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Natural Resources Indicator

  • Market review

    Market review

    Download PDF Indicator

    In this quarter's edition:
    • Evolution of the 'big oil' business model
       -  Insight from Tom Nelson, Portfolio Manager.
    • Detailed insight into select commodities

    Commodities and resource equities got off to a solid start in 2019, tracking global equity markets higher. After a difficult end to 2018, the asset class benefited from progress in trade talks between the US and China, quantitative easing measures in China and a more dovish tone in general from the main central banks. While projections for global growth were re-based lower over the quarter, these support mechanisms proved more beneficial to the individual demand dynamics for most metals. Natural resource equities outperformed their physical peers, with the MSCI ACWI Select Natural Resources Capped Index returning 12.8% versus 6.3% from the Bloomberg Commodity Index, in US dollar terms.

    The first quarter of 2019 saw a strong recovery in crude oil prices. Having fallen over 40% from $86/bl to $50/bl in the fourth quarter, Brent crude rose steadily through the quarter to reach $68/bl by the end of March. OPEC cuts, continued chaos in Venezuela, and robust global demand provided a supportive fundamental backdrop for the oil price. In precious metals, gold was fairly range bound. There were swings along the way as trade talks ebbed and flowed, but it ended the quarter about where it started at just under US$1,300 per ounce. Industrial metals benefited from the improvement in relations between the US and China, with most metals linked to steel production rallying well, in addition to copper. In agriculture, grains were down, while proteins rallied.

    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

    • OPEC+ production cuts, in addition to supply concerns in other countries, could push prices higher in the near term.
    • Base metals and bulks will remain volatile as trade talks ebb and flow over the short term.
    • Gold should remain supported by slower global growth and a dovish US Federal Reserve.
    • We expect agriculture and basic foodstuffs markets to recover in 2019 as supply growth wanes.

    Views of Investec Asset Management’s Natural Resources team and reflect preferences within respective asset class. As at 31.03.19.

    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.

    Important Information

    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. The information contained in this document is believed to be reliable but may be inaccurate or incomplete. Any opinions stated are honestly held but are not guaranteed and should not be relied upon.
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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 May 2019.

  • Insights from your PM

    Evolution of the ‘big oil’ business model

    Insight from Tom Nelson
    Portfolio Manager, Natural Resources

    Tom Nelson, Portfolio Manager.

    The oil price collapse from mid-2014 ushered in the latest business model of ‘value over volume’ for ‘big oil’. We believe it is the long-term threat of climate change, electrification and renewable energy that will dictate the next. Read more about the energy transition in our recently published research entitled Energy 3.0.

    Financial necessity forced the majors (Exxon Mobil, Royal Dutch Shell, Chevron, BP, TOTAL, Eni and Statoil) to cut capital expenditures on oil and gas investments by almost half, as oil prices tumbled from $115 per barrel (bl) in June 2014, to $47/bl by January 2015 and on to $27/bl by January 2016. However, the repercussions were more profound than the headline figures. Internally, staff at the majors found new and innovative ways to do more for less. Externally, service costs fell dramatically as long-life physical assets quickly became oversupplied and taxes on oil production eased, having steadily crept higher as governments sought a higher share of profit (sometimes as high as 90%). Host countries, like service companies, had to compete for the limited capital available.

    The results are impressive. With oil prices averaging around $72/bl in 2018, the majors generated a return on capital employed (ROCE) of around 8%, which appears to be higher than their cost of capital, for the first time since 2012. We believe ROCE will rise to around 10% in 2019. Additionally, free cash flow yields are approaching 10%, comfortably covering dividend yields that averaged over 5% in 2018. Again, the first time they have done this since oil prices collapsed almost five years ago. The financial results are testament to the considerable self-help performed by these companies, but it also demonstrates the importance of not chasing production volume. In the run-up to 2014 the majors, motivated by production growth, competed for the same mega-projects resulting in unattractive fiscal terms, rampant cost inflation and poor project execution.

    But yesteryear’s business model of volume maximisation should be permanently archived by the energy transition, not just temporarily by lower oil prices. While it is potentially too early and too difficult to predict peak oil demand with any accuracy, the reality for the oil majors is that the adoption of low-carbon technologies will ultimately slow and decrease demand for oil over time – and very likely within the lifetime of any new oil field.

