FidelityConnects: Materials, metals and energy: Analyst insights

[00:03:41] Pamela Ritchie: Hello, and welcome to Fidelity Connects. I'm Pamela Ritchie. Let's zero in on the material sector to end out this week. As a global trade story tilts to demand from other markets and new partnerships are now opening up how will commodities perform? For instance, does a shift to nuclear power have quite a different short term investment thesis to a long term investments thesis? Will the global copper pull-forward earlier this year confuse pricing until 2026? How does the story for potash pan out in this rocky global marketplace? Tying together for us today the impact of new trade dealings and the outlook for many materials producers is Fidelity equity research analyst, Claire Fleming. Claire, great to see you again. How are you?

[00:04:27] Claire Fleming: Good, thanks. Great to be here.

[00:04:28] Pamela Ritchie: Very happy that you can join us. We'll ask everyone to send questions in for the next half hour or so for Claire. There are many headlines about lots of different things in the world but there's no question that nuclear is one of the big ones. This ties into uranium for you. I wonder if you can just paint us a little bit of a picture of, I mean, it seems like tectonic shifts for this once mothballed industry in a lot of different ways. Tell us how everything has changed in the last however many months, six months.

[00:04:58] Claire Fleming: I think it's been a really interesting time to be covering the sector just because there has been so much change over the past even few months and, especially, few years for the industry. I think what we've been seeing is that you've seen continued announcements related to new reactors in China as a source of generation for their grid but for the first time in a long time you're starting to see more discussion around new reactors in Western countries as well, especially with more recently some of the executive orders coming out of the U.S. starting to look more at the opportunities to be adding new reactors to the fleet.

[00:05:34] I think that creates a lot of potential opportunities and change across that value chain ranging from the upstream commodities like uranium that I look at more closely to companies involved with all the steps along that you need to support a reactor, from converting that uranium once it comes into the mine and enriching it and fabricating it into those little bundles the reactors need, or the parts that go into building those reactors and maintaining them. There's a lot of collaboration from myself to working with the power and utilities analysts and the industrials analysts to help portfolio managers understand what these announcements could mean for the longer term earnings and valuation of the companies that we're researching and helping them to find the best opportunities across those different areas of the value chain within the industry.

[00:06:27] Pamela Ritchie: It's so interesting. I wonder if you could speak to if there are a lot of opportunities to invest across the value chain. We can pick on nuclear for a second, but it may be a broader story of ... it seems like a lot of different pieces of the story of nuclear are actually government owned so I don't know how investment dollars flow. Maybe that bids up other things but tell us the dynamics of what's available to invest in within this story.

[00:06:53] Claire Fleming: I think this is an industry where you do have some of that scarcity value for companies just because, as you mentioned, especially in certain parts of the world a lot of areas of this value chain are more government owned for national security reasons or private companies involved in the value chain which really reduces that potential opportunity set that you have to get exposure to this in a public equities portfolio.  I think some of the scarcity value has been contributing to the increase in valuation multiples that we've seen across this industry. That is definitely a factor that comes into consideration when PMs are thinking about what the right valuation for these types of companies are.

[00:07:35] Pamela Ritchie: That's so interesting. You mentioned so that portfolio managers can, obviously, can get a longer term view, it is a long term view, right? I mean, nuclear reactor is not going to be ... the new ones that are being discussed are not going to be ready in two years. This is a much longer term story.

[00:07:53] Claire Fleming: It is a very long duration story for nuclear but I think what's interesting is that the demand outlook compared to other areas of my coverage group that can be more cyclical or have more variability, at least that existing reactor base gives you visibility on what that base demand growth outlook could be. No matter the tariff scenario or other factors you at least have more visibility on what that demand could be. These additional reactor announcements become potential sources of optionality and that can tie into sort of what that longer term uranium price could be if you do get these additional capacity investments going through. I think that even though this is a very long duration theme I think what's great about building your financial models and scenarios that you can understand how that impacts the long term supply demand picture and what sort of that multi-year outlook as well if they're not involved necessarily in the upstream commodity. Also, if there are companies that could be involved in the sort of early work and studies that would go into these new reactors or supplying the parts. As you mentioned, there's companies that can even get an upfront payment for using their technology as that IP payment over that reactor life. There's a lot of ways that companies can benefit from this trend even though the duration of those impacts can vary based on what area of the value chain they're in.

