Energy Transition Materials ETF | Monthly Report

Energy Transition Materials ETF Key Takeaways | November

The underlying index of theEnergy Transition Materials ETF fell -14.47% in October. Few resource commodity-related industries (excluding the safe-haven precious metals) performed well. The resource group has been under pressure for most of the year from the unrelenting rise in bond yields a persistently strong U.S. dollar weak economic data and credit stress from China. However the Israel-Hamas war with its threat of further regional conflagration catalyzed a wave of risk-off selling in virtually all asset classes. Spot uranium was among the few non-precious metal commodities to post a positive month. Most equity groups in energy transition and natural resources declined.

After its unrelenting climb into the summer the equity market &mdash as measured by the S&P 500 Index &mdash declined three months in a row through the end of October with a -8.61% drawdown from the July 31 peak. The rise in long-dated bond yields was a primary driver of the risk-off environment. Until early summer these rising yields were attributed to increasing growth expectations. Since then they have been attributed to a rising term premium &mdash the additional yield needed to compensate for the risk of holding long-duration bonds. In addition to raising borrowing costs and slowing economic growth a high term premium will likely tighten financial conditions and pressure asset prices.

The lithium carbonate spot price slowed its descent in October falling -1.91% during the month to $10.14 per pound &mdash a small decline compared to its -17.79% drop in September. Electric vehicle (EV) sales are the main driving force in lithium markets and recent activity has not met expectations. In October Tesla released poor Q3 earnings and commentaries by GM Mercedes-Benz and other EV makers have shown a weaker-than-expected market. This slowdown in the downstream lithium sector coincided with the fourth quarter which in the past has exhibited seasonally high demand and encouraged refiners to restock inventories thereby increasing demand for lithium. However this dynamic has been absent in 2023 which is pressuring the market.

Notably the weakness in demand is relative to expectations rather than absolute. EV sales in 2022 were over 10 million vehicles a level five times that of 2019. Further despite the recent weakness EV sales for 2023 are forecast at 14 million vehicles. This level puts 23 countries at the 5% adoption rate for electric vehicles. This rate is considered to be a tipping point for a technology’s penetration of its overall market as it moves along an “S” curve from early adopters to early majority.

In October stocks of lithium miners fell by -21.06% as the softer lithium price and negative EV sentiment weighed on the market.1 Continuing weakness in China (the world’s largest lithium consumer) high interest rates and other macroeconomic factors combined to pressure equities and capital-intensive sectors. Although the fall in the lithium spot price has reduced miners’ margins they are still profitable at current prices. An S&P Global Market Intelligence analysis released in October showed that current margins are still high enough to incentivize lithium miners’ pipeline projects. A lower-than-current spot price of $15000 per tonne for lithium carbonate or $6.80 per pound results in a payback period of five years or less for 80% of the projects analyzed. This five-year payback period is considered typical in the mining industry and puts recent price decreases into context. The reality is however that prices are still much higher than historical levels.

Mergers and acquisitions continued to be a driving force in lithium mining. Albemarle Corporation &mdash the largest lithium producer in 2022 &mdash abandoned its proposed $4.2 billion takeover of Australian lithium miner Liontown Resources. Australia’s richest woman Gina Rinehart built up a blocking minority that prompted Albemarle to walk away from the deal due to “the growing complexities associated with executing the transaction” which tanked Liontown’s stock price. Another Australian miner of lithium and nickel Azure Minerals received a $1 billion takeover offer from Sociedad Quimica y Minera de Chile SA (SQM) representing a 44% premium to the stock price. SQM was 2022’s second-largest lithium producer. Azure agreed to the offer but Gina Rinehart has also built an 18.3% stake in Azure and there is speculation that she may attempt to block this takeover as well. Azure’s stock price outperformed significantly in October.

In addition Codelco &mdash the world’s largest copper producer which has been chosen by the Chilean state to lead the country’s lithium development &mdash agreed to buy Lithium Power International Ltd. for $245 million representing a 119% premium to the stock price. Finally Tecpetrol Internacional S.L. acquired Alpha Lithium Corporation for C$241 million a 13% premium. We believe mergers and acquisitions may continue to provide a tailwind in the lithium mining space especially given recent price weakness. A continued deal flow will showcase the stronger long-term outlook for industry’s leaders.

The copper spot price fell -2.23% to $3.64 per pound in September and shares of copper miners dropped by -10.25%. Copper is the third-largest metals market behind iron ore and gold with a very diverse demand segment profile that spans construction electronics electric vehicles renewables and beyond. Given the large market and diverse demand profile the copper spot price is seen as a barometer of the global economy. The market dynamics we noted earlier &mdash including an unrelenting rise in bond yields a persistent strong U.S. dollar weak economic data and credit stress from China &mdash have also been headwinds for this market.

The copper price is still at a level that provides healthy profitability to most major producers. However many copper miners say that profitability is not high enough to incentivize major new copper mines that require billions of dollars of investment. This is a problem because demand for copper is set to increase significantly due to its intensive use in the global energy transition (e.g. for electricity grids EVs solar panels and more).

The situation is exacerbated by disruptions in current copper supply. Production from Chilean state-owned copper miner Codelco is at a 25-year low (despite it recently posting better-than-expected 2023 copper production numbers). Elsewhere Panama’s Congress advanced a bill to cancel a production agreement between Canada’s First Quantum Minerals and Panamanian copper mine Cobre Panama. Cobre Panama started production in 2019 cost $6.8 billion to build and accounts for around 1.5% of global copper production. Panama’s President also signed a moratorium on new mining projects. First Quantum’s contract remains at risk and is currently being reviewed by Panama’s Supreme Court. At the same time ore grades are declining industry-wide there is a dearth of major new copper discoveries and lead times from discovery to first production stretch out more than 16 years. All these factors highlight the vulnerability of the copper production supply chain and the likelihood that supply deficits may ultimately bolster the copper spot price.

The nickel spot price fell -2.91% in October and shares of nickel miners fell -10.86%. Currently nickel’s demand comes mainly from stainless steel. However lithium-ion batteries for EVs are the most significant demand growth driver because nickel is a critical mineral for NMC cathodes (nickel manganese and cobalt oxides used in lithium-ion batteries). The demand for nickel from stainless steel producers lends cyclicality to its price. Like copper nickel was negatively affected by macroeconomic developments. Further like lithium nickel was hurt in the short term by recent weakness in EVs.

In the long term nickel demand is expected to grow significantly due to its use in NMC cathodes. Nickel-intensive cathodes are gaining traction because adding nickel to batteries provides greater energy density and increases an EV’s vehicle driving range. As global demand for EVs grows nickel supply is unlikely to keep up with demand even as additional supply comes online from Indonesia. A major factor in this supply-demand imbalance is that Russia is a significant nickel producer &mdash including the Class 1 nickel needed for lithium-ion batteries &mdash and is likely to remain under economic sanctions for quite some time.

Source of all performance data: Bloomberg / HANetf as of 31.10.2023. 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&mdashan 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&mdashoften a decade or longer&mdash to bring new production online. Sanctions on Russia the world’s largest producers of many commodities only aggravate the situation&mdashwhile 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.

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