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Natural Resources Indicator

  • Market review

    Market review

    Download PDF Indicator

    In this quarter's edition:
    • Cycle remains favourable for mining equities
       -  Insight from George Cheveley, Portfolio Manager.
    • Detailed insight into select commodities

    Commodities and resource equities were weighed down for part of the second quarter by US-China trade tensions and concern about a global economic slowdown. But they recovered towards quarter end, along with equity markets generally, as the US Federal Reserve (Fed) indicated a dovish shift and a willingness to cut interest rates to support growth. Overall, natural resource stocks and physical commodities were little changed over the quarter, with the MSCI ACWI Select Natural Resources Capped Index gaining 0.9% and the Bloomberg Commodity Index losing -1.2%, in US dollar terms.

    Among industrial metals, iron ore (+37%) surged on better-than-expected demand from Chinese steelmakers and a supply squeeze. In precious metals, gold (+9.1%) had a strong quarter, largely on gains towards quarter end driven by the Fed’s dovish turn, as well as poor economic data and some weakening of the US dollar. Oil producers lost ground, with Brent crude prices declining 2.7% over the three months despite late gains on escalating tension in the Gulf region. Oil continued to be held down by demand-growth concerns fuelled by expectations of an economic slowdown. In agriculture, corn (+18%) and wheat (+15%) both finished well ahead, partly on lowered expectations for crop yields.

    At a glance - our asset class views

    COMMODITY EQUITY
    -- - o + ++ -- - o + ++
      Energy  
      Crude Oil  
      Natural gas  
      Refiners  
    n/a Oil services  
    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  
      Pork  
      Salmon  
      Lumber  
      Pulp  

    Key themes

    • Weaker demand growth may continue to weigh on oil, although supply fundamentals remain uncertain.
    • The environmental sectors offer structural growth opportunities as renewable deployment and electric vehicle sales accelerate.
    • The case for higher gold prices is strengthening as political and economic uncertainty rises.
    • Base metals could trade sideways until a cyclical recovery takes effect, but the risk remains to the upside for many metals.
    • We expect protein markets to be strong, with prices rising across the board.

    Views of Investec Asset Management’s Natural Resources team and reflect preferences within respective asset class. As at 30.06.19.

    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.

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    This document is not for general public distribution. If you are a retail investor and receive it as part of a general circulation, please contact us at +44 (0)20 7597 1900.
    The information discusses general market activity or industry trends and is not intended to be relied upon as a forecast, research or investment advice. The economic and market forecasts presented herein reflect our judgment as at the date shown and are subject to change without notice. These forecasts will be affected by changes in interest rates, general market conditions and other political, social and economic developments. There can be no assurance that these forecasts will be achieved. Past performance should not be taken as a guide to the future, losses may be made. Data is not audited. Investment involves risks: Investors are not certain to make profits. Where index performance is shown, this is for illustrative purposes only. You cannot invest directly in an index. Investec Asset Management does not provide legal and tax advice.
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    Except as otherwise authorised, this information may not be shown, copied, transmitted, or otherwise given to any third party without Investec’s prior written consent. © 2019 Investec Asset Management. All rights reserved. Issued by Investec Asset Management. Issued by Investec Asset Management, issued June 2019.

  • Insights from your PM

    Cycle remains favourable for mining equities

    Insight from George Cheveley
    Portfolio Manager, Natural Resources

    George Cheveley, Portfolio Manager.

    Several catalysts have the potential to drive outperformance of the mining sector over the next few years. Metals prices look more likely to rise than fall from current levels, and mining equities are poised to benefit as miners’ balance sheets are stronger and a focus on cash flows is prevalent.


    Base metals and bulks outlook is finely balanced

    For base and bulk metals, the fundamentals of each commodity will ultimately determine prices. But certain themes are common to all of them.

    The global trend in industrial production, which is the primary driver of demand for base metals and bulks, is for slower growth. Concern over the US-China trade war has combined with uncertainty over automotive sales, as the transition from combustion to electric engines gets underway, to undermine manufacturing expansion in many regions. An infrastructure stimulus in China is offsetting this to a limited extent, which has favoured iron ore and coking coal over base metals, but worries persist that the second half of 2019 may see growth slow further.

