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Natural Resources Indicator

  • Market review

    Market review

    Download PDF Indicator

    Our team’s views on the recent developments within the Natural Resources sector.

    Global equities were rocked by two distinct bouts of headline volatility over the fourth-quarter – they were fairly evenly split, occurring in October and December. Growth concerns stemming from a rise in trade tensions and slowing global growth proved the catalysts, sending equities lower, while at the same time negatively impacting the demand outlooks for various commodities and resource equities. The US dollar gained slightly over the quarter, but it retreated in December, which did offer a degree of support to the asset class as most markets materially sold off. Natural resource equites underperformed their physical peers, with the MSCI ACWI Select Natural Resources Capped Index returning -14.8% versus -9.4% from the Bloomberg Commodity Index, in US dollar terms.

    Oil prices posted the largest losses, down 35% on the quarter as OPEC+ (primarily Saudi Arabia, the Gulf states and Russia) kept the oil markets in check by pumping additional oil from its spare capacity to offset any lost supplies from Iran. Precious metals performed well, with gold, silver and palladium all posting decent gains, as investors sought safe, or at least safer, havens. As mentioned above, global growth concerns kept industrial metals under pressure over the quarter. Iron ore was the outlier, rallying 7% over the quarter – with huge intra-month swings along the way. In agriculture, protein held up well, while at the other end, grains and softs sold off.

    At a glance - our asset class views

    COMMODITY EQUITY
    -- - o + ++ -- - o + ++
      Energy  
    Crude Oil  
      Natural gas  
      Refiners  
    n/a Oil services  
    n/a Wind  
    n/a Solar  
    COMMODITY EQUITY
    -- - o + ++ -- - o + ++
      Precious metals  
      Gold  
      Silver  
      Platinum  
      Palladium  
    COMMODITY EQUITY
    -- - o + ++ -- - o + ++
      Base metals & bulks  
      Copper  
      Aluminium  
      Zinc  
      Nickel  
      Iron ore  
      Coking coal  
      Thermal coal  
      Steel  
    COMMODITY EQUITY
    -- - o + ++ -- - o + ++
      Agriculture & softs  
      Corn  
      Soybean  
      Potash  
      Nitrogen  
      Salmon  
      Lumber  
      OSB  
      Pulp  

    Key themes

    • Oil price moves in the final quarter reminded us of the power OPEC+ still has in influencing the broader market. With production cuts set to take hold, we expect higher oil prices in early 2019.
    • Gold prices should find support from slowing global growth, a weaker US dollar and a more dovish Fed.
    • We believe agriculture and basic foodstuffs markets should recover in 2019 as supply growth wanes.

    For professional investors and financial advisors only. Not for distribution to the public or within a country where distribution would be contrary to applicable law or regulations.

    Important Information

    This material is for informational purposes only and should not be construed as an offer, or solicitation of an offer, to buy or sell securities. All of the views expressed about the markets, securities or companies reflect the personal views of the individual named. While opinions stated are honestly held, they are not guarantees and should not be relied on. Investec Asset Management in the normal course of its activities as an international investment manager may already hold or intend to purchase or sell the stocks mentioned on behalf of its clients. The information or opinions provided should not be taken as specific advice on the merits of any investment decision. This content may contains statements about expected or anticipated future events and financial results that are forward-looking in nature and, as a result, are subject to certain risks and uncertainties, such as general economic, market and business conditions, new legislation and regulatory actions, competitive and general economic factors and conditions and the occurrence of unexpected events. Actual results may differ materially from those stated herein.
    All rights reserved. Issued by Investec Asset Management. Issued by Investec Asset Management, issued February 2019.

  • A letter from your PM

    Outlook for gold equities looks brighter in 2019

    A letter from George Cheveley
    Portfolio Manager, Natural Resources

    George Cheveley, Portfolio Manager.

    Given the falls in world stock markets in the final quarter of 2018, gold equities have moved back onto the agenda for many investors as they look to diversify their portfolios. In a dismal third quarter of 2018, a falling gold price and the closure of one of the larger gold funds in the US combined to drive the NYSE Arca Gold Miners Index down 15.5%.

    However, in the fourth quarter of 2018, this was almost entirely reversed and, while down on the year, gold equity returns beat those of the MSCI AC World and were just behind the S&P 500. The chart below illustrates the performance in 2018 and the negative correlation of gold equities to the broader markets.

