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Global Resources - Dumper Truck

Global Resources - Monthly Update

Artikel | 22 December 2017

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Market review

There was some divergence in the performance of commodity prices during November. Iron ore¹ (16.4%) and coking coal¹ (18.7%) were the best performing commodities, as demand for quality inputs proved better than many had feared following the implementation of steel production cuts in China. The cuts to steel production are part of a broader reduction in industrial activity to reign in pollution during China’s ‘heating season’, which runs from November to March.

Industrial metals were mostly lower during the month correcting gains seen in the preceding months. Weakening Chinese economic data and slowing home sales increased concern over the outlook for demand in the world’s top consumer. Nickel² (-4.7%), Aluminium² (-4.7%), Zinc² (-3.7%) and Copper² (-0.6%) declined, while Lead² (+2.2%) recorded the largest monthly gain. The oil price² (+5.7%) finished the month higher after the Organisation of the Petroleum Exporting Countries (OPEC) agreed to extend oil production cuts, as widely anticipated. The extension means that OPEC and allied producers will side line almost 2% of global oil supply until the end of 2018. Weakness in the US dollar supported the Gold price, which edged 0.5% higher to $1273/oz.

¹ Source: Bloomberg

²Source: Factset

Fund performance

The Fund returned -1.9% (Class B Acc shares, net of fees and taxes, in GBP terms) in November, compared to its customised benchmark, 75% Euromoney Global Mining / 25% MSCI AC World Energy, which returned -2.1%. Please remember that past performance is not a guide to future performance.


An overweight to uranium producer Cameco was the top contributor to relative performance. The company’s share price rallied after it suspended its large McArthur River mine for 10 months in a bid to cut global supply of uranium. Cameco’s share price was further boosted in early December when the world’s biggest uranium producer, Kazatomprom, followed Cameco’s lead by announcing it would cut production by 20% over the next three years. Cameco’s fundamentals remain in good shape, with a healthy balance sheet and sound cash generation, which will improve on higher uranium prices.

Teck Resources’ share price performed well during November after investors digested Q3 earnings announced at the end of October. The company also announced a surprise supplemental dividend and share buyback midmonth, which further supported the share price. Teck is attractively valued, has strong cash flow generation, robust coking coal margins and exposure to improved zinc and copper markets.

Among the detractors from relative performance was Vestas Wind Systems. The company’s share price fell the most in almost six years after the company, the world’s leading wind-turbine maker, reported earnings before interest and tax that trailed analysts’ estimates. The company said the competitiveness of wind energy and increased costs were taking a toll on profits. Despite a weak Q3, wind energy remains a growth market, particularly offshore.

Fund activity

We rotated the exposure to large diversified miners during November, reducing our exposure to Glencore and recycling the proceeds into Vale and Teck Resources. Teck maintains the portfolio’s diversified exposure, whilst partly mirroring Glencore’s coal and base metal exposure.

The rapid deleveraging of Vale continues, while corporate governance is also on an improving trajectory. In conjunction with that, the shifts in pricing dynamics within the iron ore markets are showing increasing signs of structural change – this should be positive for Vale, a producer of such large volumes of very high grade material which is attracting significant pricing premiums.

Recent reports of accounting irregularities at Glencore’s Katanga site are concerning and among the subjects of an ongoing investigation by the Ontario Securities Commission. Further, with the shares having performed well relative to peers since increasing the position at the end of 2015, profits have been taken.

Please remember that the value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested.

Market outlook

We are broadly constructive on the outlook for the mining sector. Positive global economic indicators suggest that the synchronous recovery in both developed and developing economies will continue in 2018. This should be supportive for both commodity prices and resources equities.

Chinese industrial profits grew 25.1% over the year to October compared to 27.7% in September. Coal, steel, petrochemical and oil sectors were the major drivers of industrial profit growth. Outside of bulk commodities, we expect moderate demand growth for most other commodities in the near term, supported by China’s focus on economic stability.