    However, we are now eight years from the peak in commodity prices and investment in new supply, and even in sustaining existing supply, has been cut. The effects are being felt. In iron ore, the tailings dam failure in Brazil has been exacerbated by the fact that producers are struggling to increase volumes. In copper and coking coal, disruptions and the low level of new supply have meant volumes are below forecasts.

    The disruption in Brazil caused iron ore prices to outperform enormously in the first half of 2019, rising approximately 60%. Base metals have been mixed, with demand concerns offsetting supply interruptions. For the second half of the year, the key question is whether demand growth will continue to slow or stabilise. A resolution of the US-China trade dispute would see an immediate uplift in prices, particularly for base metals.

    But in the medium term, prices could trade sideways until a cyclical recovery takes effect. The risk, though, remains to the upside for many metals, not least because we are starting a new election cycle in the US and the Chinese government remains committed to maintaining growth.


    Gold price outlook skewed to the upside

    Turning to gold, prices are supported by a number of factors and the case for higher prices is strengthening as political and economic uncertainty rises. The almost complete reversal of US Federal Reserve policy since late last year has been a major driver of the precious metal recently. In November 2018, expectations were still for a number of interest rate cuts this year, but now at least one cut by year end is expected and possibly more. This has led to a record number of bonds trading with a negative yield as markets search for safe havens.

    Stock markets have not been immune to the economic uncertainty and sharp falls in global equity indices in the fourth quarter of 2018 and may this year have prompted rallies in gold and gold equities. Gold has historically been a good diversifier for portfolios as it is uncorrelated to most markets, and recent moves have served to reinforce its diversifying status. Investor interest in gold exchange-trade funds and gold equities has increased as concern has mounted that we are near the peak for general equity markets.

    Gold has historically been a good diversifier for portfolios

    The main headwind for gold prices in recent years has been the strength of the US dollar, which means gold in many other currencies is at record levels, thus deterring buyers in those countries.

    However, the US dollar could turn into a powerful driver of the next move upwards in gold prices as not only investors but also central banks begin to question the status of the greenback as a reserve currency.

    Central bank net purchases of gold in 2018 were the second highest on record — the highest being in 1967 — led by Russia and China. The motivation, at least in part, seems to be to diversify away from US-dollar assets such as treasuries. We believe this is a long term trend: ‘de-dollarisation’ could prove to be a major positive driver of gold prices over the next few decades as governments and individuals look to diversify their reserves and the US dollar loses its status as the pre-eminent safe haven.

    Our medium-term forecast for gold prices has remained at US$1350/oz for a number of years, but we have always acknowledged that the risks of a major move were skewed to the upside. The downside for gold prices has been limited by the cost curve and the willingness of the Chinese and other governments to increase purchases whenever prices have fallen. If we see US dollar weakness, the upside could be considerable.


    Mining equities well supported by strong cashflows and low debt levels

    For mining equities in general, we maintain our view that the outlook is, on balance, far better than many investors perceive. The traumatic sell-off of mining equities between 2011 and 2015 following the end of the commodity supercycle has left major scars, not only on investors but also on the mining companies themselves. This is clearly why, despite reasonable performance by many companies since early 2016, many investors have remained wary of the sector.

    However, with record cash flows, much of which are being returned to shareholders, and much lower debt levels, many mining companies are in the strongest position we have seen for decades.

    If growth stabilises, or perhaps picks up, we would expect a strong rally in base metals and bulks equities. If not, we would expect gold equities to rally sharply. These trends have been very evident in the past year. But we have also noted that the large diversified mining companies have proven to be very defensive, by virtue of their strong balance sheets, high margins and conservative investment plans.

