Ten Bagger: Commodity bets are getting bearish and that's often when the bull returns

Welcome to Ten-Bagger, where Lowell Resources Fund chief investment officer John Forwood gives us his take on a sector of the ASX resources market full of value.

This month, John zooms in on the record net short position in commodities and its historical significance.

Buy low, sell high.

That’s the seemingly simple formula that underpins success for traders in equity markets.

But financial instruments are a complicated thing, and there’s plenty of hedge funds out there who want credit for picking the losers as well.

Shorting, a bet on prices going down where investors borrow shares, commodities or other units of stock from their beneficial owner then sell them back in the hope of pocketing the difference, has grown as an investment tactic at the big end of town in recent years.

And in commodity markets, the dive in metals and energy prices seen this year has hit sentiment and sent short bets flying.

According to Bloomberg data, investors are at the strongest net short position in commodity trading since data was first collected in 2011.

But gamblers, whatever their level of expertise, are often wrong and Lowell Resources Fund (ASX:LRT) chief investment officer John Forwood notes history shows us this isn’t always the Doomsday signal you may think.

“It is interesting, that if you look at the last couple of times it bottomed and I’m not saying this is the bottom in terms of the maximum number of net shorts, but the last time it hit these levels actually the Commodity Index moved up over the next couple of years,” Forwood said.

“That’s the silver lining in it, that maybe is indicating a bottom but you certainly wouldn’t hang your hat on it.”

Noah’s Rule’s Sean Russo said in a note to clients that today’s environment is a bit less fertile for a quick bounce than the last time commodity futures went negative in 2015, or when they came close in 2019.

“The lows in late 2015 followed 18 months of deeply entrenched -ve WS. If the market does break the early 2024 lows, the potential for lower should not be discounted,” he said.

But he questioned how long commodity prices, across agriculture, energy and metals, can stay depressed.

“People have to eat, everyone is travelling, the world is fragmenting, and governments everywhere are re-arming and throwing money at mines and infrastructure. How low can commodity prices really go?” he said.

“Hedge Funds are short, betting on a recession/China meltdown. They can be here today and in bonds tomorrow. When the circus moves on it’s hard not to see how prices don’t wind higher. The trick, as it was in 15/16 and 19/20, is not to unravel in the interim.”

Short equities

The shift in sentiment against commodities comes as resources stocks, largely those in battery metals, dominate the short-selling stats on the ASX.

Pilbara Minerals (ASX:PLS) remains the most shorted stock on the ASX, with around 22% of its shares held short, a pure play bet on bearish lithium sentiment with spodumene prices at a three year low.

Eight of the top 10 shorted stocks on the ASX are in resources and energy, Forwood noted.

“Pilbara, Liontown, Syrah, Chalice, Lynus, Strike Energy, Sayona Mining and Paladin, probably six of those eight are battery metals focused,” he said.

“It’s interesting to see no gold stocks in the top 10 most shorted. Westgold is the most shorted gold stock, and that’s number 15.”

In previous rebounds, Forwood said market fundamentals began to outweigh speculation. One potential trigger could be rate cuts, something that fuelled the shift to hard commodities during the Covid years.

Most analysts are pricing in a US Fed interest rate cut for September at this point.

“If that were the case then we could be looking at something that’s a little bit reminiscent of the last time we went net short,” Forwood mused.

“A US rate cut does seem to be on the cards. The question is, how much of that is already priced in?

“I would say, looking at the junior resources market there’s not much of that rate cut priced in at this stage.”

Despite weakness in previously booming commodities like iron ore and lithium, Forwood still sees opportunities, many of them in the comparatively outperforming gold and copper markets.

Haulage routes and consolidation plays

Forwood’s two stocks of interest this month are in the junior gold space at two ends of the prolific Eastern Goldfields.

One is Medallion Metals (ASX:MM8). The Ravensthorpe-focused gold explorer boasts an ore reserve at its Kundip mining centre of 10.27Mt at 1.9g/t gold and 0.2% copper for 610,000oz Au and 24,000t Cu.

Most of that material – 490,000oz Au and 15,000t Cu – sits in an open pit grading 1.7g/t.

Beyond that total mineral resources clock in at 1.3Moz of gold at 2.1g/t and 59,000t copper at 0.3%.

MM8 garnered attention this month after entering negotiations to repurpose IGO’s (ASX:IGO) closing Cosmic Boy mill at its Forrestania nickel ops to process gold.

While operating costs due to haulage would go up, it could save substantially on capex by utilising existing process infrastructure, Forwood said.

“If you do the sums 130km, maybe it’s 10c/t a km, maybe it’s as high as 20c but I don’t think would be,” he suggested.

“Let’s call it 20 bucks a tonne for trucking, that’s 0.2 of a gram equivalent operating cost.

“They would still need to add a gold circuit to Cosmic Boy, but if you remove the need to build a whole new mill you could possibly save well over $100 million.”

The other juniors Forwood is training his eyes on have the opportunity to take part in gold consolidation at elevated prices.

“Trucking costs seem to have been stabilised, whereas the metal prices have been going up with inflation, at least in gold,” he said.

To borrow a chess analogy, it means there are some pawns who, in the right scenario, could march up the board and convert into queens.

“The Lowell Resources Fund has been in Astral Resources (ASX:AAR) for some time, and they’ve got their million ounces plus just outside Gold Fields’ St Ives mine,” Forwood noted.

“We keep on hearing Gold Fields is short of good grade ore to feed through St Ives.

“So Astral is another one where we think there’s a play, and it’s not just Gold Fields that might be interested.

“There’s a possibility that Westgold Resources (ASX:WGX) (who just bought the Beta Hunt mine and Higginsville plant in a takeover of Karora Resources) could run the ruler over them as well.”

The views, information, or opinions expressed in the interviews in this article are solely those of the interviewees and do not represent the views of Stockhead. Stockhead does not provide, endorse or otherwise assume responsibility for any financial product advice contained in this article.