BCIM - DBB: Base Metal ETF For The Energy Transition Watchlist

2023-11-15 23:01:09 ET

Summary

• DBB provides a rare opportunity for gaining exposure to futures contracts on three highly-liquid base metals: copper, aluminum, and zinc.
• Cu, Al, and Zn are expected to see a significant boom in demand long-term given the important role they will play in the global energy transition.
• These three metals have seen a rough year in terms of price performance, down about 8% on average in the past year.

Invesco DB Base Metals Fund ETF ( DBB ) to date has proven useful as a mechanism for exploiting commodity supply disruptions usually brought on by crises like conflicts, trade wars, and pandemics, and as a potential inflation hedge. Yet, the DBB ETF - which tracks copper, aluminum, and zinc futures contracts - could be a solid long-term investment vehicle as well, in light of the expected boom in demand that will accompany the global race to net zero emissions. However, I need to see more evidence of this strong clean energy narrative being reflected in market pricing trends before I place another bet on DBB. Hence, I rate it a hold.

Awaiting The Base Metal Boom

DBB, incepted in 2007, seeks to track the DBIQ Optimum Yield Industrial Metals Excess Return index, which is comprised of notional amounts tied to copper, aluminum, and zinc futures contracts traded on the London Metal Exchange ((LME)). Total assets under management stand at about $135.6 million (as of 11/14/2023), split evenly amongst the three metals.

Collateral is made up of treasury bills, treasury ETFs, money markets, and cash.

Copper, aluminum, zinc along with tin, nickel, and lead are among the base (nonferrous) metals traded on the LME. Base metals are relatively cheap, widely used in commercial applications, and generally abundant, although there are concerns about long-term potential copper shortages, which we shall touch on.

Copper, aluminum, and zinc are the most liquid of the metals with average daily volume last month of roughly 129.6k, 205.4k, and 80k, respectively. Four of the six base metals have had rough years in terms of price returns with Cu, Al, Zn down 8% on average and nickel down over 30%.

Over the past five years DBB, with respect to price return has underperformed the market dramatically, rising 16% (about ~3.2% on annualized basis) vs. the S&P 500's 60+%. However, to point out its situational utility, DBB rose 20% in early 2022 over concerns of potential mass supply shortages amid Russia's invasion of Ukraine. Meanwhile, the S&P 500 fell overall by almost 10% during the same period.

Yet, the "Ukraine war premium" was short-lived. Fears that began in anticipation of the invasion and spiked in its wake dissipated as shortages never reached the heights many projected. As a result, DBB has fallen by over 30% since March 4, 2022, when it reached $26.97, its highest level in over 14 years. Base metal prices are also highly contingent on fluctuations in exchange rates, interest rates - and any directional signals from the Fed, along with demand from China, the world's largest consumer of industrial metals.

For investors with a long-term horizon, however, DBB may still hold promise from the expected linear boom in demand for base metals due to their importance in the global green transition - which could lead to a structural change in market pricing. Large components of demand for base metals may escape the trappings of cyclicality, and the aforesaid near-term dependencies. A "secular break," so to speak, as suggested by some experts.

Copper demand for example is expected to rise 35% to more than 34.3mln tons by 2035, largely driven by clean energy technology requirements, according to the IEA's mid-range forecast , which is based on the assumption government's implement announced net zero pledges. In the worst case scenario demand would rise only 24% by 2035. Demand would have to increase by more than 50% by 2035 in order to remain on track to reach net zero by 2050.

Meanwhile, because of expected supply constraints, annual copper shortfalls are widely expected to reach anywhere from 1-10mln tons by 2035. However, it is important to note substantial copper deficits may not begin to hit until 2027, according to S&P projections . In the near term, although a slight deficit is forecasted for 2023, the International Copper Study Group projects a surplus of 467k tons in 2024.

The latest S&P Global consensus price forecasts , as of September 30, 2023, have copper rising to $4.32/lb by 2027, roughly 18% from prevailing prices.

When it comes to aluminum, the U.S. Department of Energy projects demand soaring to around 150mln tons/year, driven by its increasing use in vehicle lightweighting.

A CRU study las t year, which put aluminum consumption at about 120mln tons/year in 2030, projected that 75% of the metal's demand growth will come from the transportation, electrical, construction, and packaging sectors combined. Consensus price forecasts have aluminum rising about 20% to $1.24/lb by 2027.

After a fall of 4.3% in 2022, global demand for refined zinc is forecasted to rise by 1.1% to 13.6mln tons in 2023 and by 2.5% to almost 14mln tons in 2024. However, global supply of refined zinc is forecast to exceed demand in both 2023 and 2024 by 248k tons and 367k tons, respectively.

Longer term, Clean energy demand for zinc will grow by about 6% annually from now until 2035, according to the IEA, largely due to wind power application requirements. Consensus estimates have the price of zinc rising over 7% by 2027.

In sum, the three metals tracked by DBB would grow by an average of 15.5% in total from now until 2027, an annualized growth rate of 3.1 percent.

DBB ETF Risk & Return

If one does believe gaining exposure to copper, zinc, and aluminum is a sound investment decision, the next question is whether DBB is the best mechanism for achieving this objective. When compared to all other ETFs, DBB garners a hold quant score of 2.7 with B's in momentum and liquidity but D's in expenses, dividends, and risk. DBB ranks 25 out of 39 commodities-focused ETFs graded by Seeking Alpha.

DBB's solid momentum grade is being driven by its performance over the past month, +2.7% vs. the ETF median of 0.87%. DBB's 1Y total return of -5.32% is well below the ETF median and the commodities-focused median of 1.87%.

DBB's price performance looks even more solid when compared to two other base metal ETFs. The abrdn Bloomberg Industrial Metals Strategy K-1 Free ETF ( BCIM ) and the Teucrium Aila Long-Short Base Metals Strategy ETF ( OAIB ), which was incepted earlier this year.

DBB's expense ratio of 0.75% is relatively high compared to the ETF median of 0.44% although the commodity-focused median is 0.60%. BCIM's expense ratio is .40% and OAIB is at 1.64%.

In terms of risk, the tracking error marks and high short interest as % of outstanding shares are certainly concerning although only 8 ETFs in the commodities-focused sphere have risk grades higher than a D.

DBB has a poor dividend score, with a yield of 0.99%, compared to the ETF overall median. However, only 12 of the 39 commodities-focused ETFs offer dividends and the median yield on those is only 0.85%.

Invesco clearly warns that the fund is speculative and involves a high degree of risk. Commodities and futures generally are volatile and not suitable for all investors, who could lose all of their investments in the fund.

Conclusion

DBB offers investors a rare opportunity to bet on futures contracts for three highly liquid base metals: copper, aluminum, and zinc. While I have used this mechanism on a short-term basis for exploiting supply disruptions, long-term investors still might be interested in gaining exposure to these metals given the key role they will play in the global energy transition. However, I still need to see more evidence of the energy transition narrative translating into higher base metal price returns - certainly more than 3% on an annualized basis. Until then, I rate DBB a hold.

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