Investec Commodity comment - Jun 13 - Fund Manager Comment06 Sep 2013
Market review
South African equities ended almost unchanged in the second quarter, but volatility was high during this period. The sector laggards remain mostly confined to resource stocks with gold (-33.5%), platinum (-23.9%), coal (-10%) and diversified miners (-10.8%) all experiencing double-digit losses in rands. Year to date, the resources sector is trailing the overall market by 19.4 percentage points. Industrial stocks mostly held their ground over the quarter and defensive stocks, on average, achieved strong absolute returns. Financials lagged, with banks down 6.2% and life insurers flat for the quarter after a particularly weak June.
Portfolio review
The Investec Commodity Fund outperformed its benchmark over the quarter. During the second quarter, data was mixed. Data pointing to a recovering US economy was quickly replaced by fears around quantitative easing (QE) tapering. China's economic growth data also slowed, with the market's fears compounded by a cash squeeze on their interbank market. Gold miners bore the brunt of the sell-off. The gold price had its worst quarter in a century, losing more than 23% over the review period. The platinum miners fared only slightly better, with weak global sentiment and the threat of mining strikes putting pressure on the platinum price. Oil & Gas was the best performing resources sector, with the weaker rand supporting Sasol, offsetting a slightly weaker oil price. The rand weakened 6.4% against the dollar, continuing from a depreciation of 9% in the last quarter. For local miners, the rand weakness is a definite short-term tailwind. Our primary concern is that the instability in the mining sector is a key driver of the rand sell-off. Mathematically, earnings go up on a weaker rand, but the risk to deliver is higher. The weaker rand also creates opportunities for unions to push for bigger pay rises. These moves suited our portfolio positioning. The portfolio's holdings outperformed the benchmark, and our overweight positions in Mondi and Sasol outperformed Gold Fields, Harmony and Impala Platinum, to which we remain underweight.
Portfolio activity
The major trades for the quarter involved shifting the portfolio further towards rand hedges with less exposure to large local labour forces. The largest trade for the month involved selling Anglo American to a larger underweight position and using the cash to bring Kumba Iron Ore to an overweight position. We believe that Anglo American faces further earnings downgrades due to lower coal, copper and platinum prices. Continued disappointments at its Minas Rio iron ore project and metallurgical coal's soaring costs are also eroding the company's profitability. On the other hand, it's no longer prudent being underweight Kumba Iron Ore, in light of its underperformance year to date. Kumba Iron Ore is discounting iron ore falling back to $80 per ton, which we think is unlikely. We no longer see downgrade risks to Kumba Iron Ore's earnings, and yield support exists at these levels (9% dividend yield at spot). Lastly, Kumba Iron Ore matches our broader portfolio thesis of preferring rand hedges less exposed to local underground labour. The company does not have wage negotiations this year. Wage cost as a percentage of total costs is small so the company can sustain higher wage increases, and its employees are well paid and benefit from company profitability. We moderated our gold price view further and reduced earnings expectations for gold shares. We are now significantly below consensus, despite basing our expectations on a weaker rand. We consequently sold DRDGOLD completely. We retain our overweight position in BHP Billiton. The company's production growth forecasts for 2013 (copper, iron ore and oil) are favourable and its higher margins should command a ratings premium. Most importantly, it has only 6% South African exposure and is already a very generous employer when it comes to wages paid. Finally, we remain overweight Sasol. We believe Sasol's earning will be upgraded by the market if the following occurs: current oil prices and the rand stay as they are, the expected volume growth from improving Synfuels is realised, Oryx remains strong and chemical prices recover.
Portfolio positioning
Most mined commodities faced severe headwinds in recent months as global growth decelerated. Concerns over the strength of fundamentals were exacerbated by supply expansions. We expect individual supply factors to be the key driver of commodity preference in 2013:
- Increased supply will weigh on iron ore and, to a lesser extent, copper.
- Price weakness caused by exchange traded fund redemptions will likely convince many investors that the existential risks to the financial system have been largely reduced, which will place gold under further pressure.
- In contrast, we expect Brent oil to continue to move within the range seen over the past couple of years because of the continuous supply issues outside of the US.
- We continue to expect supply problems and closures to support both platinum and palladium prices.
In light of the current South African mining labour situation, we prefer non-mining rand hedges. Sasol, Kumba Iron Ore and the paper shares (Mondi and Sappi) are geared to a weaker rand and have excellent labour relations. Our preferred South African-listed miner is BHP Billiton, with only 6% exposure to South Africa. Our preferred local gold share, AngloGold, has only 33% of its production in South Africa (unlike our least preferred, Harmony, with 94%). We continue to position the portfolio based on our earnings forecasts, relative to consensus expectations. This is in accordance with our commodity price views and company modelling work, which pre-empted these market revisions.