[00:09:24] Pamela Ritchie: Oh, my gosh, that's fascinating that you're digging into this on behalf of everyone at Fidelity. It is a fascinating time. Let's talk a little bit about the story for copper. Before January, sort of even into February, all we heard was just every cargo ship that could be filled with copper was hitting the U.S. shores before tariffs, that they knew were coming, hit and then there's this massive pull-forward story. Is that still the case? That's still very much in the market's pricing right now?

[00:09:57] Claire Fleming: I think it is interesting to see some of the impacts or dislocations that you've gotten in global pricing benchmarks just given some of potential outcomes for tariffs. As you mentioned, just given speculation that the ongoing Section 232 investigation and other factors in U.S. policy could potentially lead to a tariff being implemented for copper. I think that investigation is similar to what you would have even seen for steel or aluminum in the first Trump administration as a potential tariff really to help protect and incentivize domestic supply of certain commodities for various reasons but some could also relate to national security.

[00:10:38] Even though nothing's been announced yet, that investigation's ongoing, you've started to see U.S. prices for copper trading at a premium to global benchmarks just because there's a view that tariffs could be implemented which is creating some interesting dislocations, as you mentioned, given that traders are sending copper over on ships thinking that they could benefit from getting that material into the U.S. ahead of any potential tariffs, but then that started to tighten up some of the global pricing benchmarks this year just because as that material goes to the U.S., and some of it is a bit stockpiled until we get clarity on what tariff rates could be, you're starting to see other global exchanges tighten on inventory which has contributed to higher global pricing benchmarks. 

[00:11:24] I think that could be a bit of a shorter term risk, of course, depending on what tariff rate gets announced or how that investigation concludes  because if you do have visibility that could start to disincentivize that material from continuing to flow to the U.S. and help bring some of those global exchanges into more balance, and also could reduce the incentive to stockpile some of that material in the U.S. and work through some of that inventory that's been building in the U.S. year-to-date.

[00:11:54] Pamela Ritchie: That's so interesting because it's such a story that fits with the tariff as sort of a macro global trade theme. Within the demand for copper, which has its own story, are you able to sort of put that aside and take a look at some of the other pieces driving the demand picture for copper right now?

[00:12:14] Claire Fleming: You're right. Of course, everything that I mentioned about some of those inventory flows that's all more shorter term. I think there have been some moving pieces impacting the demand outlook for copper changing over the past couple of months. I think especially compared to the discussion we would have had in April on this it seems like for the China market the worst case has been avoided in terms of tariffs and implications of that for export related industries. I think there's a bit more optimism on that front but I think that there's still some domestic challenges for Chinese copper consumption growth compared to some other periods of time. Maybe to expand on two end markets in particular related to property and the electrical grid just since those are still such big drivers, I think the property market, even though there's been some challenges for a few years now we're still seeing...

[00:13:12] Pamela Ritchie: This is in the U.S. or...

[00:13:12] Claire Fleming: Still specific to China but we're still seeing negative completions year--over-year of properties and that usually tends to be the more copper intensive part. You think of a condo building at the end when you need to put on all your electrical wiring and appliances and HVAC systems and all of that. That's still a bit of a headwind in the shorter term as you start to cycle through some of those lower completions. Related to the grid, I think that's definitely, still specific to China, that's definitely been a bright spot year-to-date, the level of investment they've been seeing in the electrical grid, but there are some factors or leading indicators that indicate some of that could be starting to moderate as you see fewer subsidies for renewable generation like solar in that market, that that could lead to some declining investment. Often that tends to be a leading indicator of some of the grid investment, just what the renewable spending has been. Even though there's still definitely a global growthy outlook for renewables longer term there are some factors suggesting that some of that strength in grid related spending could be moderating.

