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March 11, 2020

Commodities Strategy | Metals Update

As oil capitulates through even the most pessimistic of floors after this past weekends U-turn from Saudi Arabia declaring a price war (after the OPEC+ alliance shattered), its tarnished the entire commodity brand; the ~60% peak-to-tough YTD repricing in WTI internalizes not only virus-induced demand destruction due to the cutback in transportation but an awkwardly timed policy ‘response’ from OPEC and an impending game of volumes Energy is the lynchpin for all commodities and a harbinger of economic growth. Thus, given a new lower regime (~$30s, not $50-$60 oil) and the historically positive correlations with all metals, the note below ex-plores the historical connection between oil and metals through various fundamental and macro lenses:

1. The micro and macro thinking from which to ana-

lyze the impact of lower Oil on individual metals

2. A summary of long & short-term correlations be-

tween Oil and Base & Precious metals

3. The historical reaction in metals during large-

scale deleveraging episodes (>10%DoD) in Oil

4. The hypothetical upside/downside levels in each metal (with oil at $25 and $50) giving their statisti-

cal relationship

Nicky Shiels Commodity Strategist (Metals 212-225-6724 Commodities Derivatives nicky.shiels@scotiabank.com

Follow us on Twitter @ScotiaMetals

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Commodities Strategy | Metals Update

1. The micro and macro thinking from which to analyze the impact of lower oil on roughly individual metals:

Gold/Silver:

Energy trends have important (dis)inflationary implications for the global economy beyond being a growth (or recession) gauge. The deflationary spiral provide bearish head-

winds for all commodities (including Gold as historical analysis below will show) in the short-term; it carries negative implications for overleveraged credit (margin/liquidity-related selling), dampens sentiment around global growth and lowers the cost of production floors for many producers. Just like Gold was another asset / line item to sell un-der extreme equity market volatility, so too will it be subject to ‘margin-related’ selling as energy/credit markets seize up. However in the longer-term, Gold should wake-up to the global over indebtedness which as clearly restrained growth, and had a disinflationary impact on major sectors which will drive more experimental CB polices resulting in dilutive currencies (net bearish in s/t, bullish in medium to long-term)

Despite the Feds focus on core inflation, a major asset repricing shock of this size has implications for both Main and Wall street, that will force them to take notice. The most

recent major oil collapse (Q1 2016) was enough to put the Fed on hold throughout 2016. Their objective to achieve “sustained inflation” has all but disappeared now and given the compounded impact on growth / financial conditions/ credit and liquidity, this only accelerates the urgency to cut rates further AND aggressively expand their Balance Sheet, despite pushback that monetary policy isn’t the appropriate ‘cure’ to the virus (net bullish)

Financial or official sector flows:

Any losses in energy blights potential investor/haven inflows into precious from both active & passive strategies; gold will get thrown out with general derisking across all com-

modities (net bearish).

Lower oil is a blessing for net oil importing EM countries who are large gold consumers (e.g.: India). CA deficit EM countries (Turkey, Philippines, SA, China and Indonesia)

were all targets under much higher oil prices (in 2018) but with much lower energy pricing, currency/funding pressures are alleviated. (net neutral)

Net oil exporting countries, especially those with CA deficits and/or with lower reserves, will have to contend with dwindling export revenues, which curbs the CBs ability to

support their currency. While its IMPOSSIBLE to confirm, the mere threat of oil-sensitive economies who ALSO own sizeable gold reserves is there (China, Russia, Venezue-la, Mexico, Colombia, Saudi Arabia, Brazil & Libya rank in the top 40 official Gold holders); they may potentially stem their pace of their recent purchases, or choose to down-size gold exposure in the face of energy and EMFX constraints. (net bearish).

PGMs:

Theres been a series of major fundamental announcements over the past week in the PGM sector (Amplats converter explosion, BASFS 3-way catalyst, and Norilsk ramp up

of Rhodium output). Regardless, lower energy / diesel prices are a blessing in disguise for large energy users (including some of the larger PGM producers) as it lowers their units costs while revenues are driven higher due to higher byproduct prices and a weaker ZAR. Frustratingly, constraints from Eskom and / or idiosyncratic factors (AMS refin-ing capacity offline) comes at a costly time (its missed opportunity if one cannot ramp up production when the stars are aligning).

Overall, the major energy repricing is net reduction in costs (outside of by-product strength) that will allow historically expensive PGM shafts/mines to continue operating for

longer which should help plug some of the Palladium/Rhodium deficits, but should continue to swell the Platinum surplus (all demand metrics held equal).

Base metals:

Input costs: in theory, lower oil/energy prices pushes down input costs, and lowers cost of production floors. Metals exposures to oil vary by mine and region, but generally

energy costs (directly via fuel costs and indirectly via power generation costs) are highest for Ali (at >50% share of total costs). Nickel is next exposed (~25% share of costs), then Copper (~22%), and zinc/lead (~18%). This oil repricing, which is likely to be sustained, will lower the consensus “cost of production” floor in Ali, and accelerate any bear-ish argument. If Aluminum falls through $1500, most U.S. smelters are at risk and may be forced to shut operations

EM Demand: higher oil is an burden for most countries, especially ones who are net oil importers and rely on external funding. This negatively plays out via drastic currency

weakness which ultimately impacts their base metals purchasing power. A stronger US$ but also weaker EM demand puts a large overhang on base metals pricing.

