Market Review

Economic momentum continued to wane in the third quarter, as impetus from restocking and government stimulus fell away. Negative wealth effects continue to weigh on developed market consumers, with risks to the downside.

"Apparent" Chinese commodity demand has lagged real economic indicators as large stock positions accumulated during 2009 are worked off. Despite this synchronous slowdown, commodity prices remain elevated. In our opinion, such price levels are a reflection not only of microeconomic fundamentals, but also abundant liquidity finding a home in commodity investments. Inflows into commodities are unlikely to reverse until real rates increase, which will in all likelihood be delayed until policy makers are confident in the sustainability of an eventual recovery. The probability of rally from the current high base is increasing.

The flip side of extraordinary liquidity provision is a debasement of reserve currencies, which is playing out in stronger emerging market currencies via the carry trade. This has partially offset the frothiness in commodity markets.

Performance

The fund has lagged the benchmark during the third quarter and year to date but has outperformed over two and three years.

In the past quarter, overweight positions in the paper and packaging sector, Sasol and AECI added to performance. Our underweight position in gold both locally and internationally also added to performance, despite record gold prices being reached towards the end of the quarter. Underweight positions in Kumba Iron ore and Assore detracted from performance.

Internationally, chemical industry overweights, Bayer and Royal DSM, added to performance. Transocean, which was added recently, also contributed to performance as more clarity emerged post the BP Macondo oil spill. Our core holding in Petrobras detracted from performance due to a substantial equity raising to fund their medium-term investment programme.

What SIM did

Locally, we reduced our position in Mondi into strength. However it remains one of our top picks in the sector and we have retained a substantial position in the counter. Barloworld has lagged due to a depressed construction environment. While the turnaround in that sector appears to be far off, we added further to the position given what we view as a large value opportunity. We also reduced the fund's positions in Anglogold Ashanti, Exxaro, Arcelor Mittal and African Rainbow Minerals primarily to raise cash.

During the quarter, Anglogold announced a significant capital raising to terminate its hedge book. While they are now fully exposed to spot gold prices, we are more negative given the resulting dilution, lack of balance sheet flexibility and increased financial gearing.

Arcerlor Mittal SA has remained surprisingly resilient considering the weak outlook for global and domestic steel markets; a dilutionary BEE deal and the potential loss of the favourable Sishen cost-plus supply contract.

SIM Strategy

The fund's principal objective is capital growth and preservation through alpha generation (achieving returns in excess of the market). The fund is guided by its value-based investment philosophy, preferring shares that are cheap relative to intrinsic value. We expect the forthcoming year to provide opportunities to rebalance the fund from its current defensive stance towards high beta (market sensitive) plays, while capitalising on unprecedented volatility. An improvement in macroeconomic data would signal potential opportunities, particularly in the US, with a key indicator a bottoming in housing markets and a recovery in consumer confidence and spending.

During the quarter the Australian government announced the proposed imposition of a Resources Super Profit Tax (RSPT), which met with vociferous opposition by major mining houses. Historically, Australia has been very competitive and efficient in meeting the significant incremental demand from Asian countries, notably China. But an RSPT in its current form threatens the long term supply picture.

The other major development this quarter was BP's Macondo oil spill in the US Gulf of Mexico. BP's failure to quickly contain the spill points to the physical limitations when operating at such depths. US regulators reacted to the spill by imposing a six-month drilling moratorium. While it is still too early to conclude on the wider implications for deepwater oil production, preliminary estimates don't yet point to any significant production losses in the medium term.

What added to - detracted from - performance
The fund outperformed its benchmark in both the quarter and first six months of the year. Locally the large overweight position in Mondi and the large underweight in gold detracted from performance.With investment cases for these counters still intact, there appears to be no justification to reverse positions. Overweights in Mvelaphanda and AECI added to performance. The switch from Rio Tinto preceded the announcement of the RSPT in Australia, and the portfolio therefore benefitted quite nicely from its overweight in Anglo American and underweight in the Australian majors.

Internationally, positions in Total, ENI and Thyssen Krupp detracted from performance. Barrick Gold outperformed in line with gold stocks globally. Chemical stocks such as BASF and DSM proved quite defensive and added to performance.