    To their credit, the majors, particularly those in Europe, are acutely aware of this. All European majors now report Scope 3 carbon emissions (the total emissions created by using the oil and gas they produce), they include a carbon price or taxation in economic decision-making and have started to invest in new energies. While these business models are yet to be fully defined, we are starting to see different strategies emerge. We believe two will become more prevalent in the coming years:

    • 'Big energy' – The transition from ‘big oil’ to ‘big energy’ will include diversification away from oil and gas production, into power generation and adopting a more customer-centric business model previously held by utilities.
    • Specialist – While some revenue diversification is likely, the specialist strategy will continue to focus on oil and gas production. This strategy will require a focus on low-cost production, value-creation and will be underpinned by shareholder returns, both dividend and buybacks. Growth will be measured on a per-share basis, while absolute production levels may shrink over time.
    There are advantages and disadvantages to both strategies. The ‘big energy’ strategy may boost growth and enlarge the customer base but comes with the risks of developing new, less profitable business lines and the potential for shareholder rotation. The specialist strategy should come with less operational risk but increases regulatory and social risk. Regardless, we believe the majors each need to develop a clear and actionable strategy for the energy transition. We have thus developed an investment framework to help identify the companies most likely to win from the energy transition in both the old and new energy sectors.

     


    In addition to developing a clear strategy, we believe the majors must act to limit a regulatory or social backlash in the near term. To do this, we believe they need to deliver on commitments to end unnecessary emissions from non-safety related flaring or methane leaks during gas production and reduce direct carbon emissions where possible.

    To this end, progress is being made. We were encouraged to see Shell adopt environmental metrics in management’s pay plans, while ExxonMobil became one of 2018’s largest corporate purchasers of clean energy after agreeing a 500 megawatt power purchasing agreement (PPA) with Ørsted to provide wind and solar power for its oil and gas extraction activities in the Permian basin. Most impactful of all may be ENI’s commitment to carbon-neutral Scope 1 operations by 2030, potentially the clearest example of the ‘specialist’ strategy. We expect to see much more of this.


    Investec Asset Management Global Energy investment framework

    chart

    Source: Investec Asset Management, December 2018. This is not a buy, sell or hold recommendation for any particular security.


    The energy transition will happen over a long period of time, but the oil majors need to move very quickly to position themselves for a period of profound industrial change. Investor attitudes are changing and the social licence of hydrocarbon companies is under threat. Nevertheless, we believe that existing energy companies have a vital role to play in the energy transition; low-cost oil and natural gas will form part of our energy supply for decades to come and we as investors must engage actively with these companies to ensure that their business is managed responsibly. With an evolving industrial strategy, a continued focus on returns over growth, and a clear commitment to return cash to shareholders, big oil can be a winner from the energy transition.

     

    Tom Nelson
    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  
    n/a Wind  
    n/a Solar  

    Oil

    Recent developments: The first quarter of 2019 saw a strong recovery in crude oil prices. Having fallen over 40% from $86/bl in early October to $50/bl in late December, Brent crude rose steadily through the quarter to reach $68/bl by the end of March. Given the v-shaped nature of the oil price recovery, consistent with global equities and many other asset classes, the average price level for crude oil in the first quarter (Q1) of 2019 versus Q4 of 2018 was not markedly different: $64/bl in Q1, compared to $69 in Q4. OPEC cuts, continued chaos in Venezuela, and robust global demand provided a supportive fundamental backdrop for the oil price.

    Market outlook: Oil markets, buoyed by a seemingly strong commitment from Saudi Arabia to stick to the agreed cuts, have continued to tighten through the first quarter of 2019, reversing much of the inventory build that took place in the fourth quarter of 2018. Saudi Arabia’s commitment to the supply cuts was further emphasised by its decision, alongside Russia and other OPEC countries, to cancel a planned meeting in April in favour of rolling over cuts to June. This commitment is despite looming supply concerns from Venezuela and from Iran where US waivers are set to expire, potentially resulting in a further curtailment to the country’s production.

    News of escalating violence in Libya, which produces 1.1 million bl/d, offers another supply concern. We believe these risks could result in further upward pressure to oil prices in the near-term. However, we don’t expect Saudi Arabia, which has a large amount of spare capacity, to allow prices to reach levels that either derail demand or tempt US Shale producers to break their new-found capital discipline.

     

    Environmental & renewable energy

    Recent developments: The solar sector started 2019 strongly as module, cell and polysilicon prices all experienced flat prices following significant declines in 2018. The fall in prices last year was driven by a change in Chinese policy (mid-year) to reduce subsidies which had a short-term impact on demand. We saw a strong rebound in solar equities in the first quarter as 2018 demand finished higher than many had expected and the outlook for 2019 was positive as demand from many smaller markets grew as the cost of solar is now at or below grid parity in many parts of the world. According to PV InfoLink, strong first-quarter demand came from India, Japan, US, Vietnam, Australia, Ukraine, Pakistan, Brazil, Spain and Egypt, highlighting the breadth of countries seeing growth in solar projects. China, the largest producer and consumer of solar modules, remains a difficult market to forecast in the short term as we have seen a raft of government documents and draft policies that have kept many commentators struggling to forecast short-term demand. The Chinese government has laid out a detailed process for local/provincial governments to aggregate and prioritise solar projects based on numerous factors including cost. The National Energy Administration (NEA) in turn will then rank the projects and announce the approved list. What remains unclear is the timing of this process, something we will be watching closely over the coming months.