    Of course, investors are now asking if this was just a ’flash in the pan’ and, with China and US now re-engaged on trade negotiations, markets may calm down and gold’s attraction wane. However, we believe there is still a compelling case to hold gold equities at this stage in the cycle and it is one that is not just based on the expectation of rising gold prices.

    Nevertheless, gold prices look more likely to rise over the coming year. The US dollar strength which has been weighing on gold for the past year appears to have rolled over.

    Figure 1: Gold equities vs broader equity indices

    Source: Bloomberg, as at 31.12.18.

    With economic indicators starting to turn down in the US, as the impact of tax cuts weakens and the repatriation of companies’ foreign holdings completes, the US dollar has fallen back marginally. The rapid change in consensus forecasts on the Fed’s future interest rate schedule – the probability of a rate cut in twelve months’ time is now higher than the chance of another rise – is a major support for gold prices, not least because it will put pressure on the US dollar. Even if the dollar does not weaken dramatically, if it stops strengthening, then the markets are likely to focus on other factors such as possible rate cuts or even inflation.

    While the collapse in oil prices in late 2018 has taken some pressure off short-term inflation measures, the continued rise in wages in the US and elsewhere points to the potential for higher inflation in many markets. While this is not a focus for markets currently, if the world economy does recover, then it could be an important driver later in the year.

    Finally, with global equity and bond markets facing increased political uncertainty as populism rises, alongside the withdrawal of central bank funding as the US tightens its balance sheet, further falls and, at least increased volatility, seem likely. Gold’s basic attraction as a safe haven in uncertain times remains very powerful and continues to prove itself as a diversifier for portfolios.

    However, against a backdrop that is generally positive for gold prices, gold mining companies are arguably in their best condition to benefit. After years of restructuring and balance sheet deleveraging, there are now a number of companies globally which are well-placed to generate good returns even if gold prices remain at current levels. Many investors, even those convinced of the case for gold, remain cautious about precious metal equities and the perception is often that they have underperformed since 2011 when the market turned. In addition, the volatility of equities is also seen as a deterrent to investors trying to lower the volatility of their overall portfolios.

    We remain positive on precious metal equities for the reasons outlined below:

    1. Gold equities have performed better than many investors perceive over the past three years as they recovered from the dramatic derating following gold price falls from 2012 onwards. Certainly, much of their outperformance was in the first half of 2016, but after a period of consolidation they have once again picked up in recent months as the chart above shows. This is no accident as along with better gold prices, company fundamentals have improved as debt has been reduced and costs cut.
    2. Management teams, many of which have changed in recent years, are much more focused on capital allocation and cost control, which in turn is starting to drive up returns on capital employed. This change is a longer-term project but augurs well for those companies which have embraced it, and for the industry as a whole, as indiscriminate development is reduced. Not only has volume growth been lowered but also costs of development have come down as there is less competition for contractors and services.
    3. As returns have improved and debt has been reduced, companies are now just starting to increase cash returns to shareholders via dividends and/or buybacks. The gold sector has been notoriously bad at returning cash to shareholders, as shorter-life mines mean that they are focused on developing the next project. However, as investors have begun to call out companies who continually develop mines and pay themselves well without generating real returns, the leading companies are demonstrating that the best teams can return cash to shareholders as well as maintain or even grow production.
    4. With the merger of Barrick and Randgold, completed on 1 January 2019, and the recent announcement that Newmont Mining will buy Goldcorp in a US$10 billion deal, we believe there will be further consolidation in the gold industry and a restructuring at the asset level. Barrick has made it very clear it wants to reduce the number of mines it operates and focus on Tier 1 assets. Others, such as Anglogold and Pan American Silver have made it clear they wish to sell non-core mines, while companies such as B2Gold, Endeavour Mining, SSR Mining, Kinross, and Newcrest are all looking at possible acquisitions. As companies have seen the positive reaction to the Barrick/Randgold merger, it has underlined the need for more consolidation, not least to provide companies of a size and liquidity to attract larger, generalist investors.
    5. As a result of this restructuring, the sector has improved as a whole, though the variation among companies is wide. Nevertheless, one benefit, which the chart (figure 2) demonstrates, is that as debt levels have come down, the volatility of the gold miners index has also reduced dramatically. Certainly, gold equities remain volatile, and more volatile than gold itself, but with the reduced financial leverage, they now offer more stable exposure to gold prices but still with operating leverage. As the industry restructuring continues to develop, we would expect the equities to continue to offer good upside but also reasonable returns at current prices.