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Commodities Strategy | Metals Update

2. Summary of long and short-term correlations between Oil and Base & Precious metals

Over the longer-term (since 1993), on average there are positive daily correlations between all metals vs Brent and WTI.

Platinum (+0.94%), copper (+0.90%), silver (+0.81%) and gold (+0.75%) all exhibit the strongest correlations to WTI, while Palladium (+0.37%) and zinc (+0.60%) have the weakest correlation. (Correlation heat map)

The rolling correlation between oil and metals usually picks up during economic expansions, which is logical as all boats (commodities) rise on typical de-mand-pull dynamics. However during periods of distress or recessionary periods, in which there is perhaps an idiosyncratic interventionist supply response (e.g.: OPEC in 2014), correlations with metals tend to weaken. (Chart 1)

Despite most base metals largely carving out new lower 2020 floors earlier this week given the oil plunge, the complex (BCOM industrial Metals Sub index) hasn't capsized to or through 2016 or 2008 lows, which is the case with energy. That’s largely explained by the fact that:

Base metals have relatively tighter balances (e.g: deficits expected for 2020 in Cu for first time in years, vs surpluses in 1H for crude). That’s also witnessed in inventories, with crude inventories rising from near structural highs, while base metals inventories are increasing but from near cyclical lows

Crude demand will take a relatively bigger hit due to diminished air travel and impact on transportation.

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Commodities Strategy | Metals Update

Chart 1: Rolling 2 year correlations between WTI prices and metals

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Commodities Strategy | Metals Update

3. Historical reaction in metals to large-scale oil selloffs

Chart 2 highlights the same-day response in all metals when Oil falls by more than 10% in one day. There are 14 historical instances when Oil has washed out to this extent

All metals often follow the large selloff in oil with average declines of -1% to -3% in Precious Metals and average declines of -2 to -3% across all Base prod-ucts

Despite the calls for Gold to act up as a fear hedge (which its failed to do this week), the historical analysis helps explains why Gold, at the core, is still a commodity and will perform relatively well, but it will be extremely tough for it to diverge and breakout on extreme equity volatility and oil flush outs.

Chart 2a: Daily precious metal price reaction changes when WTI falls by 10% or more

Chart 2b: Daily base metal price reaction changes when WTI falls by 10% or more

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Commodities Strategy | Metals Update

4. Oil at $25 or $50? Where does that put all metals:

Regressing oil prices on all metals over the past 10years, helps to show that oil prices can in fact explain 67% / 66% / 51% / 48% of Platinum, Copper, Nick-el & Silver prices respectively (the metals most correlated with WTI over the past 10 years).

In contrast, metals such as Palladium and Zinc are weakly associated with WTI price action.

Thus, IF crude had to take another leg lower (to $25 – bear case), or rebound back to $50 (bull case), the table below shows the simulated results for all metals.

Most notable are the ones with stronger correlations AND relatively larger downside: i.e.: under just current oil pricing, the bearish potential in Silver & Nickel is huge at 27-28% (~$12 Silver and $9200 Nickel).

Copper and Platinum both also enjoy very strong correlations with oil pricing, but their downside potential is relatively smaller (~12-13% across each, putting Copper at under $5,000 and Platinum <$760)

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Commodities Strategy | Metals Update

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promise or representation as to the future. Past performance or simulated past performance is not a reliable indicator of future results. Forecasts are not a reliable indicator of future performance..

This presentation has not been prepared (i) by a member of the research department of Scotiabank, or (ii) in accordance with the legal requirements designed to promote the independence of invest-

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Investment Industry Regulatory Organization of Canada. The Bank of Nova Scotia and Scotiabank Europe plc. are authorised by the UK Prudential Regulation Authority. The Bank of Nova Scotia is

subject to regulation by the UK Financial Conduct Authority and limited regulation by the UK Prudential Regulation Authority. Scotiabank Europe plc is regulated by the UK Financial Conduct Authority

and the UK Prudential Regulation Authority. Details about the extent of The Bank of Nova Scotia 's regulation by the UK Prudential Regulation Authority are available upon request. Scotiabank Inver-

lat, S.A., Scotia Inverlat Casa de Bolsa, S.A. de C.V., and Scotia Derivados, S.A. de C.V., are each authorized and regulated by the Mexican financial authorities.

