that could require nearly two-thirds of new cars and light trucks sold to be EVs by 2032.  As with copper and other commodities, we believe moves by global central banks to reduce interest rates will also support the nickel market, given that lower rates generally lessen the cost of carrying inventories, and thus provide support for nickel prices.

ESG Copper Miners ETF Key Takeaways

The copper spot price rose 4.34% to $3.98 per pound in March, breaking through the twin barriers of $4 per pound and $9,000 per metric ton during the month.  Copper miner stocks provided additional leverage by rising 17.99%, while shares of copper juniors went up by 18.22%.

In previous months, copper had been holding steady due to a tug-of-war between strong fundamentals and mixed economic data. In March, the stars aligned for the copper market, as continued positive supply-demand developments coincided with strong economic data. In the U.S., moderating inflation expectations boosted market sentiment when the Fed indicated it was still forecasting three interest rate cuts by the end of the year. Central banks have largely been synchronized in this supportive monetary policy, as indicated by the 50-plus rate cuts announced globally in the last three months.

Copper has benefited from this easing cycle since easier conditions for economic growth correlate with greater demand for copper. “Dr. Copper” is an economic bellwether used in numerous areas of the economy such as construction, electronics and transport. The growth impetus could be seen, for example, in the Global Purchasing Managers’ Index (PMI) which reached 52.3 in March, a nine-month high.  (Readings higher than 50 indicate economic expansion.)

With the improvement in business cycle conditions, copper may be set up for continued success for several reasons. For one, it has historically performed best in expansionary economic phases. Further, interest rate cuts in a non-recessionary environment have typically led to higher commodity prices. Copper is uniquely predisposed to these conditions and is currently the best-performing commodity featured in the analysis below. Notably, copper mining stocks have also provided further leverage to increases in the copper spot price. Historically, there is a very strong correlation of 0.88 between copper mining stocks and the copper spot price, and mining stocks have typically almost doubled moves in the spot price as measured by a beta of 1.8.

Elsewhere, treatment charges to turn copper concentrate into refined metal have plummeted in 2024. Treatment charges are the fees smelters charge miners, and a lower fee means a smaller margin for the smelter and a tighter mine supply. They have now fallen below $10 per metric ton, far below the previous $80 to $100 level.

As these fees have collapsed, smelters’ profitability has fallen to such an extent that the Chinese smelters held a crisis meeting in March in which they agreed to curtail production. Though no aggregate limits were specifically set, they pledged to re-arrange maintenance work, reduce utilization rates, and delay the start of new projects. Further, smelters are also buying more copper scrap instead of concentrate, causing the copper scrap discount to shrink. Following the meeting, Bloomberg reported that Chinese smelters were proposing a 5% to 10% production cut.

Treatment charges are at the lowest levels in a decade, but they have been this low before. The last three times treatment charges fell below $30, copper prices rose 20%, 11% and 24% in the following three months. Notably, China produces half of the world’s refined copper, and any reduction in refined copper supply can potentially lead to a supply squeeze. Going forward, we believe China’s continued investment in the midstream will drive growth in copper smelter production to outpace increases in global copper mine supply.

Chinese copper smelters are not the only ones struggling. Smelters in Zambia are also being disrupted as the country is in the midst of an El Niño-induced power crisis and has been rationing electricity.  These disruptions come at a time when the copper market has already been pushed into a supply-demand deficit. Recent months have seen the closure of the Cobre Panama mine (which represented around 1.5% of global copper production) and copper production cuts from Anglo American. Meanwhile Codelco, the largest copper miner in the world, is producing at its lowest level in 25 years and further having to suspend mine operations in March at its Radomiro Tomic mine, the world’s twelfth-largest copper mine.

We believe that the copper market is entering a period of escalating deficits as constrained supply meets rising demand from increased electricity usage among developing countries and developed countries’ immense electricity needs for new technologies like AI. Further, we believe this will benefit the copper spot price and, ultimately, copper miners.

Source of all performance data: Bloomberg / HANetf as of 31.03.2024. 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.

Energy Transition Materials ETF Performance
As of 31/03/2024

1M3M6MYTD12M3YSI
Sprott Energy Transition Materials UCITS ETF9.97%-4.47%-8.45%-4.47%-23.46%nan%-23.08%
The Nasdaq Sprott Energy Transition Materials Ex Uranium Index10.01%-4.35%-8.36%-4.35%-23.24%-11.62%-22.79%

Please note that all performance figures are showing net data. Source: Bloomberg / HANetf. Data as of 31/03/2024

Performance before inception is based on back-tested data. Backtesting is the process of evaluating an investment strategy by applying it to historical data to simulate what the performance of such a strategy would have been. Back-tested data does not represent actual performance and should not be interpreted as an indication of actual or future performance. Past performance for the index is in USD. Past performance is not an indicator for future results and should not be the sole factor of consideration when selecting a product. Investors should read the prospectus of the Issuer (“Prospectus”) before investing and should refer to the section of the Prospectus entitled ‘Risk Factors’ for further details of risks associated with an investment in this product. When you invest in ETFs and ETCs, your capital is at risk.