Market review
–Metals and minerals prices generally rebounded from recent reverses. Gold regained some of its recent losses, finishing up 7.3%over the month. Palladium and platinum also showed signs of improvement, rising 10.6% and 8.5% respectively, on expectations of improved industrial demand in autocatalysts.
–Iron ore led price performance in the industrial commodity arena to finish 11.5% higher. The rise reflected better global economic sentiment,as well as draw downs in Chinese steel and iron ore stocks.
–US economic recovery, even if more muted than previous recoveries, remains on track with GDP expanding at a better-than-expected annual rate of 1.7% over the June quarter. Residential fixed investment increased by 13.4%, a sign that housing continues to rebound, which is positive for commodity demand. China was also a positive influence. The country’s new leadership responded to fears about China’s economic health by emphasising its intention to defend target GDP growth rates.
–At the same time, firmer steel prices in China encouraged iron ore purchases amid limited availability of spot cargoes. Recent heavy rains in Western Australia’s iron ore rich Pilbara region also contributed to better prices.
–Base metal prices climbed too: copper (+1.9%), aluminium (+1.7%), nickel (+1.2%) and lead (+0.9%). Zinc was something of an outlier as the price fell (-0.5%).
–Oil (+6.4%) rose on the back of Middle East unrest coupled with an improving global economic outlook. Although Egypt is not a big oil producer or exporter, the Suez Canal and the Sumed pipeline are both important transit routes for global crude flows from the Middle East.
Fund activity
–We sold positions in junior mining companies Blackthorn Resources, Gryphon Minerals,
PMI Gold and Resource Generation. Their balance sheets are likely to become increasingly pressured and all four companies might need to secure new funding, which we believe could be problematic in the current environment. Financiers have become cautious about smaller mining stocks with African exposure.
– Blackthorn is active in zinc development in Burkina Faso and copper in Zambia, while counterparts Gryphon Minerals and PMI Gold have gold projects in Burkina Faso and Ghana, respectively. Resource Generation is involved in thermal coal in South Africa.
– By contrast, we increased our position in the world’s largest silver producer Mexican-based Fresnillo, China’s largest coal company China Shenhua, and US palladium and platinum producer Stillwater Mining.
–Fresnillo is a large, low cost silver producer with a strong growth profile underpinned by balance sheet strength.
– China Shenhua offers a compelling value opportunity in our judgment. Its share price has corrected significantly and current market pessimism virtually discounts the prospect of any improvement in thermal coal pricing, offering an excellent opportunity to add to our position in this high quality, low cost industry champion.
–Our research suggests that Stillwater Mining is well-placed to benefit from the global trend towards tighter vehicles emission legislation. Palladium is used in vehicle autocatalysts to convert three harmful compounds — carbon monoxide, hydrocarbons and nitrogen oxides —into harmless ones. The world’s major palladium resources are located in Russia and South Africa, countries associated with a degree of investment and governance uncertainty. Stillwater, by comparison, offers industrial customers greater supply security with its US produced palladium.
Market outlook and fund positioning
–Large swings between overblown optimism and excessive pessimism are features of the global resources industry. In good times, capacity gets ramped up, companies go on buying sprees and low quality/high cost assets get developed. Widespread excitement can sweep investors into thinking that good times can be virtually indefinite.
–On the other hand, when the industry is running at a somewhat slower pace, companies cut capacity, reduce capital expenditure and cut exploration budgets. Investors follow suit by becoming downbeat. Ironically, such periods contain the seeds for better future profitability. Capacity cuts and reduced investment creates shortages and thus even relatively small upswings in demand can result in significant price movements.
–We are acutely aware that both highs and lows do not last. Rather than being directed by market emotion, we follow a consistent investment philosophy. Evidence-based, unemotional assessment of companies and industries grounds our research process. Our investment principles drive us to look for quality companies that are positioned to perform well through the cycle. We define quality companies as those with world-class ore bodies, larger-than-average margins, strong balance sheets and management with proven operational expertise. Companies with these attributes dominate the fund and we remain confident in their ability to deliver good profitability through full investment cycles.
