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Goehring & Rozencwajg Associates, LLC’s Q2 2019 Natural Resource Market Commentary

Goehring & Rozencwajg Associates, LLC is a New York-based fundamental research firm that exclusively focuses on contrarian natural resource investments. The company believes that the best way to find value in natural resource and global commodity markets is when: (1) financial measurements are cheap, (2) investors are discouraged, and (3) prices are depressed.

100% employee-owned, the company is composed of 3 members – a non-investment professional and 2 investment professionals. The team has over 3 decades of natural resource investment experience and has been working together for 9 years. The firm is being co-managed by Leigh R. Goehring and Adam A. Rozencwajg, CFA. Joseph Herlihy acts as the COO and CCO.

Goehring has been doing natural resource investing for over 25 years. He started his Wall Street career when he worked in the Bank of New York’s Trust Department in 1982. This Hamilton University alumnus held portfolio manager positions at Prudential-Jennison (1991-2005) and Chilton Investment Company (2005-2015).

Rozencwajg, a CFA charter-holder with 9 years of investment experience, is an expert in corporate finance, equities, financial modeling, and valuation. This Columbia University alumnus worked at Lehman Brothers as a Corporate Finance Analyst (2006-2007) and at Chilton Investment Company as Vice President for Research (2007-2015). He worked with Goehring at Chilton before they started Goehring & Rozencwajg Associates, LLC.

In its Q2 2019 Natural Resource Market Commentary, Goehring & Rozencwajg discussed how high gold prices could go based on research. Other topics covered in the commentary include: (1) the current state of oil markets (both domestic and overseas), (2) commodities vs. commodity stocks, (3) weak natural gas prices, (4) copper supply and demand, and (5) global weather patterns and their effects on global agriculture.

“Escalating trade war rhetoric from the Trump administration, combined with worries over slowing Chinese growth, cast weakness over global resource markets in Q2. Oil prices were again volatile. WTI traded as high as $66 per barrel in April before pulling back to a low of $51 in June amid worries surrounding slowing global oil demand. The International Energy Agency (IEA) cut its oil demand growth estimates for the first quarter of 2019 to only 310,000b/d y/y and they lowered Q2 growth to 800,000 b/d.

Oil prices did rebound to almost $60 per barrel by the end of June, as OPEC successfully rolled over its production agreement from last November. Energy-related stocks continued to underperform the actual commodity. For example, while WTI and Brent prices declined 3% for the quarter, the XOP (the S&P E&P ETF) fell 11%and the OIH (the Oil Services ETF) fell almost 14%. We have seen a radical underperformance of energy-related equities versus the oil prices over the past three years. Since bottoming in Q1 of 2016, oil rallied over 125%, while E&P stocks (as measured by the XOP) are up barely 10% and the oil service stocks are now down almost 30%. The radical underperformance of energy-related equities has produced tremendous value and we remain bullish on the group.

Although the IEA believes the global oil market is in surplus, we vigorously disagree with their analysis. Both WTI and Brent oil prices remain extremely backwardated and this backwardation has not decreased in the last 3 months. If market balances had loosened as much as portrayed by IEA data since the beginning of 2019, we should have seen both WTI and Brent markets swing into contango, which has definitely not happened. (For those unfamiliar with the terms “contango” and “backwardation,” they refer to the position of future prices versus today’s spot price. A market where the future price is higher than spot is “contangoed,” indicating that supply is greater than demand and that inventories are building. A market where the future price is lower than today’s spot price is “backwardated,” indicating that demand is greater than supply and that inventories are tight.) We remain bullish on oil prices and believe the second half of the year will see significant strength. Please refer to the “Oil Section” of this letter where we will discuss market balances, the “missing barrels,” Q1 demand disruptions, and the outlook for both the US shales and non-OPEC/non-US oil supply. Contrary to consensus opinion, the oil market today is very tight and we believe it will continue to tighten as 2019 unfolds.

Natural gas prices were very weak in Q2. Henry Hub prices fell by 13%.The reason for the pronounced weakness was simple: supply continued to surge. The latest IEA data suggests that US natural gas supply continues to grow at near record rates. According to the last published data for May, US dry gas supply is growing at almost 9 bcf /day, or by almost 10% year-over-year. Surging production from the Delaware side of the Permian Basin remains the strongest source of production growth. LNG exports continue to surge and should grow by 6 bcf this year. However, LNG export capacity growth will slow significantly in 2020. Without any slowdown in supply or further drops in the natural gas rig count, the natural gas market will remain in structural surplus. Please see the natural gas section where we discuss the problems facing the US natural gas market.

Base metals were weak in Q2. Trump-related trade war fears and manufacturing weakness in China weighed on all the base metals. Zinc was the weakest, falling by 14%, while copper fell 8%. Aluminum and nickel were down 6% and 3%, respectively. A number of developments occurred in global copper markets since our last letter which underpin our bullish copper thesis. First, RioTinto (RIO) announced a significant delay in first production from its massive Oyu Tolgoi underground mine in Mongolia. Rio Tinto has experienced underground rock conditions that were “more challenging” than expected. The company admitted that a reinterpretation of the underground rock mechanics would require design changes and that first production would be pushed out between 18 months to 2 ½ years. First copper production was originally scheduled for year-end 2020, but this could now be pushed out to mid-2023. Underground production from Oyu Tolgoi was scheduled to eventually surpass 400,000 tonnes per day, representing about 2% of global mine production. Given the problems with rock mechanics and the associated capital cost “blow-out,” we would not be surprised to see Oyu Tolgoi’s first production delayed further.”

You can download a copy of Goehring & Rozencwajg Associates, LLC’s Q2 2019 Natural Resource Market Commentary here:

Goehring & Rozencwajg Associates, LLC’s Q2 2019 Natural Resource Market Commentary

You can also see the list of our 2019 Q2 investor letters and download them on this page.

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