The start to the second half of 2008 saw a dramatic shift in markets, with the focus shifting from inflation to the outlook for global growth. This is an important consideration for resource sector investments since commodities are a levered play on global growth, and especially since we have emerged from one of the strongest global economic upswings in history. The reaction in commodity markets and resource sector equities has been severe, finally reflecting this trend change. The JSE Resources Index return was -47.4% over six months!

The fund has been defensively positioned in anticipation of this turnaround, outperforming the benchmark by 4.6% in the year to September 2008.

Bulk commodities remain the star performers: iron, steel and coal prices have all more than doubled, and spot prices have not yet declined significantly relative to contract prices. These commodities are directly related to industrialisation and urbanisation trends that are evident in developing countries, notably China. Our view has been for a moderation in global steel demand, driven by a saturation of steel intensity in Chinese urban areas. This trend has been further exacerbated by destocking ( following panic buying earlier in the year) and a tighter global credit environment, which has reduced finance available for construction and durable goods purchases such as automobiles. Related shares have fallen dramatically ( 55% over six months) from overbought levels to fair levels and still remain expensive relative to the sector. With bulk commodity prices typically being a late cycle play (peaking two years after base metals), we expect buying opportunities to emerge in future. Gold has been defensive during this cycle, remaining steady in the year to date. The medium-term outlook is positive; the market is constrained by declining mine supply and official sector sales, with both fabricated and investment demand competing for this declining pool of gold. The negative real rates, financial uncertainty and risk aversion that we are currently experiencing are further supportive of investment demand. Structurally, however, gold has poor characteristics as a commodity: fragmented supply with associated low returns, elastic supply/demand and large above ground stocks. We have cut some of the overvalued counters such as Goldcorp, Goldfields and Harmony as they outperformed, but have retained positions in Barrick and Anglogold where we still see value, competitive cost positions and geographic diversity.

Platinum group metals have seen a dramatic turnaround due to falling auto catalyst demand, investment liquidation and increased secondary supply, bringing the PGM basket to 60% below its peak in May, and below incentive price levels. Despite this cyclical slowdown, we remain positive on the long-term outlook for the industry based on ongoing environmental demand and constrained supply. Our favoured counter is Anglo Platinum based on its operating leverage, and we see the recent weakness as an opportunity to accumulate. Along with PGM metals, base metals have been the weakest performers, with many trading at or below marginal cost level. Concerns about supply constraints have been overwhelmed by demand fears. Copper, the bellwether which was resilient for the first nine months, has finally fallen back to more fundamental levels. Aluminium is trading at marginal cost levels, while zinc and nickel are trading below marginal costs. This has been a key contributor to the poor performance of the diversified miners, who derive around half of their earnings from this industry. The pullback has been used as a buying opportunity to close our underweight at attractive levels. Oil has performed better than PGM and base metals, down 20% since the start of the year, with an interim peak above $140/bbl. The price still reflects a supply constrained market and a "demand rationing" level. The outlook is bearish given the expected supply response in 2009 coinciding with demand moderation that should see spare capacity being restored and prices receding. The overweight in energy is a potential funding source given opportunities arising elsewhere.

Positions in our top picks, AECI and Mondi, have been lightened to take advantage of fund opportunities arising in the rest of the sector.

Commodities have not yet reflected the economic turmoil that has become so prevalent in other sectors, increasing their attractiveness as an alternate asset class and portfolio diversifier. Bulk commodities have been the strongest performers, followed by energy and precious metals, with industrial metals lagging. The common themes are resilient demand, especially from developing economies, struggling supply side, cost inflation and rising investment demand. The impact of investment demand has been questioned following increases of similar magnitudes for non-screen traded commodities and testimony from influential bodies such as the Commodities Futures Trading Commission before the US Senate.

The bulk commodities have been mainly driven by tightness in the steel market and infrastructure demand, which has given steel producers pricing power. Iron-ore contracts have been settled in the range of 65-90%, while prices of hard coking coal have tripled following the flooding of Australian mines. Steel prices have reacted early to spot price movements so that most steel producers will maintain or increase their margins despite these increases. The entire energy complex has rallied sharply, with oil up by more than 50% on 2007 in the year to date, and 100% up on a spot basis.

Oil prices above $140/bbl pose a serious threat to the world given the period in which they have increased as well as the magnitude thereof relative to global GDP. The increase in oil prices this year represents around 4% of global GDP, a significant transfer of wealth from consumers to energy exporters. This movement is unprecedented, even going back to the past two oil crises during the 1970s, and is thus likely to result in significant behavioural changes to the extent available technologies allow. Uranium spot prices have been weak, pulling back to $60/lb despite the positive long-term outlook, offering some interesting opportunities.