8

March 11, 2020

Commodities Strategy | Metals Update

The information contained in this presentation is being provided for information and discussion purposes only. An investment decision should not be made solely on the basis of the contents of this

presentation. This presentation is being provided upon the express understanding that no representation or warranty, express or implied, is made, or responsibility of any kind accepted, by The Bank of

Nova Scotia, Scotiabank Europe plc, or any of their respective affiliates (“Scotiabank”TM), their directors, agents or employees with respect to the completeness or accuracy of the information, conclu-

sions and opinions provided herein, or as to the achievement or reasonableness of any projections, targets, estimates, or forecasts and nothing in this presentation should be relied upon as a promise

or representation as to the future. Past performance or simulated past performance is not a reliable indicator of future results. Forecasts are not a reliable indicator of future performance.. This presenta-

tion has not been prepared (i) by a member of the research department of Scotiabank, or (ii) in accordance with the legal requirements designed to promote the independence of investment research. It

is considered a marketing communication for regulatory purposes and is solely for the use of sophisticated institutional investors. This presentation does not constitute investment advice or any person-

al recommendation to invest in a financial instrument or “investment research” as defined by the UK Prudential Regulation Authority and the UK Financial Conduct Authority, and its content is not sub-

ject to any prohibition on dealing ahead of the dissemination of investment research.

The information contained in this presentation reflects prevailing conditions and our judgment as of the date of the presentation, all of which are subject to change or amendment without notice, and the

delivery of any such amended information at any time does not imply that the information (whether amended or not) contained in this presentation is correct as of any time subsequent to its date. Sco-

tiabank undertakes no obligation to update or correct any information contained herein or otherwise to advise as to any future change to it. Scotiabank does not provide any applicable tax, accounting

or legal advice and in all cases independent professional advice should be sought in those areas.

This presentation incorporates information which is either non-public, confidential or proprietary in nature, and is being furnished on the express basis that this information will not be used in a manner

inconsistent with its confidential nature or be disclosed to anyone other than as may be required by law or to those who have been informed of the confidential and proprietary nature of this presenta-

tion. This presentation and its contents are strictly confidential to the person to whom it is delivered and may not be copied or distributed in whole or in part or disclosed by such persons to any other

person without the prior written consent of Scotiabank. This presentation and the information contained herein remain the property of Scotiabank.

This presentation is not and shall not be construed as an offer, invitation, recommendation or solicitation to sell, issue, purchase or subscribe any securities or bank debt in any jurisdiction or to enter

into any transaction. Nothing in this document contains a commitment by Scotiabank to sell, issue, purchase or subscribe for financial instruments, or securities, to provide debt or to invest in any way

in any transaction described herein, or otherwise provide monies to any party. Any participation by Scotiabank in any transaction would only be provided in writing after satisfactory legal, financial, tax,

accounting and commercial due diligence, as well as being subject to internal approval processes. Any transaction implementing any proposal discussed in this document shall be exclusively upon the

terms and subject to the conditions set out in the definitive agreement related thereto.

This presentation is not directed to or intended for use by any person resident or located in any country where the distribution of such information is contrary to the laws of such country. Scotiabank, its

directors, officers, employees or clients may currently or from time to time own or hold interests in long or short positions in any securities referred to herein, and may at any time make purchases or

sales of these securities as principal or agent. Scotiabank may also have provided or may provide investment banking, capital markets or other services to the companies referred to in this presentation.

TM Trademark of The Bank of Nova Scotia. Used under license, where applicable. Scotiabank, together with "Global Banking and Markets", is a marketing name for the global corporate and investment

banking and capital markets businesses of The Bank of Nova Scotia and certain of its affiliates in the countries where they operate, including Scotia Capital Inc., Scotia Capital (USA) Inc., Scotiabanc

Inc.; Citadel Hill Advisors L.L.C.; The Bank of Nova Scotia Trust Company of New York; Scotiabank Europe plc; Scotiabank (Ireland) Designated Activity Company; Scotiabank Inverlat S.A., Institución

de Banca Múltiple, Scotia Inverlat Casa de Bolsa S.A. de C.V., Scotia Inverlat Derivados S.A. de C.V. – all members of the Scotiabank Group and authorized users of the mark. The Bank of Nova Sco-

tia is incorporated in Canada with limited liability. Scotia Capital Inc. is a member of CIPF. Scotia Capital (USA) Inc. is a registered broker-dealer with the SEC and is a member of the NASD and SIPC.

The Bank of Nova Scotia is authorised and regulated by the Office of the Superintendent of Financial Institutions of Canada. Scotia Capital Inc. is authorised and regulated by the Investment Industry

Regulatory Organization of Canada. The Bank of Nova Scotia and Scotiabank Europe plc. are authorised by the UK Prudential Regulation Authority. The Bank of Nova Scotia is subject to regulation by

the UK Financial Conduct Authority and limited regulation by the UK Prudential Regulation Authority. Scotiabank Europe plc is regulated by the UK Financial Conduct Authority and the UK Prudential

Regulation Authority. Details about the extent of The Bank of Nova Scotia 's regulation by the UK Prudential Regulation Authority are available upon request. Scotiabank Inverlat, S.A., Scotia Inverlat

Casa de Bolsa, S.A. de C.V., and Scotia Derivados, S.A. de C.V., are each authorized and regulated by the Mexican financial authorities.