What SIM did
Locally we reduced our position in AECI as medium-term earnings are unlikely to benefit from any significant contribution from property sales, given the outlook for the property market and the depleted inventory of property for sale. Proceeds from this funded an increase in our Sasol and Anglo American positions. Sasol has started exhibiting a turnaround in operational performance, which bodes well for the group if sustained. Anglo Platinum outperformed Impala Platinum in the past quarter in line with the market's growing confidence in the management team and their promised turnaround, especially on the cost management front. At current levels a preference for either is difficult to justify so a switch was made into Impala Platinum.

Internationally Lafarge has underperformed Holcim quite significantly, despite the groups' similar earnings performance and levels of financial risk. We switched the entire Holcimposition into Lafarge to capitalise on this opportunity.

We added Transocean, the dominant player in deepwater rigs globally, to the portfolio. Collectively the three partners (BP, Anadarko, Mitsui & Co) and rig contractor Transocean have seen $137bn wiped off their market capitalisation since the start of the spill, with most of the pain ($90bn) borne by BP's stock. While this promises to be one of the largest corporate legal payouts in history, the market appears to have overplayed the potential liability for Transocean given current legal agreements with clients.

SIM Strategy
The fund's principal objective is capital growth and preservation, as well as alpha generation. The fund is guided by its value-based investment philosophy, preferring shares that are cheap relative to intrinsic value. The coming year is expected to provide opportunities to rebalance the fund from its current defensive stance towards high-beta plays, capitalising on unprecedented volatility. An improvement in macro-economic data would provide important signals, particularly in the US, with a key indicator a bottoming in housing markets and a recovery in consumer confidence and spending.

Market review

Commodity prices regained their record highs despite weaker fundamentals, such as reported stock levels, during the quarter. Much of the increased investor interest in commodities was in response to overly accommodative monetary and fiscal policy in the developed world.

In global energy markets a notable development during the quarter was the dislocation between oil and gas prices, with the ratio currently around twice the long run average in favour of crude oil. This is primarily due to the accelerated development of shale gas reserves in the US, with production costs now as competitive as conventional sources.

As long as it contains capital costs, Sasol could be a beneficiary because its GTL technology effectively arbitrages the differences between these commodity prices. With the US still the largest consumer and importer of oil, this structural shift in energy availability could encourage substitution, even in transport applications. Success within the US and elsewhere would dramatically alter the energy and geopolitical landscapes.

What added to - detracted from - performance

The fund continues to perform positively in both absolute and relative terms. Our short position in gold stocks has added value. However, after underperforming, valuations within the broader sector are converging and we would look to add selectively as we believe the magnitude of our underweight here is no longer justified.

The fund's biggest stock exposure is an overweight position in Mondi. This has paid off handsomely as a result of the recovery in the corrugated packaging and uncoated wood-free markets. While we are mindful of the potential headwinds given overcapacity in the sector, the investment case with respect to intrinsic value, free cash generation and quality of management and assets remains intact. Despite the lagging SA economic recovery and strong rand, another large position in the fund, AECI, performed well on stronger-than-expected second half earnings.

Meanwhile, our short position in the bulk commodity companies hurt performance. The surprising factor here was the weak response of domestic Chinese production for coal and iron ore, which has supported the seaborne markets.

Our long Highveld Steel versus short Arcelor Mittal position worked well as Arcelor Mittal didn't convert its portion of the Sishen mining right. Failure to restore this favourable contract would be positive for Highveld from a both a market share and profitability perspective.

What SIM did

During the quarter we continued to reduce our underweight in precious metals by adding to the gold stocks we already hold, namely Anglogold Ashanti and Goldfields. We also introduced a new counter, Gold One.

Mvela Resources remains the cheapest precious metal play in our opinion and we have added further to our overweight in the share, especially with the recent widening in the discount to net asset value (NAV) again.