Precious metals have consolidated this quarter - a common seasonal trend for gold and a pullback from overbought levels for PGMs following the abrupt supply disruptions in the first quarter. Industrial metals have lagged the broader commodity complex, except for aluminium which has rallied sharply due to power costs and shortages in producing regions. Nickel has pulled back on the destocking of the stainless steel market and is trading close to the cost of alternate supply in nickel pig iron, an attractive proposition once the restocking cycle begins.

The consolidation theme is continually being reinforced. Following the Billiton bid for Rio, which is forecast to be drawn out by competition processes, we have seen an unsuccessful bid from Vale (CVRD) for Xstrata. Corporate action has added premiums to most counters in the sector. The number of large, focused commodity producers is diminishing and the remaining few are potential targets.

The fund is mainly positioned where we see value, typically sectors that are out of favour. Locally these include the gold and paper stocks. The fund has also retained significant positions in the platinum stocks, where we balance the apparent rich valuations with the positive outlook for the PGM markets, counterbalancing our underweight in the diversified miners. Internationally we are positioned in energy stocks with strong organic growth opportunities and are continuously looking for selective opportunities in growth markets that offer value. Core holdings include Rio Tinto, BASF, Petrobras and Barrick Gold. The position in Alcoa has been cut on the rally in aluminum and switched into Thyssen Krupp, which has not yet seen the full benefit of steel price increases given its dependence on contracts. On the local front our top three picks in the sector are AECI, Mondi and Anglogold. AECI at current levels provides cheap gearing to the supply growth in the mining industry and value unlock from its extensive surplus property portfolio.

Mondi has performed poorly given general apathy towards the sector, particularly from international investors, and a worsening outlook for the European market. Mondi is defensive given its cost structure and market position, which are not reflected in its substantial discount to net asset value. European paper producers are likely to benefit from the eventual strengthening of the US dollar and turn in energy prices.

Anglogold announced a rights issue together with its first-quarter results, which has afforded it more financial flexibility from its growing hedge book. Its cost position and cost management together with its diversified production base make it attractive. The company trades at a significant discount to its peers, being priced like the other major SA gold producers.

Sanlam Resources Fund changed its name to SIM Resources Fund on 1 August 2008.

The moderation of developed-world growth that began in 2007 has continued and intensified in 2008, led primarily by problems in the US financial sector. At present aggregate global demand growth is expected to moderate by 1% (0.5% previously) and global industrial production by around 1.5%, leaving a moderate level of global growth but breaking the trend of acceleration we have witnessed since the start of the cycle. Uncertainty abounds as to the depth and breadth of the current slowdown, with a recovery expected towards to the end of 2008. Emerging economies will continue to be supported by strong fixed invested and stable intra emerging-market trade, which has remained strong despite declining exports to the US.

At first the implications for commodities would appear negative because commodities have always been a leveraged play on global growth. However, the impact has been more than offset by supply disruptions in most commodities. Counter intuitively, commodity markets have tightened as demand growth slowed. China, the key engine for commodity demand, has been on a high structural growth path with GDP averaging 10% p.a. in real terms and has always remained relatively insulated from global cycles. If net exports remain flat in 2008, Chinese GDP growth should moderate by around 3%, leaving a still healthy 8-9% growth.

The reaction of the US monetary authorities has been to cut the Fed funds rate by 3% in the past six months, over and above the direct injection of liquidity into the sector. The signal is concern over growth outweighing inflation, which until now has displayed little evidence of second-round effects in core inflation measures. The Euro authorities, on the other hand, have always been more hawkish on inflation and have held rates, thereby widening the spread to the US, and undermining the US dollar. The aggressive US rate cutting also creates an interesting dilemma for exporters to the US that have pegged their currencies to the dollar. They could follow US monetary policy and risk overheating their economies even further or revalue their currencies against the dollar. The dollar has lost 17% since US rate cutting began in August 2007. Investors have attempted to hedge against the weakening dollar through investment in commodities, particularly via precious metals but also through commodity funds, which have seen more inflows in the first quarter of 2008 than in all of 2007.

South Africa is facing its own challenges in this environment. The electricity crisis that surfaced in January 2008 threatens to unravel the positive growth story, particularly for the energy-intensive mining sector. Investment flows have thus far supported the rand and financed SA's large current account deficit. Any reversal in this investment would be negative for the rand, which has already reached record lows against other commodity currencies like the Australian and Canadian dollars, making it one of the weakest major currencies globally. The volume impact may be limited over time given inefficient usage practice and prioritisation of the mining sector given its economic and strategic importance, but will undoubtedly reduce cost competitiveness as Eskom raises prices sharply and companies seek alternative sources of power. The effect on global markets has been most prominent in markets where SA dominates, for example platinum, where the price reaction has far outweighed the loss in production due to critical shortages of material and inelastic demand.