Thematics to watch in 2018 are likely to include ongoing supply constraint from miners and Chinese processing companies, a pick-up in merger and acquisition (M&A) activity, inflation, and cash returns to shareholders. Efforts to reduce overcapacity in steel production on environmental grounds have boosted the profitability of steel mills, providing the impetus for stronger steel production and iron ore consumption in the short term. Over the longer term we also see potential for reduced demand for both coking coal and lower grade iron ore owing to policies encouraging cleaner and more efficient steel production. These policies will most likely benefit producers of higher quality iron ore and coking coal. Higher cost quality inputs generate higher output and less pollution.

After tightening in 2017, the copper market has moved into deficit. Few projects are being brought on line over the next few years and in the near term there are risks to mine supply from labour renegotiations in Chile and geopolitical tremors in the Democratic Republic of the Congo, Zambia and Indonesia. At the same time Chinese demand will benefit from greater investment in the electrical grid. In the medium term, demand for copper and nickel will be boosted by the ongoing electrification of the vehicle fleet. Higher prices will be required to stimulate investment in new mines.

The primary risks to be cognisant of are a slowdown in the Chinese economy, global protectionism and rising interest rates. Chinese demand in 2018 is likely to slow down but not collapse and we expect that constrained supply will remain a key support factor for commodities. Inflation which has been relatively subdued since the global financial crisis may well surprise to the upside forcing central banks to continue tightening. The US Fed’s decisions on interest rates continue to be the key focus for investors globally providing some support for the US dollar. This might work to moderate commodity price increases in coming months. Positive short term real rates raise the value of the US dollar, while diminishing the appeal of gold which does not have a yield. With that said, commodities more broadly have historically proved to perform well through a rising rate cycle as long as global growth holds up, although of course this cannot be guaranteed.

A rebalancing in oil supply and demand has been progressing over the past several months, as demand has remained more robust than market expectations and supply discipline has held firm. Expectations regarding the growth in supply of US oil, especially from unconventional shale plays, have also abated as producers increasingly focus on economic rationality and equity funding dries up. The recent OPEC decision to extend their 1.8m barrel a day production cut to the end of 2018 was greeted with relief by oil companies. The production restraint, combined with more synchronised global growth, strong increases in oil consumption and heavy refinery runs should continue to reduce global oil inventories and support oil prices in 2018. While cost pressures are far less severe than the 2004-2012 period, we expect industry costs to be up >5% in 2018 through a combination of foreign exchange, oil and other input cost and labour inflation. This will push up and possibly steepen commodity supply curves supporting prices and should disproportionately benefit companies with lower costs, although this cannot be guaranteed.

Resources equities valuations are undemanding and, in our view, continue to factor in lower commodity prices. Even with 10% higher capex in 2018, mid-cycle free cash flow yields of around 10% and the potential for dividend yields of around 5% are making the sector look relatively attractive to us. Third party investor surveys indicate generalist investors remain broadly neutral, despite the improved back-drop.

We have gradually reduced the portfolio’s exposure to the larger cap (‘oak trees’) in favour of higher growth ‘acorns’ (small cap) and ‘saplings’ (mid-cap) with high quality assets, low cost development projects and solid balance sheets. In the initial phases of a recovery, they are laggards but as the industry improves, we anticipate that companies such as TMAC Resources, Pretium Resources, MAG Silver, First Quantum or Petra Diamonds, who have been investing through the downturn, will be well rewarded by the market. Their projects are top quartile and the fact that they have been funded through the downturn is testament to the robust nature of their project economics. Smaller companies are inherently higher risk, but catalysts such as exploration success, permitting and development, or operational turnarounds can be drivers of the ‘acorns’ and ‘saplings’ in the portfolio. These types of catalyst-rich names could also increasingly be of interest from an M&A perspective as larger companies look to replenish their capital starved project pipelines. We observe that for the first time in several years exploration spending is up, which should bode well for the small and mid-cap companies in the portfolio.

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