We added further to our Sasol position because the stock was offering good relative value and management has been increasingly confident of an operating turnaround. Internationally, we sold out of Rio Tinto completely and switched into Anglo American and BHP Billiton. Rio Tinto has run hard as iron prices and aluminum have picked up. Aluminum has rallied despite very weak fundamentals so stocks like Anglo American offer much better relative value, especially in the unlisted rump of the group.

SIM Strategy

The fund's principal objective is capital growth and preservation through alpha generation (achieving returns in excess of the market). The fund is guided by its value-based investment philosophy, preferring shares that are cheap relative to intrinsic value. We expect the forthcoming year to provide opportunities to rebalance the fund from its current defensive stance towards highbeta (market sensitive) plays, while capitalising on unprecedented volatility. An improvement in macro-economic data would provide important signals of potential opportunities, particularly in the US, with a key indicator a bottoming in housing markets and a recovery in consumer confidence and spending.

Market Review
The current economic environment is characterised by an abundance of cheap money as a result of neutral real rates in developed countries, put in place to prevent persistent deflation. The low level of nominal interest rates has played out in asset price inflation, predominantly in equities, and has also stabilised property values. Globally, central banks have so far been reluctant to withdraw their stimulus measures to avoid a "double-dip" recession. Governments have also shied away from difficult decisions, such as hiking taxes or cutting spending to balance budgets, with the preferred exit route on of reflation by monetising growing public sector debt burdens. This environment has been beneficial for commodity investors, given lower holding costs and yield spread. Apparent demand for most commodities within China remained strong through the crisis, even accelerating in some cases, as the government sought to stimulate the economy through an increase in lending and infrastructure spending. The combination of cheap money in developed markets and insatiable Chinese demand have been the dominant drivers of commodity markets in 2009. Price levels are expected to be supported in 2010 by an OECD-recovery and strong Chinese demand, with premature monetary tightening a key risk factor. Commodity prices continued to improve in the last quarter, absent dollar weakness and despite an overhang of inventory and production capacity. Gold underperformed industrial metals and platinum group metals (PGM) in the fourth quarter. Gold has held up surprisingly well in absolute terms on the back of increased central bank purchases. The rally in PGMprices seems justified by higher cost structures and improving auto demand, with the platinum-to-gold price ratio still depressed. The rally in base metals looks fragile. With China completing its restocking early in 2009, metal continues to pile up in London Metal Exchange (LME) warehouses. Bulk commodities are being driven by supply constraints within China and surprisingly strong steel production. While this does not bode well for global steel markets given anaemic demand outside China, expectations for iron ore and coking coal annual contract settlements have turned decisively positive.

What SIM did
The strong rand and weakened consumer continues to weigh on the local manufacturing sector, which will delay the earnings recovery. While value in the local paper and chemical sectors was apparent at the beginning of the quarter, we saw a need to realise some profits and implement some risk management following the good third quarter performance. As a result we reduced overweight exposures to AECI and Afrox In our last commentary we identified the undervaluation of the Anglo American Plc rump. This discount was eliminated during the fourth quarter and we have subsequently taken profits on this trade. We again increased our holding in Mvelaphanda Resources, as the discount to NAV again opened up to more than 10%. Subsequent strength in Northam Platinum and recent takeover speculation has enhanced this position. This counter remains our preferred precious metals play.

What added to - and detracted - from performance
The fund outperformed the benchmark during the fourth quarter and over one and three years. This quarter's performance was mainly driven by the outperformance of Anglo American, Anglo Platinum and Mvelaphanda Resources, where we have overweight positions, and the underperformance of the gold sector, which is our largest underweight. Our underweight position in the bulk sector and overweight in chemicals and Mondi were drags on performance. The investment case for related counters has not changed significantly; hence no portfolio action was necessary.

SIM Strategy
The fund's principal objective is capital growth, preservation and alpha generation. The fund is guided by its value-based investment philosophy, preferring shares that are cheap relative to intrinsic value. The coming year is expected to provide opportunities to rebalance the fund from its current defensive stance towards high-beta plays, capitalising on unprecedented volatility. An improvement in macro-economic data would provide important signals, particularly in the US. A key indicator would be a bottoming in housing markets and a recovery in consumer confidence and spending.