Our preference within the commodity space remains precious metals, with strong fundamentals and direct benefit from low real rates. The bulk contract settlements have been concluded with 65- 70% for iron ore and over 200% for coking coal. Still outstanding are the thermal coal and Australian iron-ore settlements. We don't expect further momentum in prices the next year as some normality resumes on the supply side. The oil price is threatened from an affordability perspective above $110/bbl, with our analysis showing that this would bring oil expenditure as a percentage of global GDP back to peak levels last seen in at the end of the 1970s, which had a major impact on oil and global aggregate consumption. Our preference within the energy complex is natural gas, which is well supported by higher thermal coal and oil prices.

Against this backdrop commodity shares continue to perform well. On a rolling 12-month basis the benchmark gained 27.4%, with almost identical returns from the JSE Resources Index and MSCI Basic Materials and Energy composite. The fund returned 30.6% over this period. During the period under review some profits were taken in the precious metals space, mainly from Goldcorp and SA Platinum miners, some of which was rotated into Anglogold, which remains one of the cheapest stocks in this space. Positions were built further in Mondi and AECI as defensive positions, and some weight was also added to Anglo American, exploiting the sharp pullback in the diversified miners during January.

The fund maintains a defensive stance in the sector, with some gearing to the cycle in areas where we see value. Our preferred investments are in the precious metal and paper sectors.

2007 was a tale of two halves, the first half dominated by synchronous global growth and the second half punctuated by a moderation in developed-world growth. Monetary policy makers are quickly moving to defend growth, with one eye still on the inflation "genie", but their efforts may be in vain given some of the excesses that have built up in the global housing and credit markets over the past decade. Despite the negativity in the second half of the year, commodity shares delivered a strong performance in 2007. The JSE Resources Index was up 25.8%, MSCI Basic Materials Index up 27.8% and the MSCI Energy Index up 24.2% in rand terms. The fund returned 29.3% against this backdrop (before costs). The relative stability of the rand exchange rate, which strengthened against the US dollar, made this the first calendar year since 2004 in which the MSCI component (international) beat the performance of the local shares. Local resource shares, whose prices are set in dollar, benefit greatly from real depreciation in the rand through margin expansion.

As always, stock picking was key. Locally and internationally the best-performing shares were the bulk commodity stocks, with strong performances in iron ore, coal and shipping. Iron-ore spot prices had an extremely strong rally during the second half of 2007 as shortages emerged in China. This bodes well for contract settlements in 2008 and for local producers like Kumba Iron Ore, and the diversifieds that control a large portion of this market. Coal prices also showed very strong increases in 2007, up an estimated 40%. The Pacific market tightened due to a shift in China to a net import situation and prolonged supply disruptions in Australia. Again this is positive for the likes of the diversified miners and Exxaro locally. Despite these good performances, we have struggled to find value among the diversifieds, bulks or base-metal companies and hence retain underweight positions. A significant further development in the fourth quarter was BHP Billiton's paper bid for Rio Tinto to create a mining super giant. The fund has benefited from a rerating in Rio Tinto to a level 10% above the 3 BHP for 1 Rio share offer. While the value in the combination is clear, the sharing of this value is a potential deal breaker. Alcoa has been retained as a defensive position, on valuation and in preference for aluminium among the base metals. One of the laggards was the gold sector, especially the SA miners. This performance was in spite of a strong gold price, up 31% in 2007. While the international stocks such as Barrick, Newmont and Goldcorp did get some traction in the final quarter of the year, the local Gold-mining Index declined by 21% as a result of poor production and cost performances. Local gold stocks still present an opportunity, especially from a relative value perspective, with my top pick being Anglogold, which has demonstrated good cost containment compared with its peers. The issue of the Anglo share overhang has almost been resolved and the new leadership is in place. The only significant unresolved issues are the large hedge book and the resource life. Anglogold makes up 4.7% of the fund, the top gold holding together with Barrick.

The other notable laggard was the paper sector. The sector has suffered from a lack of pricing power, which should be alleviated once the commodity cycle rolls over. The diverging-demand trend theme will be more persistent and continue to pressure fibre costs while creating supply overhangs. The shares are more than discounting this subdued outlook. My top pick here is Mondi, now making up 8.4% of the fund after being added to in the last quarter. Besides the attractive valuation, the company has an attractive cost and market position and proactive management.

Lastly a word on energy. The oil price has continued to rally, up to $100/bbl recently. In my opinion this can be attributed more to geopolitical concerns than fundamentals. The developing fundamental trend since 2005 is bearish, with some tightening in 2007 but not enough to justify this rally. The fund continues to maintain an overweight position here because of the apparent value in companies with long-life resources and organic growth, such as Petrobras and Gazprom. Petrobras surged on a significant new oil discovery. The risk currently lies in a retracement in the oil price, and consequently I took some profits in the last quarter of the year. The fund retains a defensive stance in the sector, with some gearing to the cycle in areas where we see value. Our preferred investments are in the precious metals and paper sectors.