    Market outlook: China represented approximately 40% of global solar demand in 2018, down from over 50% only a year before. With numerous unknowns surrounding Chinese demand we remain cautious in the near term and expect the second half of this year to be stronger than the first as policy and timings become clearer. However, many other markets are positive and growing in importance and we expect strong demand (potentially +20% year-on-year from the rest of the world) in the higher quality Mono modules from the US, Europe, Middle East and many other regions in 2019. As technology continues to improve, we expect another year of lower costs and rising new builds in the sector, something that is not new. With this continuing trend, solar is now the cheapest form of energy in many parts of the world and we remain positive on the cost and technology leaders within the sector over the long term.

  • 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: Consensus forecasts for iron ore started the year predicting a gradual decline in prices to around $60/t CIF China, 62% grade. However, the tragic tailings dam collapse at one of Vale’s mines in Brumadinho, Brazil has changed its short and long-term outlook as the authorities and mining companies globally react to the terrible accident and loss of many lives, with over 300 people dead or still missing. In the short term, mines totalling 93 million tonnes per year (MTPY)(just over 6% of global seaborne supply) of iron ore production have been closed in Brazil, some temporarily. While Vale was maintaining shipments from inventories, these have now been run down and exports have fallen off in recent weeks to reflect the closures. We expect around 50 MTPY to be lost from Vale’s supply this year as some will be made up from inventories and capacity at its other mines and some capacity may be reopened in due course. In the meantime, iron ore prices have moved up to over $90/t as cyclones in Australia have also caused supply disruptions just as steel demand hits peak levels at the start of the summer construction season in the northern hemisphere.

    Market outlook: While steel demand growth is expected to slow this year from last year’s strong growth, the infrastructure stimulus in China and continuing strong US economy look likely to support some small increase in demand. Scrap will feed some of this, but iron ore demand looks set to be at least equal to 2018. With the supply reduction from Brazil, prices will be supported at higher than normal levels for some time. However, prices above $90/t will certainly attract supplies from marginal producers and the other large miners will look to squeeze extra tonnes from their systems – though this has not been too successful so far. As demand weakens seasonally in the second half of the year, prices may well weaken, although we believe an average price of $70/t or above is still possible in the second half and even into 2020, if steel demand holds up. Longer term, the rules around tailings dam construction and monitoring will be tightened further and permitting will become longer which will inevitably raise the long-term price for iron ore, making those producers with long-life assets already in production more valuable.

     

    Nickel

    Recent developments: Nickel had a strong start to 2019 after falling to unsustainable lows around US$10,700/tn (tn), as the market focused on low-cost nickel pig iron production (NPI) coming from Indonesia and China. Stainless steel production (70% of total demand) fell at the start of the year, but nickel prices were well into the bottom of the cost curve below US$11,000/tn. Therefore, with few, if any, operations being profitable (creating no incentive for supply), prices quickly rebounded, finishing the period at more sustainable levels around US$13,000/tn.

    Market outlook: Nickel could come under pressure in the short term, with combined NPI production from China and Indonesia set to grow another 21% (compared to 25% last year). However, the deficit appears likely to persist given the significant underinvestment in supply historically. We remain positive over the medium term, given the deficit and strong projected growth from nickel use in batteries (which also requires a higher quality nickel product – NPI is typically lower grade), which could accelerate as more electric vehicle manufacturers shift towards nickel rich chemistries, given better energy density and vehicle range. We also believe stainless steel production should recover over the rest of the year, as evidenced by stainless mills reporting strong orders for the second quarter.

  • Precious metals

    Portfolio positioning snapshot

    An overview of our positioning in a selection of commodities

    Precious metals

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

    Gold

    Recent developments: Gold started the quarter well, rallying to a high of US$1,341 per ounce in mid-February – its highest level since April 2018. Gains were attributable to a markedly more dovish tone from the Fed since the start of the year. Trade tensions dominated the headlines again this quarter and helped to support gold prices. Demand from central banks also appear to be strong, particularly from Russia, Kazakhstan and China. Volatility noticeably picked up in March. The tide started to turn with regards to trade talks, as renewed optimism started to creep into proceedings. This served to lift investor confidence in riskier assets, which weighed on the gold price. However, further caution from the Fed over global growth forecasts created sufficient investor concern to see prices rally once more into quarter-end. Prices dropped as the quarter-end drew in, with no clear catalyst for this move.

    Investor demand for gold rose over the quarter, with exchange traded fund (ETF) holdings rising to 72.3 million ounces from 71.1 million ounces. Net speculative positions on the Comex rose from approximately 7.6 million ounces at the end of December to a long of approximately 12.0 million ounces by end-March.