    Large diversified mining companies have proven to be very defensive


    Longer-term outlook remains solid as social contribution becomes more apparent

    Another interesting trend that has emerged this year has been the willingness of mining companies to engage with investors and the wider public on their contribution to society. In recent years, the mining industry has faced a lot of negative press on issues such as safety, child labour, corruption and carbon emissions. These are all important issues. But at the same time, companies are increasingly looking to emphasise the crucial role they have to play in providing resources for the energy transition and the benefits that society receives from the mining sector.

     

    George Cheveley
    Portfolio Manager, Natural Resources

  • 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  

    Oil

    Recent developments: Oil producers lost ground in the second quarter of 2019. Brent crude prices declined 2.7% over the three months, despite late gains partly on escalating tension in the Gulf region. There were other threats to supply in the period, notably falls in Venezuelan and Iranian production. But overall, these concerns were dominated by worries over the demand outlook for oil, with the global economy showing further signs of slowing and the US and China remaining at loggerheads in their trade dispute. After a sharp sell-off at the end of May, oil recovered somewhat in June as the US and China agreed to resume talks, but not enough to recoup losses earlier in the period.

    Market outlook: The data has started to reflect our continued concerns that a strong US dollar, combined with an escalating trade war, is dampening oil demand growth. While the increasingly militarised dispute between the US and Iran has heightened geopolitical risk, we view the muted market reaction to events as a sign of fundamental supply/demand softness. However, we recognise that there are currently a large number of unknowns, each of which could push the market into considerable over- or undersupply in the near term.

     

    Environmental & renewable energy

    Recent developments: The path to a lower carbon future continued to reshape global industry sectors in the second quarter, but the dynamics across the three key themes of decarbonisation – renewable energy, resource efficiency and electrification – remained complex, reminding everyone that they require careful insight, risk awareness and active decision-making.

    The world’s renewable power generation capacity continues to grow, according to energy company BP, rising by almost 15% over 2018. Wind and solar now provide 9% of the world’s electricity. It also emerged this quarter that renewable energy production capacity in the US has overtaken coal for the first time.

    In Europe in particular we have seen a number of very progressive policy announcements. Britain became the first major economy to make a legislative commitment to reaching net zero carbon emissions by 2050. There are now 19 member states, representing 81% of total EU greenhouse gas emissions (GHGs) emissions, that have indicated support for a net-zero GHG target, the implementation of which would be a significant driver of revenue growth for the companies exposed to decarbonisation of the energy system. The electric vehicle (EV) value chain had a more complicated start to the year. Weakness in the general automotive market, cuts to EV subsidies in China and decelerating sales growth at Tesla all led to significant underperformance in EV-related equities.

    Market outlook: The EV market is one to watch in the coming months. We expect a significant acceleration in EV sales as we move into 2020, driven by the launch of new models with more attractive ranges and price characteristics. A key driver of the EV market is higher European emissions standards: by the end of 2021, automotive manufacturers must ensure that the average emissions of their new cars sold in Europe are 95g/km or less, compared to average emissions in 2018 of 120g/km. EVs receive double credits (i.e., manufacturers can count them twice in calculating fleet-level emissions, so offering more EVs will help them reach their target), which is driving model launches. BMW has brought forward its electric car strategy, aiming to roll out 25 electric or hybrid models by 2023, two years earlier than planned. Toyota has also accelerated EV launches.

  • 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  

    Iron ore

    Recent developments: Iron ore prices continued their upward march in June, driven by supply tightness as Chinese port stocks fell sharply. Prices are now around US$115 a tonne (t), the highest since April 2014. Chinese steel production continues to hit new highs and is running at an annualised rate of around 1 billion tonnes a year. Supply from Brazil has been hit by closures following the tailings dam collapse at Vale’s Brumadinho mine. In addition, a cyclone in Western Australia in March and quality problems at Rio Tinto’s mines have limited Australian production growth. Rio Tinto has reduced its production guidance this year by around 15 million tonnes. Years of tight cost control have led to little flexibility and we understand that BHP has warned some steel mills that it cannot guarantee the usual quality on a number of shipments. The forward curve is still pricing iron ore below US$80/t in 2020, so current prices are not seen as sustainable. But this is limiting the marginal supply response as hedging forward prices is difficult, with little liquidity.

