Commodities and Energy Equities Finally Present Compelling Investment Opportunity

• Commodities like gold, silver, copper and uranium showing bullish technical setups and potential for further upside
• Oil prices are rangebound but could pull back further short-term before rising in Q4; natural gas prices are rising on tighter supply/demand
• Energy stocks likely to follow commodity prices, with natural gas stocks looking relatively cheap; opportunities in specific basins and for potential M&A
• Improving investor sentiment toward energy stocks, with generalists returning and new investors from family offices in, US and Europe showing interest
• Key metrics for energy stocks include strong balance sheets, insider ownership, and exposure to productive basins; service companies are also becoming attractive

The commodities complex, spanning precious metals, base metals and energy, presents compelling opportunities for investors. With many commodities and natural resource stocks emerging from multi-year corrections, the stage appears set for a cyclical bull market.

Precious and Base Metals Outlook

Gold is exhibiting a strong technical foundation for further gains after basing it for several years. Gold has formed a multi-year cup-and-handle pattern, suggesting substantial upside potential as it reaches new highs. The bigger the base, the higher the space above once it does break out. We think there's plenty of room to go to the upside. Silver and copper also act bullishly, with copper miners leading the complex higher. The COPX copper miners ETF has surged to multi-year highs on strong volume, which is a sign of sustainable demand. Unless we see a long run at the end, you don't typically see rising volume on up moves until a blow-off top. We're not there yet.

Silver miners and junior silver ETFs, which are relatively strong, are close to breaking out above multi-year resistance levels. While gold miners face some overhead resistance from 2020-2022 peaks, the GDX ETF is hitting higher highs on the short-term chart. Watch for decisive breakouts; if gold continues to move higher and the miners slice right through that resistance in one fell swoop, that's an extremely bullish message.

Uranium Poised for Breakout

The uranium sector has gone through ups and downs but appears poised for another breakout. The URA and URNM ETFs have retraced early-year spikes but are now back-testing those highs.This consolidation as constructive and believes a decisive breakout would open up a significant upside, given the lack of overhead resistance.

Both ETFs have responded brilliantly to tests of key support from the early-year breakout. They are storing up energy in this consolidation, and the breakouts could be more sustainable with greater potential upside. Watch for URA to take out the 2023 highs as a signal that the next leg higher is underway.

Oil and Natural Gas Dynamics

Oil prices have fluctuated in a $20 range for over a year, capped in the mid-$80s and bottoming in the mid-$60s. West Texas Intermediate (WTI) is currently testing the $80 level, but expect some further downside in the near term. Rising U.S. gasoline and distillates inventories evidence that supply is outpacing demand.

If we continue to get builds over the coming weeks without a big jump in exports, we could see oil decline below $75 and possibly even $70. The market is pricing in a "war premium" of $5-8 per barrel due to tensions between Israel and Hamas. A resolution there could deflate some of that geopolitical risk premium.

However, we remain bullish on oil prices for the fourth quarter, forecasting a rally to $90 per barrel. Expect seasonal demand strength from the summer driving season and tighter supply balances if OPEC maintains production discipline. The natural gas market presents a more constructive outlook, with prices recovering above $2 per MMBtu after spending much of early 2023 below that level. Several factors drive this improvement, including:

1. Higher LNG exports as the Freeport terminal returned to service, adding 2 Bcf/d of demand
2. Declining US production due to lower drilling activity and depletion, with output falling from over 105 Bcf/d in December to 95 Bcf/d in April
3. The potential for gas demand to exceed supply in the cooling season, leading to storage draws instead of injections

These dynamics support a multi-year bull cycle for natural gas. Prices could reach $3.50 in the 2023/24 winter, and the forward curve underpins the potential upside. Many natural gas equities are trading at just 2-3x cash flow and a fraction of net asset value (NAV). If we are in a multi-year bull market, these stocks could rerate to 5-7x cash flow and trade closer to NAV, as we've seen in historical cycles.

Opportunities in Energy Equities

While oil and gas prices can be volatile, energy equities offer investors compelling risk/reward propositions. We favor natural gas-focused producers with strong balance sheets, high insider ownership, and exposure to productive basins like the Montney shale in Canada. M&A could be a catalyst for the energy sector, especially if oil prices decline and spur consolidation. Historically, we've seen more deals happen when prices rise because companies compare the cost of acquisitions versus organic drilling. But if prices fall and sellers become more motivated, that could kick-start more takeover activity.