    In the Investec Global Gold strategy, we continue to focus on active management, choosing a concentrated portfolio, currently around 30 companies, which we believe are ahead of their peers and can offer reasonable liquidity and improving returns, even at current gold prices. Having outperformed our index over the short and long term, net of fees, we believe our approach has been shown to provide investors with a good alternative, or supplement, to physical gold holdings/ETFs or passive equity funds.

    With the prospect of rising gold prices, as well as industry consolidation, the outlook for the sector is very promising and it should continue to provide good diversification for investors.



    George Cheveley
    Portfolio Manager, Natural Resources

    Figure 2: Gold equity bolatility vs Net Debt to EBITDA

    Source: Bloomberg, as at 31.12.18.

  • Energy

    Portfolio positioning snapshot

    An overview of our positioning in a selection of commodities

    Energy

    COMMODITY EQUITY
    -- - o + ++ -- - o + ++
      Energy  
    Crude Oil  
      Natural gas  
      Refiners  
    n/a Oil services  
    n/a Wind  
    n/a Solar  

    Oil

    Recent developments: The fourth quarter signalled the end of oil’s strong year-to-date performance. After posting gains of 5%, 17% and 7% respectively, in each of the first three quarters, prices retreated 35% in the final quarter. Prices reached a high of c. $85 per barrel (bl) in October as US sanctions on Iran ramped up. This was despite OPEC+ (primarily Saudi Arabia, the Gulf states and Russia) having promised it would keep oil markets in check by pumping additional oil from its spare capacity to offset any lost supplies from Iran. It seems the market appeared sceptical. It soon became clear that OPEC+ had indeed responded and by the end October had increased production by almost 1 million barrels per day (bl/d) and oil prices began to fall. However, right before US sanctions on Iran were implemented in November, the US granted waivers to eight countries to continue the import of Iranian crude. The surprising move – which went against all prior US rhetoric – caught OPEC+ off-guard and resulted in the market being significantly oversupplied in November. As we moved into December, prices rallied on expectations the cartel would reduce supply to support prices. The lack of finer detail around the structure of the cuts, combined with rising fears of an economic slowdown in 2019, saw prices fall further into year-end.

    Market outlook: While market scepticism surrounding the announced cuts by OPEC+ remains, we view the decision to first increase production as oil reached $85/bl and then implement cuts as oil prices fell below $60/bl as a clear indication that the group is trying to manage prices within a certain range. We believe compliance with the announced cuts, led by Saudi Arabia, should be strong and will therefore provide a boost to prices in early 2019 as markets fall into undersupply.

     

    Solar

    Recent developments: The fourth quarter ended a volatile year for solar companies, driven primarily by a significant change to Chinese policy. In early June, China’s National Development and Reform Commission halted subsidies for all utility scale installations and instituted a 10GW distributed generation (DG) subsidy quota. China is the largest consumer of solar panels in the world (approximately 40%) and this news came as a shock to the market, as previous guidance was to phase out payments over several years. This action drove polysilicon, wafer and solar module prices lower in the second half of 2018, with pricing in some cases falling 50% relative to a year ago.

    Market outlook: 2018 was a difficult year for environmental companies, but with one of the last remaining and largest subsidy overhangs (China/Solar) now removed, we believe 2019 is shaping up to be a positive year for solar demand and solar equities. We have seen a trough and plateau of wafer and module prices through December and several lower quality manufacturers have left the market. Continued market consolidation and lower prices have driven new solar demand from smaller markets as we see solar at, or below, grid parity in many parts of the world. With global demand stronger in 2018 than many expected, 2019 looks well balanced or even undersupplied. This should create a more positive backdrop for the year ahead.

  • Base metals & bulks

    Portfolio positioning snapshot

    An overview of our positioning in a selection of commodities

    Base metals & bulks

    COMMODITY EQUITY
    -- - o + ++ -- - o + ++
      Base metals & bulks  
      Copper  
      Aluminium  
      Zinc  
      Nickel  
      Iron ore  
      Coking coal  
      Thermal coal  
      Steel  

    Zinc

    Recent developments: Zinc prices continued to fall through 2018 to a low of $2,300 per tonne (t) in mid-August before recovering marginally in the fourth quarter to close at $2,467/t, down 25.7% for the year. Increasing supply was the main cause of zinc’s decline earlier in the year, but these fears eased as prices fell and as Chinese numbers showed no recovery in zinc mine output. Exchange stocks ended the year just over 150,000 tonnes, a level not seen since the beginning of 2008 and less than a tenth of the peak in 2013. Prices remain in backwardation, suggesting tightness in physical markets and while treatment charges for zinc concentrates have risen sharply in recent months, this has been mainly due to a lack of smelting capacity rather than a huge surge in mine supply.

