The Fund generated a return of 2.4% for the third quarter of 2012. The best performing stocks were Mondi, Omnia and BHP Billiton, while the worst performing stocks were Lonmin, Exxaro and Sappi.

During the September quarter, the South African Resource Sector has been impacted by some very big domestic and global factors - our preferred positioning in these uncertain times is in defensive, low cost and diversified companies, to be cautious of trailing and forecast earnings multiples and to seek through the cycle earnings resilience (as is offered by BHP Billiton).

The first significant factor for the Fund was the labour unrest that spread from the large platinum mines, in mid-August, in the Rustenburg region, into the gold operating regions, and subsequently into coal, chrome and iron ore mining. Secondly, the reducing expectations for Chinese economic growth and commodity consumption, having a significantly negative impact, in particular, on iron ore pricing. Thirdly, in response to the weak global macro-economic environment, attempts by governments to stimulate their economies through monetary easing - providing support for commodity prices (from September), and especially precious metals into the quarter-end, but as yet uncertain impact on industrial commodity consumption.

Despite the attempts to stimulate the global economy, once a commodity has passed its cyclical peak it is likely to continue to weaken for several years. Iron ore is an example of this, where pricing peaked above $200/t in 2011, but has since fallen to around $100/t. This had a negative impact on Kumba and Exxaro, despite their apparently attractive cash generation, PE and dividend history.

Converse to the peaking iron ore market is the platinum sector, where the sector's competitive position has been weak at the company level for several years, due to cyclically weak demand and prices for platinum and associated metals. While the impact of supply disruption, together with stimulus, has seen a recovery in metal prices, the share prices were unable to benefit due to the difficult operating environment compounded by the wave of industrial action sweeping the industry (which actually started with Impala Platinum in January 2012 - but brought to prominence by the violent strike at Lonmin in August). We view supply disruption as a low quality driver of price/margin recovery - preferring evidence of end user demand recovery, which for the most part remains elusive in the sector

All sectors had disappointing performances with the Fund’s worst performing sector being Platinum (-16.0%). The Fund’s best mining sector was Gold that returned -1.2%.
Earnings downgrades have been a feature for mining companies for the last quarter across the whole sector with the exception of those exposed to Iron Ore. Expectations for commodity prices have been too high and this was something that had been recognized by the market. Even so, platinum and copper have been very weak. When the revenue of a company is declining, it is very difficult for earnings to grow.

Another driver of the poor earnings has been the increase in taxes across the globe for mining companies, particularly in Australia and South America. In addition, other regulatory pressures such as environmental, have delayed projects or pushed their costs up. However, by far the biggest culprit to poor earnings has been the rising costs, which has often been linked to poor production volumes. Kumba has been on the right side of all these factors, whereas Anglo Platinum has been on the wrong side. Thus Kumba has outperformed Anglo platinum’s earnings by 14% since the start of the year and in price by 20%.

The big issue still weighing on resource companies is the future capital allocation. Lowly rated companies in resources typically have big projects ahead of them such as Sasol and Anglogold. We feel it is better to be exposed to companies whose capex spend is near an end, all else being equal.

The Fund generated a positive return for the quarter ending March 2012, comfortably outperforming the sector mean.

The biggest contributors to the Fund's performance were Mondi (25.6%), Exxaro (20.6%) and Kumba (7.5%), while the biggest detractors were Platinum and Gold.

Global cyclicals are still very much out of favour. Six months ago Greece was the reason, currently it is China. Sometimes the market makes up reasons to explain share price performance. Much is made of commodity prices and forecasts when dealing with resource companies, but over a complete cycle within a resource portfolio, it all comes down to costs and capital allocation. Both of these are in the main related to the quality of the ore body and management decisions.

South African gold equities are a good illustration of this. Despite a gold price that rose over the last 10 years, earnings have been very pedestrian. Mainly rising costs (associated with falling production), as well as share issuance have been the culprits. In addition, some poor decisions (Target by Harmony, South Deeps by Goldfields, Hedge Book by Anglogold), turned out to be very expensive. South African gold mines are now near the top of the cost curve, which makes them vulnerable to a flat or falling gold price. What has changed in favour of South African gold companies are that the valuation today reflects the risks, cost base and asset quality of these mines.

We have moved from a trailing PE of over 25 to a current trailing PE of 11.

The portfolio generated a return of 6.3% for the quarter ending December 2011. The biggest contributors to the portfolio's performance were Sasol, Kumba and BHP Billiton, with the biggest detractor being Exxaro.

Most resource companies will find themselves in similar positions for 2012. Firstly, volume growth from current operations will be stagnant. And also margins can't rise much more, with the exception of platinum and steel. Rising costs and taxes will also be a common theme. The big difference will be balance sheet structure and capital allocation. A company like Sasol has a strong balance sheet but has massive capital commitments. Will these projects deliver according to plans? The truth is one will only know in three or four years' time. Kumba has a strong balance sheet as well, but its Capex commitments are basically done. Capital expenditure isn't bad, it's just difficult to value and on balance, returns are normally lower than forecast. Some companies have proven to be better than others and interestingly, some sectors are worse than others. Gold and steel companies have been poor allocaters of capital.

The success of companies going forward will very much be determined by individual company and sector discipline.