Energy Service Sector Revival

The oilfield service sector presents opportunities as drilling and completion activity recovers from depressed levels. After several tough years, pressure pumpers (frac crews) will benefit from improved utilization and pricing. Pressure pumpers want to work 20-22 hours daily on multi-well pads to maximize efficiency. STEP noted 83% utilization in Q1 due to a 63-day straight job, which is hugely positive for margins.

When evaluating service companies, focus on three key factors:

1. Financial strength, so that operators cannot squeeze them on pricing
2. Insider ownership, to ensure management is aligned with shareholders
3. Exposure to the right basins and service lines to capture the upcycle

Investor Sentiment Improving

After years of underweighting the sector, generalist investors are returning to the energy space due to poor returns and ESG concerns. We've seen strong interest at recent conferences from institutional and retail investors who had previously avoided the industry. Generalists are coming back to the space, starting with large and mid-caps. Companies are seeing interest from family offices, US and European investors that they hadn't met with in years. This broadening of the investor base could provide additional support for energy stocks as the cycle matures.

Risks to Monitor

While the outlook for commodities and natural resource equities is broadly positive, investors should be aware of potential risks. A key threat would be a severe global recession that impairs demand for raw materials. Central bank tightening to combat inflation could slow economic activity more than currently anticipated.

Other risks include geopolitical disruptions to commodity supplies or an OPEC policy shift to higher production. A breakthrough in US-Iran nuclear negotiations could also bring additional oil supply to the market. In the oil and gas sector, a rapid surge in North American drilling in response to higher prices could overwhelm service capacity and erode profitability.bExtreme weather events or ESG pressures could also disrupt natural resource companies' operations or access to capital. Investors should monitor these risks and adjust their exposure accordingly.

The commodities sector appears to be in the early stages of a cyclical upswing, driven by supportive technical setups, constrained supply growth and recovering demand. Investors can gain exposure through ETFs tracking the underlying commodities or by carefully selecting individual natural resource equities. Energy stocks provide strong upside potential but require diligent analysis of key fundamental, operational and valuation metrics. Consulting expert opinions and detailed research reports can help navigate the risks and opportunities in this dynamic space. Investors should also closely monitor macroeconomic developments and geopolitical events that could impact the commodity cycle.

Overall, a diversified, actively managed approach to natural resource investing is prudent. This can include allocations across subsectors (precious metals, base metals, energy) and regions (North America, Latin America, Europe). Maintaining discipline around position sizing, risk management, and rebalancing will be important in the coming years. By carefully navigating the opportunities and challenges ahead, investors have the potential to generate attractive real returns from the commodities sector over a multi-year horizon. Consulting with a financial advisor to ensure investments align with overall portfolio objectives and risk tolerance is recommended.

Actionable Advice for Investors

• Gold: Consider adding exposure as gold breaks out of its multi-year base, with potential for significant upside. Gold miners may offer leverage to rising prices.
• Silver & Copper: Monitor silver and copper mining ETFs for decisive breakouts above multi-year resistance levels. Individual miners may provide even more upside.
• Uranium: The uranium sector appears poised for a sustained uptrend. Look for a clear breakout in URA or URNM to signal the next leg higher.
• Oil: Be cautious about oil prices in the near term but look for opportunities in quality producers on any pullbacks. Expect a stronger move in Q4.
• Natural Gas: Natural gas provides the most compelling opportunity, with a cyclical bull market developing. Focus on low-cost producers with strong balance sheets.
• Energy Services: Selective pressure pumpers and drillers become attractive as activity levels rise. Favor companies with basin diversity and operational efficiency.
• Risks: Monitor economic data, central bank policies, geopolitical developments and weather events that could impact commodity prices and equity valuations.
• Strategy: Take a diversified approach across subsectors and regions. Use ETFs for broad exposure and carefully selected stocks for targeted bets. Maintain risk management discipline.

Commodities and natural resource equities present attractive opportunities for investors, with supportive technical setups and fundamentals. Careful stock selection based on asset quality, financial strength, and valuation can help investors capitalize on the early stages of a cyclical upswing while managing risks. Consulting expert research and maintaining a nimble approach will be key to navigating this dynamic sector.