Investec Commodity comment - Mar 13 - Fund Manager Comment30 May 2013
Market review
South African equities recorded positive but modest returns in rands over the quarter, with the FTSE/JSE All Share Index closing 2.5% firmer. The rand weakened 9% against the US dollar and more than 6% against the euro. The resources sector's underperformance continued into the first quarter with gold (-17.9%), platinum (-13.5%) and diversified miners (-6.3%) ending sharply lower. The combined financial and industrial index rose 6.2% over the quarter, with industrials in particular performing strongly. There was a wide dispersion of returns within the broad industrial sector. Rand hedge global stocks saw double digit returns, with SABMiller and British American Tobacco rising 24.7% and 18.4% respectively. Meanwhile retailers, favoured amongst foreign shareholders, dropped nearly 10% despite a strong performance in March. Banks marginally underperformed the FTSE/JSE All Share Index, while telecommunications lost more than 7% and healthcare gained 8.8% over the quarter.
Portfolio review
The Investec Commodity Fund outperformed its benchmark over the quarter. This is in line with our theory that rand hedge counters with limited exposure to South African labour would outperform. To this end, our overweight positions in Mondi and Sasol outperformed Harmony, to which we remain underweight. Our view that iron ore shares are expensive and will receive downgrades also added alpha this quarter. This was due to our underweight holdings in both Kumba Iron Ore and Assore, which underperformed.
Portfolio activity
The major trades for the quarter involved shifting the portfolio further towards rand hedges that have less exposure to large South African labour forces. We moderated our gold price view during the quarter, reducing our earnings expectations for gold shares. As a result, we sold gold shares in aggregate. Despite the sell-off in the local gold sector, we believe there is little room for rerating in this space for three key reasons:
1. Since the early 1980s, gold miners have never rerated in periods of a declining gold price, which is our base case scenario for the next two years.
2. There are country-specific concerns and risks, such as labour unrest, policy uncertainty, power supply and structural grade declines. The risk of labour unrest in particular will be high over the coming six months.
3. South African gold shares are relatively unattractive in comparison with their global peers when it comes to the outlook for production growth, dividend yields and free cash flow yields.
The cash raised by lightening our gold weighting was deployed primarily in the platinum sub-sector. Gold companies will constantly have to establish new mines if they want to ensure that they can sustain production in 15 years' time. On the other hand, the longer lives of the platinum producers often seem to be underappreciated. We retain our overweight position in BHP Billiton. The company's production growth forecasts for 2013 (copper, iron ore and oil) are favourable and its higher margins should command a ratings premium. Most importantly, it has only 6% South African exposure and is already a very generous employer when it comes to wages paid. On the other hand, we remain underweight the other large local diversified miner, Anglo American. In contrast to BHP Billiton, Anglo American earned 49% of its 2011 earnings from South Africa. In addition, continued disappointments at its Minas Rio iron ore project, falling copper volumes at Collahuasi, and the soaring costs of metallurgical coal are all eroding Anglo American's profitability. We also remain overweight both paper shares, Sappi and Mondi. We see strong above-market earnings momentum for the paper sector driven by a combination of rising containerboard and paper prices, and accretive acquisitions. Both paper companies have much bigger exposure to Europe than to South Africa. We favour Mondi because it has a lower South African exposure (less than 10%) and a bias towards packaging over paper. We remain overweight Sasol. We believe Sasol's earnings will be upgraded by the market if the following occurs: current oil prices and the rand stay as they are, the expected volume growth from improving Synfuels is realised, Oryx remains strong, and chemical prices recover.
Portfolio positioning
Most mined commodities faced severe headwinds in recent months as global growth decelerated. Concerns over the strength of fundamentals were exacerbated by supply expansions. We expect individual supply factors to be the key driver of commodity preference in 2013, with many of the remaining outperformers (gold, iron ore and copper) likely to start coming back to earth. In summary:
- Increased supply will weigh on iron ore and, to a lesser extent, copper.
- Price weakness caused by exchange traded fund redemptions (despite Cyprus) will likely convince many investors that the existential risks to the financial system have been largely reduced, which will place gold under further pressure.
- In contrast, we expect Brent oil to continue to move within the range seen over the past couple of years because of the continuous supply issues outside of the US.
- We continue to expect supply problems and closures to support both platinum and palladium over the coming year.
It seems miners can no longer depend on rising commodity prices for earnings growth and value creation. In an environment of flat to declining commodity prices, we prefer quality miners over "leveraged" miners. In light of the current South African mining labour situation, we prefer non-mining rand hedges. Sasol and the paper shares (Mondi and Sappi) are geared to a weaker rand and have excellent labour relations and significant offshore divisions. Our preferred South African-listed miner is BHP Billiton, with only 6% exposure to South Africa. Our preferred local gold counter, AngloGold, has only 33% of its production in South Africa (unlike our least preferred, Harmony, with 94%). We continue to position the portfolio based on our earnings forecasts relative to consensus expectations. This is in accordance with our commodity price views and company modelling work, which pre-empted these market revisions.
