ENERGY INDUSTRY OUTLOOK

During the second quarter, the spot price of WTI crude oil increased 14.3% to finish the quarter at $74.13 per barrel, while the Henry Hub natural gas spot price increased 5.3% to finish at $2.96 per million cubic feet. Year-to-date, the spot price of WTI crude oil is up 22.6%, while the Henry Hub natural gas spot price is down 19.8%. Exploration and production stocks (as measured by the XLE) increased 12.7% in the second quarter of 2018. This was, in part, due to the market catching up to the rise in oil prices during the first quarter with investors coming to the realization that oil prices could remain strong in the short-term due to supply transportation constraints in the Permian Basin limiting supplies to U.S. Gulf Coast refining and export centers, robust global demand and a cooperative effort by OPEC and several other nations to limit supply growth. With respect to natural gas producers, the relatively low price of natural gas has stimulated industrial demand although we think the outlook for producers remains tempered.

The XLE outperformed the broader S&P Index, which rose 2.9%, during the same time period. The XLE rose 9.5% in April, 3.0% in May and declined 0.1% in June. Crude oil prices were supported by President Trump’s decision to withdraw the US from the Iran nuclear accord despite OPEC announcing plans at its June meeting to increase supplies - albeit at a lower rate than expected. Additionally, lower output from Venezuela and continuing production disruptions in Libya are supportive of crude prices.

Crude oil futures average $65.43 per barrel in 2019, $61.53 per barrel in 2020 and $58.72 per barrel in 2021. Natural gas futures average $2.78 per million cubic feet in 2019, $2.67 per million cubic feet in 2020 and $2.62 per million cubic feet in 2021.
The U.S. Energy Information Administration projects U.S. crude oil production will average 10.8 million barrels per day in 2018 and 11.8 million barrels per day in 2019. Production averaged 9.4 million barrels per day in 2017. U.S. dry natural gas production is expected to average 81.2 billion cubic feet per day in 2018 and 83 billion cubic feet per day in 2019. Production averaged 73.6 billion cubic feet per day in 2017.

We think the short-term supply/demand outlook is supported by firm crude oil demand driven by favorable global economic conditions and continued cooperation by OPEC. Additionally, continued geopolitical uncertainty is supportive of crude oil prices. However, longer-term, increasing supplies from the U.S. and a potential slowdown in economic activity could result in lower prices. With respect to natural gas, we think supplies from unconventional sources will remain adequate to prevent sharp increases in price despite increasing demand for export, additional natural gas-fired plant capacity and industrial demand.

METALS AND MINING INDUSTRY OUTLOOK

Mining companies (as measured by the XME) rose 4.2% during the June quarter versus 2.9% for the broader S&P 500 index. The XME appreciated 2.7% in April, 7.3% in May, but declined 5.4% in June. During the second quarter, the price of gold fell 5.5% and silver declined 0.4%.

During the second quarter, strong U.S. economic growth and the outlook for higher interest rates were supportive of the U.S. dollar which weighed on precious metal prices. However, tighter monetary policy, trade concerns and geopolitical risks could weigh on equity market returns and economic growth and investors could once again view precious metals as a safe haven for investment.

The gold/silver price ratio at the end of the quarter was 77.4x versus a 15-year average of 62.7x. Given that the current ratio lies above one standard deviation from the mean, we continue to believe silver is arguably undervalued relative to gold.

We believe the supply/demand outlook favors higher prices given that supply growth remains constrained due to underinvestment in exploration and development while the demand outlook could respond to resurgence in investment demand.

We think publicly-traded equities of precious metals producers offer an attractive way to invest given the disproportionate percentage impact higher commodity prices may have on a company’s bottom line and valuation for a given percentage increase in the commodity itself. In our view, small cap names are often overlooked in favor of larger cap players during times of weakness in commodity prices but offer strong leverage to commodity price improvement and are able to respond quickly to changing market conditions.