Sanlam Resources comment - Sep 07 - Fund Manager Comment26 Oct 2007
Commodity prices continue to remain firm, as strong demand continues to offset supply growth. The challenge of satisfying such high demand also has ramifications for the supply chain, driving up costs and constraining supply. Until now the world has experienced synchronous global growth, with emerging markets setting the pace. A sea change over the last quarter has been the moderation in growth and core inflation expectations from the developed world. The key questions now are how deep the developed world slowdown is likely to be and what fallout, if any, can be expected in the emerging economies. This growing uncertainty has resulted in excessive volatility, which suggests that we may be at an inflection point.
In this context, the JSE Resources Index delivered 42% over the last 12 months and 12% in the third quarter of 2007. The international basic materials and energy stocks fared less well, delivering 29% over the last 12 months and 5% in the third quarter. Locally, the key contributors have been the platinum and diversified mining companies and Sasol more recently, while gold equities have declined. The share prices have been driven largely by momentum in US$ commodity prices, real depreciation of the rand and corporate activity. The risk at current levels lies in a reversal in this trend coincident with high cost inflation. Attractive investments going forward will offer volume growth and good cost management.
Within the commodity space we have a preference for precious metals, coal and paper. Gold is supported by the weakening trend in the dollar and tight supply demand fundamentals. The fund has a position in Anglogold that has been depressed by the Anglo American share overhang and its hedge book. Platinum market balances have tightened over the past quarter due to supply disappointments from Anglo Platinum and Lonmin. This view is reflected in our overweight stance in Anglo Platinum and Impala Platinum. Paper has been the most depressed commodity in this cycle, requiring extensive consolidation to achieve traction in pricing. Holdings in Sappi and Mondi are expected to benefit from a cyclical recovery. Sappi is the more geared play given the lack of earnings visibility and its high cost position.
Offshore, we have added DSM, a fine chemical manufacturer and lightened our holding in Syngenta to fund this position, which was looking expensive. We have also switched our cement exposure into Holcim at the expense of Lafarge. We have lightened our position in Rio Tinto which seems to have paid a demanding price for Alcan. This has been used to continue building in Petrobras, an integrated oil company with distinguishing organic growth potential. The Rio-Alcan transaction has had an indirect positive effect on our holding in Alcoa.
The fund retains a defensive stance in the sector, with some gearing to the cycle in areas where we see value.
Sanlam Resources comment - Jun 07 - Fund Manager Comment19 Sep 2007
The positioning of the fund reflects our view of the world and its inherent risks. Within the commodities complex we have a preference for precious metals and energy over industrial and ferrous metals. Industrial and ferrous metal prices have been driven by insatiable Chinese demand, which continues to surprise on the upside. We continue to maintain a negative view of the cycle and are thus employing a defensive positioning.
While Chinese demand is undeniably strong and expected to remain that way, it is driven by an artificially weak currency. The weak currency has resulted in increasing liquidity, which in turn has led to metals-intensive fixed investment, targeted more at exports than at domestic demand. The proposed and implemented austerity measures all skirt the currency issue and are likely to remain ineffective tools to cool the economy, and at worst will prove to be pro-cyclical. It is no wonder that supply has struggled to adjust to this new paradigm. However, we believe that a supply response is already under way and is likely to result in surpluses in these markets as soon as 2007 for some major commodities like copper. In the ferrous chain, Chinese exports of steel have increased dramatically, which poses a risk to steel prices and in turn iron ore.
Precious metals continue have a less risky outlook, particularly due to a more broad-based and less cyclical demand. In the case of platinum group metals the continuing strong demand is reinforced by increasing environmental regulation, while supply remains concentrated in the hands of a few, mainly South African, producers. Gold is supported by structural weaknesses in the US currency, while mine supply remains constrained. Further appreciation in the gold price is likely to be capped by secondary supply (above ground), which is plentiful. Energy is also a beneficiary of more broad-based demand and supply constraints, driven by geology and politics.
We have a close-to-neutral weight in the platinum cluster and an overweight in gold. In this period we disposed of our holding in Eland Platinum. Our preferred exposure in the gold sector is Anglogold, which is artificially depressed by near-term expectations on costs and production, as well the overhang of shares from Anglo American, its largest shareholder. Internationally we have added new positions in:
- Petrobras and Gazprom, two companies with preferential access to reserves - a unique competitive advantage in the sector.
- Alcoa, aluminium being our preferred base metal and defensive within the complex.
- Thyssen Krupp, which has a more value-added exposure than its peers and is therefore less susceptible to developments in China. Positions in BASF and Dow Chemical have been built further.
Positions in Freeport McMoran and Lonza have been sold out completely due to valuation concerns.
Sanlam Resources comment - Mar 07 - Fund Manager Comment08 May 2007
Commodities rebounded strongly in the first quarter of 2007, particularly industrial metals and energy. This was reflected in the equities market, with both the FTSE/JSE Resources Index and MSCI Basic Materials Index outperforming the general indices and reaching new highs in absolute terms.