    Market outlook: While mine supply is growing, volumes have disappointed so far and a lack of smelting capacity worldwide is causing bottlenecks, after Chinese environmental restrictions have led to smelter cuts. If China continues to stimulate by promoting infrastructure projects, zinc demand should remain robust and forecast surpluses may turn out to be wrong. With stocks at such low levels and with the prospects of a rapid supply response from Chinese producers less likely, due to environmental restrictions, there is a risk that the market gets caught short in the coming twelve months. A marked slowdown in global growth would alter this, but even so, price risks look skewed to the upside.

     

    Copper

    Recent developments: Copper prices were weighed down by supply in 2018, falling 16.6% over the year to end at $5,965/t. Concerns over the trade war and slowing Chinese demand exacerbated copper’s woes towards the end of the year, but it was the lack of disruption to mine supply that caught most analysts by surprise. Inventories did fall over the year and demand was strong, thanks to good growth in China, but the expected large deficit never emerged as mine supply suffered minimal disruption overall. In recent years mine supply has generally ended up 5% below forecasts at the beginning of each year, but in 2018 disruptions were 1-2%, not least because there were few new mines starting and existing mines were focused on productivity improvements. Thus, the market ended the year with only a small deficit and prices reacted by falling sharply, not helped by fears that Chinese growth, which had been strong, was about to slow.

    Market outlook: There has been no let up so far in 2019 with copper prices falling in the first week to levels not seen since mid-2017. Weaker-than-expected US data has increased the prospects of slower global growth and copper is still seen of somewhat of a bellwether by speculators. With few signs of physical tightness, as premia remain flat in China, there is little to suggest this changing ahead of Chinese New Year in early February. Longer term, the fundamentals do not suggest a large deficit in the next two years unless demand remains very strong or there is a major supply disruption. With only one major new mine starting up, First Quantum’s Cobre Panama, disruptions may again be less than forecast. Larger deficits look likely farther forward but, in the meantime, we expect copper prices to trade sideways.

  • Precious metals

    Portfolio positioning snapshot

    An overview of our positioning in a selection of commodities

    Precious metals

    COMMODITY EQUITY
    -- - o + ++ -- - o + ++
      Precious metals  
      Gold  
      Silver  
      Platinum  
      Palladium  

    Gold

    Recent developments: Following a disappointing third quarter, gold enjoyed a much stronger end to the year. Interest rate expectations shifted from rate hikes until 2020, to no further rises in either 2019 or 2020 following a more dovish US Federal Reserve. Indeed, the prospects of a cut by 2020 had increased to over 25%. Combined with choppier markets and slowing growth rates, investor demand for safe haven assets such as gold rose significantly over the period. Exchange traded fund (ETF) holdings jumped to 71.1 million ounces from 67.6 million ounces. Speculative short positions on the Comex also rose from -1.8 million ounces at the end of September to a long of approximately 7.6 million ounces by mid-December. Trading within a $100 range over the quarter, the gold price stopped just short of US$1,300 per ounce, a move of almost 7%.

    Market outlook: Gold prices look more likely to rise over the coming year. The US dollar strength, which has been weighing on gold for the past year, appears to have rolled over. With economic indicators starting to turn down in the US, as the impact of tax cuts weakens and the repatriation of companies’ foreign holdings completes, the US dollar has fallen back marginally. The rapid change in consensus forecasts on US Federal Reserve interest rates – the probability of a rate cut in twelve months’ time is now higher than the chance of another rise – is a major support for gold prices, not least because it will put pressure on the dollar.

    Even if the US dollar does not weaken dramatically, if it stops strengthening, then the markets are likely to focus on other factors such as possible rate cuts or even inflation.