    Outlook: As peak steel-production season ends, the consensus is that iron ore prices will fall back below US$100/t. Supply from Brazil has recovered from the lows in April and Australian production is back at the levels of a year ago. Chinese steel production is expected to decline, if only for seasonal reasons, and marginal iron ore supply will come in gradually, especially if prices remain at these elevated levels. However, after pushing hard to meet full-year 2019 targets, Fortescue and BHP shipments are likely to fall back in July as maintenance is undertaken. Longer term, Anglo American may struggle to get approval to raise its tailings dam in Brazil, which would mean it would have to slow, or even stop, production in a year’s time.

    With Chinese steel margins still positive, production is unlikely to slow sharply, and US and European production seems to have passed a low point. Thus, demand may not wane as quickly as some forecasts suggest. A decline in iron ore prices still seems the most likely outcome, but the risks that they will hold up higher than forecast appear substantial.

     

    Copper

    Recent developments: Copper prices have moved sideways year-to-date, with the metal trading at just below US$6,000/t, which is where it started the year. Rising bullishness that began around Chinese New Year in February saw prices move up to US$6,500/t in March/April, but the US-China trade war and poor manufacturing data globally reversed these gains. Supply has generally underperformed this year as disruptions have been greater than normal, with Glencore struggling in the Democratic Republic of Congo and Codelco experiencing challenges in Chile. However, demand growth has also been lacklustre, leaving the market close to balance and reasonably well supplied. With macroeconomic indicators weakening, speculators are more inclined to sell copper as a hedge and fundamentals are not tight enough to reverse this trend. Unless there is another major disruption or a sharp recovery in demand, the copper market looks well supplied for at least two years.

    Outlook: The long-term outlook for copper remains very positive. Demand growth should be robust as the world electrifies, while supply has been curtailed by cuts to producers’ capital expenditures. However, longer-term optimism has coloured analysts’ shorter-term forecasts, which remain consistently above current spot prices. This has led to a number of earnings downgrades for copper companies in the past year as spot prices have not met these higher forecasts. While we have sympathy with the lower supply-growth forecasts, we also note that new projects are being sanctioned – e.g., Quellaveco and QB2, in Peru and Chile respectively – based on higher incentive prices. After many years of strong demand growth driven by China’s industrialisation and strong consumption in the West, the risk is that demand growth slows in the short term and the supply deficits do not materialise. Of course, lower prices will delay some projects, the market will eventually move into deficit and, with stocks not particularly high, prices will then react. But this could take some years. Copper’s cyclical recovery has been predicted for a number of years and the risk is that any further delays could lead to a price fall first.

  • 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: Gold prices fluctuated around US$1,300 per ounce (oz) for the first two months of the second quarter as concern over the outlook for the global economy waxed and waned, and as investors alternately edged towards risk assets or perceived havens. But the yellow metal broke upwards towards the end of the period, rising 8% in June to US$1,409/oz, having touched US$1,440/oz at one point in the month. It was the first time gold had been over US$1,400/oz in almost six years. The cause was dovish commentary from the Fed, poor economic data and some weakening of the US dollar from its May highs.

    Overall, gold rose 9.1% in the second quarter, outperforming the FTSE 100 (+2.0% in US dollar terms) and the S&smp;P 500 (+3.8% in US dollar terms). Investor demand for gold was strong, with exchange traded fund (ETF) holdings rising to 74.2 million ounces at the end of the second quarter from 72.3 million ounces at the start. Net speculative positions on the Comex spiked to approximately 23.7 million ounces at the end of June from 12.0 million ounces at the end of March, the highest level since August 2017.

    Outlook: The main headwind for gold prices in recent years has been the strength of the US dollar, which means gold in many other currencies is at record levels, deterring buyers in those countries. Though the dollar remains much stronger than in early 2018, any weakening could spur gold prices higher in the second half of this year. More broadly, we believe the downside for gold is limited, given support for the precious metal from slowing global growth and equity market volatility.