Despite the rebound in commodities, the view that the commodity price cycle peaked in 2006 is being maintained. Current price levels are high relative to marginal costs due to a low level of inventories. Current prices and margins have induced a supply response that will replenish inventories to equilibrium levels. Demand is expected to remain robust relative to trend levels over the medium term, driven by developing economies, notably China. Growth in China is directly related to the country's industrialisation and urbanisation, which are metals and energy intensive. There are continuing signs of a moderation in the US and Japanese economies. Further deterioration in the US housing market will present some downside risk to our demand forecasts, with a possible contagion to other economies. New equilibrium commodity price levels are likely to be higher than observed historically given the movements in the supply curve due to structural cost inflation and the growth in supply from marginal sources. This is positive for returns on existing assets but is likely to depress returns on new projects.
The sector is only partly discounting the rollover in commodity prices, hence our continued defensive stance.
- The diversified miners, Anglo and BHP Billiton, are trading on undemanding ratings, i.e. discounting the rollover in commodity prices. At current commodity price levels their cash-generation ability is significant, with a preference for capital distributions despite extensive reinvestment programmes. Their approach to acquisitive growth is more discerning, given the stretched valuations of some single-commodity assets.
- The platinum miners enjoy a highly concentrated industry structure (control supply) and an increasing regulatory focus on emission control (inelastic demand).
- Gold as a commodity is a good hedge against economic uncertainty. The underperformance of gold equities is a function of poor cost and production performances, but also a function of increased supply of stock in the equity markets, providing an attractive opportunity.
- Integrated energy companies are preferred to non-integrated refiners and upstream exploration companies, whose earnings are more cyclical.
- Cement and aggregated have undemanding ratings and attractive earnings growth prospects.
- Paper companies, especially non-integrated mills, are the one commodity yet to benefit from the cycle. In future they are likely to benefit from the rollover in energy prices and tightening industry utilisation, which will restore pricing power.
- The ferrous-metal value chain appears vulnerable given the low barriers to entry for steel companies as witnessed by the explosion in Chinese steel production and net exports. There is a risk of a spillover into upstream iron-ore producers if the steel market is oversupplied.
- Companies exposed to base metals are vulnerable to a price correction since current price levels cannot be fundamentally justified. The expected restocking in 2007 is a likely catalyst.
Sanlam Resources comment - Dec 06 - Fund Manager Comment27 Feb 2007
As expected, physical commodities started to show some weakness towards the end of the quarter. Commodity-related equities continued to trade at or near historical highs, but the performance against financial and industrial equities were below par. Commodity equities should continue to underperform the FINDI in line with weaker commodity prices. This confirms the direction of the commodity cycle. The market will remain nervous as earning expectations are adjusted higher, but the direction of equities should be downwards and volatile. Further evidence of a cycle that has peaked is rate hikes around the world, as well as the OECD lead indicator, which turned down sharply. This signals slowing demand, which is likely to coincide with escalated supply growth from new projects, resulting in downward price pressure in several key commodities. The oil price has fallen significantly during the past quarter, mostly reflecting the subsiding fears of supply shocks as well as rising inventory levels.
Oil prices should continue to normalise downward as current high stock levels weigh heavily on the market, but the increased tension in the Middle East as well as lack of public support towards US foreign policy in the region could keep the oil price higher for longer. We believe the next major move in the commodity cycle will be down, which in turn presents significant downside risk to share prices. We are therefore maintaining a defensive investment strategy and are positioning the fund accordingly.
The fund has low exposure to single-commodity metal producers, opting instead for the relative defensiveness of the large diversified counters (Rio Tinto, Anglo American and BHP Billiton). A significant portion of the fund is invested in cement and aggregated, which have undemanding ratings and attractive earnings growth prospects. We expect the margins of these companies to remain stable as the commodity cycle unwinds. More pulp and paper has been added to reduce the underweight somewhat. Industry fundamentals are showing signs of improvement. Surplus capacity, which has eroded pricing power over the past two years, is slowly being addressed. Soaring energy, chemical and transport costs that have squeezed profitability should begin to reverse with the fall in the oil price.
We are, however, concerned that the industry turnaround may be hampered by slowing global growth. The fall in the oil price and subsequent lower petroleum equity prices presented an opportunity to acquire these stocks at undemanding ratings. We believe that further weakness in the oil price is fully reflected in the share prices. The fund increased its exposure to platinum further during the quarter. Platinum offers a long-term strategic play on the trends towards more stringent emission controls and increased market share of diesel vehicles. These companies should prove more defensive than their base metal counterparts and will benefit materially from the rand weakness recently experienced. South African gold equities underperformed in 2006. After poor operational performance in 2006, AngloGold Ashanti is expected to recover from a low base. This share was added during the quarter as it should do well with increased earnings and production. We expect the gold price to remain firm in a weakening dollar environment.