     

    Palladium

    Recent developments: Palladium prices had an extraordinary year in 2018, finishing 18.6% higher. However, from the start of the year the price fell over 20% to a low in mid-August of $844/oz, before rising 50% to end the year at $1,262/oz, having briefly been higher than gold in December 2018. The last time prices were over $1,100/oz was in 2001. Initially prices suffered in the first half of 2018 from fears over car demand, particularly for gasoline cars. However, strong vehicle sales, concerns over Russian supplies and, most importantly, a continued widening deficit combined to drive the price to record levels. Ironically, this happened just as vehicle sales began to collapse, but this just highlighted that even if demand fell palladium stocks are dwindling fast. After six years of underlying deficits, the prospect of three more years of tightness finally brought about the price response. The question now is whether prices have risen high enough to prompt a supply response or, in the short term, some substitution and thrifting.

    Market outlook: Palladium prices have been in backwardation for the last eight months as physical tightness starts to bite. Stocks of palladium in the physical ETFs have fallen from a peak of over 3 million ounces in 2015 to around 700,000 ounces currently. Unless demand in auto-catalysts slumps in 2019, a further 500koz deficit looks likely. In the short term, weaker demand from autos could temper prices as well as some substitution back to platinum in auto-catalysts. Platinum is trading around $475/oz lower so the incentive to switch is high, especially as platinum continues to be over-supplied. However, there is little evidence of switching just yet and it may take a longer period of higher prices to incentivise car manufacturers to do so. However, it will happen and with EV sales just starting to accelerate, this latest rise may well end up being a spike like it was in 2001.

  • Agriculture & softs

    Portfolio positioning snapshot

    An overview of our positioning in a selection of commodities

    Agriculture & softs

    COMMODITY EQUITY
    -- - o + ++ -- - o + ++
      Agriculture & softs  
      Corn  
      Soybean  
      Potash  
      Nitrogen  
      Salmon  
      Lumber  
      OSB  
      Pulp  

    Corn

    Recent developments: During the fourth quarter of 2018, corn prices bucked the trend in general commodity markets and rose by 5.3%. The southern hemisphere summer crop was planted and began to emerge during this period. Brazil and Argentina both saw downgrades to their initial harvest estimates. This outlook for lower production caused some restocking throughout the supply chain and this additional volume had to be sourced from US stockpiles. Inventories remain ample, but the normal seasonal drawdown was exacerbated by the South American supply concerns. Furthermore, Chinese inventories were reported to be drawing fairly rapidly after a few years of subsidy changes that now provide less incentive to plant corn instead of other crops. Speculation about possible increased ethanol mandates have attractive some non-commercial interest in the corn market and at the very least caused short covering during the period.

    Market outlook: We expect corn prices to continue to rise modestly over the next few months. Further downgrades to Brazilian and Argentinean crop estimates are possible and any resolution of the US-China trade dispute will see new demand for US origin grains that should support the market. Two potential caveats should be mentioned though: 1) the African Swine Fever outbreak in China could cause larger scale herd liquidation which would negatively impact the broader animal feed market, and 2) weak poultry economics in the US may cause lower feed consumption until the middle of the year. That said, we expect US corn-planted area to fall again this year as farmers favour crops other than soybeans and corn. This should translate into another global inventory draw this year and therefore higher average prices than we saw in 2018 (when CBOT front month corn futures averaged $3.69 per bushel).

     

    Potash

    Recent developments: Potash prices continued to rise during the last three months of 2018. Spot prices are only a part of this market where large volumes are still traded on 6 and 12-month contracts. That said, it is a good indicator of demand in markets such as Brazil and the US. The US Gulf NOLA price for standard product rose 5.2% during the quarter. In Brazil, granular potash price indices rose 0.6%, but this was after a 22% increase in the first nine months of the year, which followed a 23% rise the prior year. Slightly stronger demand was matched by supply disruption and delayed start-up of new capacity. All in all, this surprised many market participants who expected the continued weak grain price environment to weigh on fertiliser demand.

    Market outlook: In our view potash prices could continue to increase steadily into second quarter of 2019. Some supply disruption and delays from 2018 are still unresolved and the seasonal demand surge before US plantings should keep the market tight. Low inventories in importing countries means continued buying, while Canadian and Russian producers are communicating to customers that they are sold out or fully committed until April. The market is waiting for new mine supply from Russia’s Eurochem, but this volume will be internally consumed by the company’s NPK production plants in the near term. Increased supply from the ramp-up of K+S’ new Bethune mine in Saskatchewan, Canada is also expected, but we believe demand growth will absorb this volume. Clearly, further supply disruptions will cause the market to perform even stronger.