     

    Silver

    Recent developments: Silver prices have continued to lag gold prices this year, falling 1.9% year-to-date to just over US$15 per ounce (oz) compared to gold’s 9.9% rise to US$1,409/oz. This has been the trend for a number of years now. The gold/silver ratio has moved from a low of 32x in April 2011 to 93x today, the highest level since 1991 when it peaked at 99.7x (when gold was US$360/oz and silver US$3.61/oz). Of course, there is no fundamental reason why silver and gold prices should be linked, though both act as safe havens and have active coin markets. Silver has arguably suffered in the past 20 years or so from weaker industrial demand. It is no longer used in X-rays and other photography because of the switch to digital; in turn, this has led to an increased supply of silver recycled from these sources. Meanwhile, US silver coin demand has slumped by over two thirds since President Trump’s election in 2016. Silver coin buyers are largely Trump supporters and thus see less need for this safe haven. On the supply side, production has remained fairly stable over the past four years, supported by a rebound in lead and zinc prices. Silver is a common by-product of mining these metals.

    Outlook: With gold prices breaking upwards, the case for rising silver prices continues to strengthen. In the short term, silver tends to react to major shifts in gold with a slight delay, so a move higher might be expected — especially as gold’s move was prompted by the prospect of falling rates and potentially more easing, which has typically pushed up silver. Industrial and coin demand has been weak in the past few years, but increased photovoltaic production to support growing solar usage is leading to a recovery in industrial demand, while rising gold prices are likely to prompt investment demand. A fall in cryptocurrency valuations has also helped silver to a small extent, as these alternatives to the precious metal have become less attractive. We are positive on gold prices currently and believe silver can match the yellow metal. Silver may even begin to outperform over the next 12 to 24 months.

  • 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  
      Pork  
      Salmon  
      Lumber  
      Pulp  

    Corn

    Recent developments: Corn prices rose sharply in the second quarter, rallying 18% to finish at US$4.20 per bushel (as measured by CBOT front-month futures). Severe and continuous flooding in the US corn belt made it impossible for farmers to follow their normal plantings regime. The resulting supply concerns more than offset weaker demand for corn during the period, which was caused by US-China trade tensions as well as weak animal feed sector demand. Fears of a poor US crop were fuelled not only by a decline in planted area due to the flooding and persistent rainfall, but also because of lower yield-expectations from shorter-cycle corn, which many farmers preferred due to the delay in getting planting done in those areas where it was still possible.

    Outlook: We expect corn prices to moderate over the rest of the year, drifting lower towards US$4 per bushel, assuming we have normal summer temperatures in the US Midwest over the remainder of July and August. The key pollination period is coming up, which will largely determine the crop size given that the planted area is now known. If the US and China agree a trade deal, we may see a temporary bid for US corn and soybeans. But the fact that Brazil has had a very successful ‘safrinha’ (literally, ‘little harvest’) second-corn crop will make countries of origin compete for the export market, especially if we see weakness in the Brazilian real. If feed demand picks up due to herd re-building following the African swine fever crises in China and Vietnam, we anticipate better pricing. But that is only expected to occur next year.

     

    Lumber

    Recent developments: Prices recovered in June after a dismal decline between February and May. Front-month futures ended the quarter 5% higher at US$379 per thousand board feet, after significant capacity shutdowns were announced in late May and early June. Demand has generally been much weaker than expected, partly due to poor weather; and with declining fibre availability in British Columbia, many producers had to make the hard decision to permanently shut down lumber plants in the province. That stemmed the price decline and caused some restocking by wholesalers during June, causing lumber to rally by over 30% from the troughs.

    Outlook: With demand poorer than anticipated so far this year, we had to lower our expectations for second half prices. We expect some of the demand to be transferred to the autumn period as housing starts planned for spring were postponed by heavy rains. However, some of those plans will probably now be cancelled or postponed into next year. A cut in interest rates would stimulate demand for new home construction somewhat, but we believe continued supply discipline will be required to drive prices upwards of US$400. That remains our base case, given the willingness and ability of the industry to idle and shut down uneconomic capacity. We therefore expect prices to gradually rise between August and November.

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