[00:14:19] Pamela Ritchie: Is that mostly because a bunch has been done, as you pointed out there? I mean, how much is it related to sort of an interest rate story as well?

[00:14:27] Claire Fleming: I think in that market you're right. They've seen incredible growth in China over the past couple of years related to renewable capacity investments. I think what you're starting to see in China, as well as some other regions, too, is just more of a focus on getting baseload sources of power. I think that kind of ties into the discussion we had on nuclear earlier where a lot of companies...

[00:14:48] Pamela Ritchie: So baseloads are like the uninterruptible sources of power. We've got nuclear, hydroelectric, gas, what else?

[00:14:55] Claire Fleming: Coal, all of those sources of generation that you can really rely on and don't depend on storage so they're more consistent especially as you...

[00:15:02] Pamela Ritchie: And the weather.

[00:15:03] Claire Fleming: Yeah, the weather. They are definitely more consistent and help to improve grid reliability for consumers. I think that's what's been evaluated more often. I think in solar and wind power, it's an area that's continued to see improvements in the cost competitiveness over time, I think, especially since I used to cover the Canadian utility sector in my first analyst assignment but it's one where there's still some challenges for reliability until battery or storage capacity starts to improve further. I think countries are just starting to take in more of those considerations into some of their grid planning going forward.

[00:15:43] Pamela Ritchie: We'll come back to copper because it is in everything but I do want to ask you about the agricultural sector, potash, obviously, specifically. How is the agricultural sector ... again, we're in the midst of sort of the tariff and trade discussion so there's actually a lot of interruptions in there but I wonder if you can sort of paint the picture for us and then we'll sort of look at some of the pieces within. Things have been interrupted.

[00:16:07] Claire Fleming: There have been a lot of headlines related to ag and trade policy but I think it's helpful to give some context on farmer budgets, especially a lot of that in North America can be driven by corn pricing. It's interesting, for me corn pricing was always very topical growing up. I grew up in a rural community, my grandfather operated a feed mill. Back then over $4 corn would be a healthy level for farmers, but just given how much inflation there's been in inputs over time, especially for farmers that are having to rent land and don't have that already paid off in terms of outright ownership, there's still some challenges on farmer budgets in the U.S., especially with the current corn crop that is showing a lot of growth year-over-year putting some pressure on pricing just because of the implications for supply growth of corn year-over-year in the U.S.

[00:17:01] For some farmers I think when there is some of that pressure on budgets you do see them prioritizing, of course, some of the basics. They still need to plant the seeds and put on a bit of crop protection to help generate some profits on those fixed land costs but it does make it a bit more challenging for some of the more discretionary purchases, like a new combine or piece of farm equipment just because budgets are under a bit more pressure and often those areas of the value chain tend to do a bit better in stronger crop pricing environments. Of course, there's always some exceptions by companies, if they're able to gain market share or have a new product or other idiosyncratic drivers but bigger picture I think those are some of the impacts you see across the value chain at this stage of the ag cycle.

[00:17:49] Pamela Ritchie: Where did you grow up? Can we ask?

[00:17:51] Claire Fleming: I grew up in Huron County, a couple hours west of Toronto.

[00:17:55] Pamela Ritchie: Okay, lots of corn fields. Okay, absolutely, I'll think of you if we drive through there next time. Let's go on to potash from there. Also a massive global story, very much a trade U.S., Canadian story but there's also the pieces that are Russia-Ukraine, the consortiums and even the Middle East. What does the global pricing picture look like for potash globally and then we'll talk about Canada and the U.S.

