Natural Resources: Investment Insights, Q4 2013

Gold
Evy Hambro

Over the quarter gold trended higher as support from the physical market, the stabilisation of ETF flows, more positive futures positioning and tensions in the Middle East prompted some safe haven interest.

The World Gold Council released their Q2 demand trends during the quarter. The wave of outflows from ETFs amounted to 402 tonnes, applying, alongside selling in the futures markets, considerable downward pressure to the gold price. Physical demand rose in dramatic style in response to the price falls. Jewellery demand reached multi-year highs, with India and China the primary contributors. Over the first six months of the year, total consumer demand in each country (jewellery, bars and coins) was nearly 50% ahead of the same period in 2012. This price sensitive response is very encouraging to see. During the gold price rout in April, the premium consumers were willing to pay for physical gold on the Shanghai Gold Exchange leapt to around $40/oz. The premium has since lowered to around $13/oz – a reminder that truly price sensitive demand should be expected to wane as prices recover. They also reported that China’s gold demand could reach 1,000 tonnes in 2013. At this level China would overtake India as the largest consumer of the yellow metal.

Fund Manager View:

Through to the end of the year, stronger physical demand for gold - from gold-gifting festivals, the Indian wedding season, Christmas gifting and Chinese New Year – should counterbalance potential selling pressure from financial investors. Any signs of faltering US economic growth should also be a catalyst for flows back into gold. It is important to note as well, that the full ramifications of quantitative easing have yet to play out, the most pertinent of which could be rising inflation – typically a strong environment for gold.

Gold equities should be responsive to any gold price momentum, given where valuations and margins currently stand. Gold equities have exhibited a beta of 1.8 to the gold price this year and the relationship has held in a rising market as well as falling one. The significant structural change in the industry that is taking place is also encouraging. New management teams, improving capital discipline and operational efficiency, and a greater willingness to return to capital to shareholders are increasingly evident and hold the key to rebuilding investor trust in our view.

 

 

Mining

Evy Hambro, Catherine Raw

Global equities had a good quarter driven by improvements in the macroeconomic landscape. The US Federal Reserve delaying the ‘tapering’ of its Quantitative Easing programme also led to an overall increase in risk appetite which fuelled the performance of riskier assets. On the macro-economic front, data from the US continued to gradually recover - although the job market remains soft - while European indicators surprised on the upside with PMIs coming in above 50. Chinese data interrupted its previous downward trend and showed encouraging signs towards the end of the period with industrial production, investment growth, electricity production and PMIs coming above expectations.

Encouraging data from China and the surge in risk appetite over the quarter was positive for most metals. Copper, aluminium, zinc and lead added 8.3%, 3.9%, 3.3% and 2.5% respectively over the quarter. Iron ore held up better than investors expected as Chinese inventories of both iron ore and steel remained low while we continue to see robust demand from construction and infrastructure. Towards the end of the period, iron ore inventories increased as more supply came into the market, but prices remained resilient and managed to stay above $130/t for most of the period. Iron ore prices added approximately 13% over the quarter to finish at $133/t.

Fund Manager View:

The mining sector and other cyclical areas have struggled over the last two years as the market has downgraded global growth expectations.

In the medium term, commodity prices are likely to remain range-bound as supply and demand have come closer into balance. We expect greater tightness to return for certain commodities, but for now mining companies need to be focused on capital discipline, operational efficiency and growing margins through cost control. In such an environment, well-managed mining businesses should be able to generate free cash flow, be in a strong position to return cash to shareholders and should see their share prices rewarded as a result.

 

 

Energy

Robin Bachelor, Poppy Allonby

Brent crude appreciated 5.4% to finish the quarter at $108/barrel. The modest global recovery has helped underpin crude prices this year, but supply disruption and risk have also had key roles to play. Outages in Libya, Nigeria, Iraq, Sudan and elsewhere have taken a meaningful volume of oil off the market. According to the International Energy Agency, production in Libya, for example, plunged to a post-war low of 150kb/d in early September, well below its post-war peak of 1.5mb/d in July 2012.

The risk of further supply disruption has also added a premium to the oil price. Conflict in Syria, tension elsewhere in the Middle East and North Africa region and the fear of contagion contributed to a 7.2% rise in Brent in August. Progressive talks between the US and Iran – including the first telephone conversation between premiers of the two countries since 1979 – and the US and Russia over Syrian disarmament eased concerns in September and the oil price pulled back accordingly.

WTI crude outpaced Brent over the period, particularly in the early stages. At the end of the quarter, the spread between the two stood at just under $6/barrel. At the start of the year, WTI traded at nearly a $20 discount. The steady momentum in the US economy, a ramp up in refinery activity post a maintenance period and flooding in Canada which reduced the oil flow from the country into America have all contributed to the narrowing.

Fund Manager View:

We expect international oil prices to remain range bound in 2013. Global economic activity is translating into modest demand growth. The high marginal cost of production for oil, OPEC’s desire for prices to sit within a relatively high range and the on-going risk of supply disruption should all be broadly supportive of oil prices remaining in in their current trading range.

In the longer term, the demand-side outlook for oil looks robust. Non-OECD countries currently make up less than half of global oil demand, but should provide almost all of the expected growth in demand. Energy consumption per person in China is, for example, far behind the levels seen in the US, and with the Chinese economy slowly transitioning from an investment-led to a more consumption driven economy, there is significant scope for the increased use of oil and natural gas.