    Market outlook: We believe there is a strong case for higher prices over the coming year. The rapid change in consensus forecasts on US Federal Reserve interest rates – the probability of a rate cut by early 2020 is now almost 60% – is a major support for gold prices, not least because it will put pressure on the US dollar. Even if the US dollar does not weaken dramatically, or even if it just stops strengthening, then markets are likely to focus on other factors such as possible rate cuts or possibly inflation.

     

    Platinum group metals (PGMS)

    Recent developments: PGMs consist of several metals, but platinum, palladium and rhodium are the largest and key ingredients in auto-catalysts. Prices for palladium hit a record $1,600/oz earlier this year before falling back to $1,376/oz at the end of the period, still up 9% year-to-date and 42% year-on-year (y/y). Meanwhile, platinum prices which are down 4% y/y, have risen 12% year to date to reach $900/oz and rhodium prices have lifted 22% year to date to $3,000/oz and are up 44% y/y. This price volatility is due to a variety of factors. Strong demand, particularly for gasoline cars, has driven strong growth in palladium and rhodium consumption, while a decline in diesel car purchases following the emissions scandal, has held back platinum usage. Palladium has been in deficit for five years but only in the past year has the tightness been felt as stocks were so high, while platinum remains in a modest surplus though stock levels never got as large. In the short term, deficits look set to persist and could be exacerbated by supply disruptions, but longer term the transition to Electric Vehicles (EVs) is casting a long shadow over the whole industry.

    Market outlook: With a South African general election on 8 May and the takeover of Lonmin by Sibanye Stillwater (which wants to cut 7,000 jobs) likely to be approved by around June, the potential for strikes in South African platinum mines is higher than normal. AMCU, one of the main mining unions, has already been on strike for over four months at Sibanye’s gold mines. Sibanye also raised money recently, by issuing shares and selling forward some gold, to shore up its balance sheet in case of a strike in its platinum mines. Any disruptions in South Africa’s mines will hit platinum and rhodium supply the most but will also affect palladium supply to a lesser extent. However, as palladium market is already tight, prices for all three metals would most likely spike. Longer term, the industry faces the threat of the transition to EVs and the decline of the internal combustion engine. But, as often happens, such a threat discourages investment in new supply which in turn leads to price spikes in the shorter term. We believe volatility will continue in this sector for some while and could see major supply issues if there are bad strikes in South Africa in coming 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  
      Salmon  
      Lumber  
      OSB  
      Pulp  

    Salmon

    Recent developments: Salmon prices recovered well recently with the active contract in Fish Pool futures rallying 8.2% during March. Prices rose 7.6% during the first quarter and are currently trading at record levels for this time of year, at around 69 Norwegian krone per kilogram. Supply during the first quarter has lagged market expectations, with Norwegian exports only up 3.1% year-to-date from a relatively low base. Chilean supply growth has moderated from high levels in 2018. Demand indications were strong, although some buying has been postponed to the second quarter with a late Easter period this year. With meat prices rising during the quarter, salmon promotions in supermarkets have been more prevalent.

    Market outlook: We believe prices may continue rising due to improved seasonal demand over the next few months. Consumption trends in China and the US should continue to support prices into the summer period. We see some downside risk to European retailer buying if prices move too high, but at current levels the anecdotal evidence is that salmon retailer margins are still positive. Over the remainder of 2019, the broader protein sector should see higher demand, driven by the need to replace pork in the diet. The Chinese hog herd and pork production is falling rapidly due to African Swine Fever that started sweeping through the country over a year ago.

     

    Nitrogen

    Recent developments: Nitrogen fertiliser prices, as measured by urea and ammonia futures, fell during the first quarter, although some recovery was seen from the lows in early March. Urea front month futures fell 8.1% in the three-month period despite a 5.6% rise since the end of February, to end the quarter at $249 per short tonne. Northern Hemisphere winter is usually the low season in terms of demand, but this year has been more extreme than normal. The extreme cold in the US Midwest was followed by flooding during the second half of March, which disrupted river, railway and road transport and meant that the supply chain could not restock, even if dealers wanted to acquire product. Europe has similarly seen a late start to the spring planting season which means dealers have not rushed to ramp-up inventories.

    Market outlook: The recent weather extremes need to be put into context. The impact of the US Midwest flooding, which came after a fortnight of freezing conditions and was followed by blizzards in certain areas, effected many parts of the fertiliser industry. From a demand perspective, near-term application of nitrogen and other inputs obviously stalled. Actual production was not so much disrupted as was the distribution, logistics and shipping segments of the supply chain. So even if there was some demand (in the Southern states or from export markets for instance), producers were not able to make the sale because delivery has been impossible for several weeks. In our view, this will create a potential inventory overhang that may take several quarters to correct. We therefore believe prices will take longer to trend up to $300 a short tonne, which may only happen in the fourth quarter of 2019.