[00:18:20] Claire Fleming: I think for potash globally it is a market that seems more balanced compared to some other commodities. I think you have seen potash prices improving since fall of last year and I think that reflects a bit better demand, especially at that lower pricing level that helped to improve affordability for farmers. I think some of the focuses on potash on a supply outlook over the next couple of years is on the Jansen project in Saskatchewan that's scheduled to still complete construction next year and maybe start to ramp up in the years following that. That does give a bit more visibility on a larger source of supply in the pipeline. I think in terms of the Russia-Belarus contribution to the supply outlook, supply from Russia has definitely been less disrupted than a lot of people initially expected once the war set in even though there's been a shift in trade flows in terms of where they're shipping that potash. I think where there's still some questions or could be potential for improvements on a multi-year basis would be Belarus  which has still had some challenges in getting back to full operating rates since that conflict set in. I think the Jansen project and Belarus still stand out as two areas to be monitoring in terms potential supply growth over a multi-year time horizon.

[00:19:44] Pamela Ritchie: That's fascinating. Within Canada it's seen as one of the commodities that the U.S. just has less of and that we typically ship a lot to. It's within the trade discussion seen as a little bit more leverage for potash than perhaps other parts of the story of the trade deal. Where does that sit right now? What are the scenarios that you're running for portfolio managers on potash sales to the U.S.?

[00:20:08] Claire Fleming: I think for potash it's a commodity where I'm less concerned about the potential tariff risk compared to some other areas of my coverage group, even though there's been a lot of headlines related to potash year-to-date, those potential tariff implications. I think maybe why I'm less concerned compared to other commodities is just because, as you mentioned, it's a commodity where the U.S. doesn't have much domestic supply. It's so challenging, capital-intensive, long time horizon to get capacity ramped up that I think it'd be challenging to bring on additional capacity in the U.S., especially shorter term which for the Canadian producers implies that even in a scenario where tariffs do get implemented they'd likely be in a better position to pass through some of those higher costs to the end farmer just because there's fewer domestic alternatives.

[00:21:00] I think the risk then becomes more indirect, kind of as I mentioned earlier, with some of pressure on farmer budgets. If you don't see an improvement in crop prices and some of those higher fertilizer costs get passed through that's a scenario where you could have some indirect impacts on demand just because potash doesn't need to be applied every single year. In more challenging crop markets sometimes you get farmers deciding to delay application just because they find it more challenging to make the economics work at lower crop prices. I think I'm less concerned about the direct impacts but it'd be more of the indirect impacts of a risk to demand if tariffs increase the price U.S. farmers are paying for fertilizer.

[00:21:44] Pamela Ritchie: We're still waiting on that. I'll just fit in a question here. It's a question coming about the price of platinum, has been soaring lately. Is it because of expected high demand? Which industries use platinum as an input? Do you cover platinum?

[00:22:04] Claire Fleming: My coverage group does focus on Canadian materials excluding the precious metals so I'm definitely not the in-house expert on precious metals but I do think there's some interesting indirect impacts of what we're seeing in terms of precious metals pricing. Of course, gold, silver have also been incredibly topical year-to-date and what that means for my coverage group, just in terms of geology, so many of the world's copper deposits are also in areas where they have gold as a part of that deposit as well, or other precious metals. It could be platinum, it could be silver. As you get increases in some of those benchmark prices it does start to improve the economics of that project overall which, especially, given how topical incentive pricing has been for copper over the past couple of years and how challenging it is to build mines ... of course, it's still incredibly challenging, there's been a lot of cost inflation but if you do get some of these higher, what you'd call by-product credit values, whether it's gold, silver, other commodities that are part of your copper deposit, that can help you to get better returns on the project and can maybe help you make that sanctioning decision if you can get conviction that that helps you get the return threshold that you would need or want before sanctioning a new copper project.

[00:23:25] Pamela Ritchie: Claire, you talk about what we can get out of the mines but that said, the processing aspect of ... really, I mean, you could take this to any commodity ... are not really in Canada for almost anything. Take us there a little bit. What's being considered? Certainly, company heads, which you would be in contact with over the course of your research that you're doing, must be doing some of the numbers on whether it makes sense to have more processing here in Canada and not be sending it off far away, whether it's copper or something else. How are those conversations forming, or are they happening, even?