Investec Commodity comment - Dec 12 - Fund Manager Comment25 Mar 2013
Market review
The FTSE/JSE All Share Index (ALSI) ended the year at record highs, adding just shy of 27% in rands to the modest gains of 2011. The ALSI rose by 10.3% over the quarter. Resources lagged the general market, recording gains of 7.3% over the 3-month period and 3.1% for the year. The gold mining (-18.4%) and platinum mining (-7%) sectors were the weakest performers in 2012, while diversified miners added 10.9% over the quarter and 12.3% for the year. The industrials sector rose strongly, with general retailers (+50.2%), health care (+59.5%) and global luxury brand Richemont (+64%) - the only constituent of the personal goods sector - seeing exceptional returns in 2012. Mobile telecommunication increased by 32.6% over the year, with the fourth quarter adding 12.7% alone. Financials also saw market-beating returns, gaining 38.1% for the year. Banks closed up 11.8% over the quarter while the life insurance sector added 12.7%.
Portfolio review
The Investec Commodity Fund outperformed its benchmark over the quarter. Mining had a better quarter, thanks largely to the market going into 'risk-on' mode because of the anticipated resolution of the US fiscal cliff. The performance was also supported by a strong increase in iron ore prices, an improvement in coking coal pricing and a weakening rand. Northam (+25%), Impala Platinum (+20.9%) and BHP Billiton (+17.6%) were exceptional performers. African Rainbow Minerals, Kumba Iron Ore, Exxaro Resources, Anglo American, Anglo American Platinum and Harmony, which are all exposed to the rand, also performed well over the review period. These share price moves generally suited our portfolio positioning: In particular, our overweight positions in Impala Platinum, Sappi and BHP Billiton all contributed to relative returns, and our portfolio also benefited from our zero weighting in ArcelorMittal, which underperformed.
Portfolio activity
- We increased our overweight position in BHP Billiton. The group's production growth prospects are favourable for 2013 (copper, iron ore and oil) and its higher margins should command a ratings premium. We remained underweight Anglo American. The company is facing structural challenges, which we believe will continue to impact earnings and share price performance. The relatively high valuation (a price earnings ratio of 15.4x) suggests that investors believe the situation will improve. We expect newly appointed CEO Mark Cutifani to take a cautious approach and not radically change the portfolio in 2013. Furthermore, we expect the current discount on South African earnings to persist.
- Anglo sold their remaining position in Mondi via a bookbuild at a 3% discount to the previous day's close. We participated and increased our overweight position in Mondi. We see strong, above-market earnings momentum for the paper sector heading into 2013. The divestiture of Mondi's 50% share in the loss-making Aylesford newsprint mill should also support earnings growth.
- We were also active in the platinum sub-sector and upped our aggregate weighting in these stocks in the belief that mine closures will tighten the supply of platinum group metals (PGMs). We therefore bought Northam to a neutral weighting. This counter has the best nearterm earnings momentum, as its operations were unaffected by strike action. We also switched more Anglo American Platinum to Impala Platinum. As before, we believe that Anglo American Platinum's strategic review is likely to favour its competitors, especially Impala Platinum. We also believe that the review results won't lead to meaningful earnings upgrades and will necessitate a book value write-down. We trimmed our overweight positions in both AngloGold and Gold Fields after poor December-quarter guidance resulted in downward earnings-per-share revisions.
- In the bulk commodity space, we trimmed Kumba Iron Ore to a further underweight position in the belief that the short-term iron ore price rally is over. We believe that the stock is trading at a significant premium to peers and that a correction is warranted. We estimate that the current share price is factoring in an average 2013 iron ore price of $165 per ton, which is ahead of spot levels and well above our estimates.
- We traded African Rainbow Minerals during the quarter and increased our exposure to overweight, after the company's results indicated the beginning of a turnaround in its struggling nickel and coal divisions.
Portfolio positioning
We still expect precious metals to outperform industrial commodities over the next 3 to 6 months. Central banks are still using unconventional monetary policy tools. Excess liquidity will likely be absorbed into commodities that can be held as investments. We believe the third round of quantitative easing will benefit mainly gold and oil, with secondary benefits for PGMs. However, we don't believe that Chinese fiscal stimulus will be commodities' saving grace, as we expect construction growth rates to weaken substantially as China's economy rebalances amid lower economic growth. We are therefore bearish towards iron ore and coal prices, which should result in significant earnings downgrades for the bulk producers. We expect the changing labour dynamics to continue to dominate the South African mining landscape in 2013. Further details on a resources rent tax are also likely to feature. We believe gold companies will explore alternatives to stem the underperformance of the equities relative to bullion. Stabilising the South African operations and increasing dividends will likely receive increased attention. The success of the Gold Fields/Sibanye unbundling could result in other companies following a similar route. Given local labour concerns, our preference is for non-mining rand hedges. Sasol and the paper shares (Mondi and Sappi) are geared to a weaker rand and have excellent labour relations and significant offshore divisions. Our preferred South African-listed miner is BHP Billiton and our preferred South African gold counter is AngloGold. We continue to position the portfolio based on our earnings forecasts, relative to consensus expectations. This is in accordance with our commodity price views and company modelling work, which pre-empted these market revisions.