[00:24:00] Claire Fleming: I could maybe talk a bit about the regulatory outlook across the value chain in North America starting with the upstream, still in the mines, and then talking about some of the processing capacity and implications. I think on the more upstream part even after the Canadian election and prior to that there's been such a discussion on wanting more Western supply chains and having that security of supply. That could potentially help the permitting process for some mines, whether they're looking for even like a mine life extension or starting to look at more new projects or deposits there could, potentially, be an easier permitting process if there is a bit more interest in supporting critical minerals production.

[00:24:45] I think the downstream investments are a bit more challenging to get visibility on just because those are ... and I think this has come up more in the U.S. too with the discussion of potential tariffs and executive orders wanting to have more domestic copper production, but building the processing capacity like smelters and the things that you need to get your final copper product in a more usable form are very capital-intensive, and, especially too, the charges globally for treating and refining copper have gotten incredibly low just given some of the tightness in available material over the past couple of years. It can be pretty challenging to make the economics work on some of those new sanctioning decisions.

[00:25:30] So I think we'll have to still wait and see a bit in terms of policy in the U.S. in terms what gets implemented for tariff rates or other domestic measures to help support copper production or processing before, especially, private companies or the private sector get more conviction in making some of those very capital-intensive investment decisions that would require sort of visibility on your longer term cash flows just given the capital expenditures going into that.

[00:26:00] Pamela Ritchie: Those are sort of the moments where you just realize how entwined certain things within the global economy are and how difficult they are to decouple. Some things would be easier, as we're finding out with all these trade discussions, some things not so easy. Is there also a discussion of, you know, if the administration, perhaps, changes after four years into something that would not want to have to have the same type of trade policy you wouldn't want to get stuck sort of mid-way through a project.

[00:26:26] Claire Fleming: Right. I think companies are just looking for that visibility. Even [indecipherable] of processing if you look at the upstream investments as well, it can take years to go through your studies, construction period on building a new copper mine in the U.S. I think there are a lot of deposits and companies that are taking steps on developing some of those projects. Of course, the best case scenario is that companies feel conviction in the economics even without tariffs or other forms of support that the economics can look attractive but I think you'd need to have that longer term visibility for companies to make a decision if they are more dependent on a tariff rate or other measures to help support the economics on some of those sanctioning decisions for mines.

[00:27:13] Pamela Ritchie: Any thoughts or anything you can share with us on what you think Q2 earnings might be? I mean, Q2 seems to be, for every industry and, really, anyone in business, seems to be the quarter that we're concerned about and where things are going to hit and where things are going to bite and whether data is going to start to really show a breakdown of trade, which is kind of expected. We're in that period right now where nothing's really happening but, I don't know, is there anything that you're watching for that you could share?

[00:27:45] Claire Fleming: The materials is an interesting sector for earnings season just because there tends to be fewer surprises in other sectors. What I mean by that is we've been able to track the commodity prices all through the quarter so when you're updating your estimates usually there's not too many surprises. I think what's always interesting for me is understanding or hearing some of those indirect anecdotes of companies that aren't in the materials sector but have read-throughs for demand. 

[00:28:12] Pamela Ritchie: Construction, industrials...

[00:28:13] Claire Fleming: Right, or even thinking of things like home builders and implications for lumber demand or other end markets, or automakers given that that's another key end market for copper or other sorts of commodities. I think for me often there's not too many surprises on sort of how commodity prices have been trending throughout Q2 but what's always helpful, I think, especially in an environment like now where there's been so much back and forth over tariff policy and other factors since Q1 earnings, it's just hearing the updated outlooks from some of the companies that are more in the end markets that could be impacting demand for some of those companies in my coverage group.

[00:28:52] Pamela Ritchie: Lumber's one of them, right?

[00:28:53] Claire Fleming: Right.

[00:28:54] Pamela Ritchie: Lumber is one of them. We haven't seen a lot of movement there.

[00:28:57] Claire Fleming: I think in the forest products industry, again, even though it's been caught up in a lot of the tariff headlines it's another industry where...

[00:29:04] Pamela Ritchie: For decades, not even just the last ... for decades.

[00:29:08] Claire Fleming: Yeah, that's always been topical. I think what we've seen is that even ... and as you said, it's always been subject to tariffs but I think what's been new is just some of the indirect risks as you get uncertainty on how tariffs could impact inflation and that causes U.S. rates to stay higher. As you've seen, all the tariff policy may be making U.S. consumers a bit more uncertain, that makes it more challenging to sort of have the confidence to move to a new location, and that's been impacting some of the repair and remodelling demand just given that often the time you do some of those repairs or remodelling around the house is either to fix up a place before you're selling or when you move into a new place and want to make some changes. That's been impacted. The affordability for new homes is still challenging with just where interest rates are and what that means for your mortgage rate in the U.S.

[00:30:01] I think it's an industry that ... a lot of areas of the forest products industry, whether it's oriented strand board or lumber it definitely could see improvements over time if we do get rate cuts in the U.S. on a multi-year basis and could see a recovery from some pretty cyclically low levels of activity. I think that recovery has definitely been pushed out with just what we've seen in trends in U. S. interest rates year-to-date. I think when you talk to the PMs it definitely depends on style or time horizon what those conversations look like. Some of the more value-oriented PMs might be more willing to look at companies at some of those more cyclically depressed areas of the market with more optimism that on a multi-year basis you could still have attractive returns in certain areas. In the near term there's definitely been more challenges to fundamentals with where interest rates are.

[00:30:57] Pamela Ritchie: So interesting. We've got just a couple of minutes here, how would you sort of wrap up some of the areas that you're looking at with concern? We started with nuclear which is very headline heavy, for sure, but it was fascinating to hear about the value chain, essentially, and how that is being rebuilt, maybe reimagined even. How would you sort of sum up some the trends that we can look to maybe after tariffs settle down?

[00:31:24] Claire Fleming: I think in the industry the key areas of opportunities outside of tariffs  once we get visibility are on some of those industry trends longer term. As you mentioned, whether it's related to nuclear power or some of the more secular demand drivers for copper, whether that's renewables or electrification there as well, understanding some of those secular industry trends. I think another interesting area often tends to be where there's supply constraints on areas longer term. Maybe the third bucket or area of opportunities is on valuation, always just having some of those updated scenarios and being able to have that framework to start conversations with portfolio managers about where there's any valuation dislocations or where companies are closer to trough levels potentially on valuation. I think it's the industry, trends, supply, disruption, and valuations that are the key areas of focus outside of just tariffs.

[00:32:20] Pamela Ritchie: We're going to go through all those things when we see you next. Claire, thank you very much for joining us here today.

[00:32:25] Claire Fleming: Great. Thank you.

[00:32:26] Pamela Ritchie: Claire Fleming joining us in studio today on Fidelity Connects. Coming up on Monday, Director of Global Macro, Jurrien Timmer. He'll be joining us to share his amazing charts, graphs, data, plus he'll comb through some of the latest macro themes. We'll certainly put the U.S. jobs, blowout number, actually, to him on Monday.

[00:32:45] On Tuesday of next week, Fidelity Dividend Fund Portfolio Manager, Don Newman. He discusses how dividends can offer investors stability in volatile times, ultimately, where he's seeing opportunities. We'll ask him a couple of questions on the Real Estate Trust that he's also managing. That's all on Tuesday.

[00:33:01] On Wednesday we will check in with Andrea Rigabon. She's Director of Procurement and Senior Legal Counsel at Fidelity Canada. She'll give us an update and kind of overview on the regulatory landscape and what changes advisors should be keeping in mind. Before we sign off today I just want to share with everyone that Fidelity Canada has launched a new podcast for investors that you can share with your clients, Ticker Talk. It's with Étienne Joncas-Bouchard, a familiar figure. It's the new show within the Upside, the podcast series, it's featuring expert insights on ETFs, market trends and investing in your 20s and 30s. The first episode launched yesterday and it can be found by searching The Upside on YouTube, Spotify or Apple Podcasts. We thank you for joining us, point you to that, have a great weekend. I'm Pamela Ritchie.