Mining, energy and resources funds dominate the bottom of fund performance tables over the year to date. It is a similar picture if you look back over the past one or two years. Prior to this many were performing exceptionally well. Many commentators suggested we were in the midst of a 30-year super-cycle where industrialisation and urbanisation in developing countries was driving demand for, and consequently the prices of, commodities higher. That said, as with most long-term trends there will be setbacks and corrections along the way and perhaps this is just one of them, the previous one being in 2008.
The JPM Natural Resources fund invests broadly across the sector in gold and precious metals companies; those mining for base metals such as copper, zinc and iron ore; and energy companies. The default position is to have approximately 30 per cent invested in each area with the remaining 10 per cent invested in more specialist companies such as those mining for diamonds, rare earth minerals or agricultural commodities. Unfortunately, being diversified across over 20 commodity types and by geography has afforded the fund little protection and it has had a torrid couple of years performance wise.
Neil Gregson, the fund’s manager, believes there are similarities today with the late 1990s. At the time of the Asian crisis emerging markets and commodities were joined at the hip. When stock markets fell so did commodity prices. To an extent it is the same today. Concern over China’s pace of economic growth can send commodity prices falling. I suspect the commodity cycle is also being influenced by concern over developed markets, particularly the stagnating economies of Europe and the UK.
Furthermore, some suggest emerging markets moving from being export-led to consumption-driven economies is another nail in the coffin of the super cycle. The consumer growth story hardly suggests basic commodities won’t do well in my view. Many emerging market consumers want the lifestyles we in the West take for granted and this will involve plenty more resource-intensive industrialisation and modernisation.
Over the short term commodities and commodity-related companies will always be at the mercy of economic events. In recent times many companies have not helped themselves as management teams have made poor decisions and failed to keep control of costs. This has been particularly true of the mining sector where escalating costs have swamped the advantage of any rises in physical commodity prices.
The JPM Natural Resources fund also has a bias towards smaller companies. This tends to be an area where Neil Gregson finds the best valuations and prospects for production growth, but unfortunately smaller companies can be driven by cash flowing into or out of the sector. Neil Gregson puts it neatly when he suggests investors tend to “rent” the sector. In other words, rather than taking a long-term buy and hold approach they tend to trade in and out meaning it is either feast or famine.
Neil Gregson has recently increased exposure to copper and aluminium producers, where he believes supply constraints are supportive of prices, with base metals now accounting for 37 per cent of the fund. Around 28 per cent of the portfolio is exposed to energy where Neil Gregson is finding a number of opportunities among shale companies, and on and offshore oil explorers in Africa and Asia. Exposure to gold mining stocks has been reduced recently, reflecting Neil Gregson’s cautious outlook for the gold price. That said he is still finding a number of stock-specific opportunities in the sector, including Banro Corp, which is targeting production growth of 533% over the next four years.
The fund is currently down over 40 per cent from its peak and I suspect many investors have been bailing out. Whether you believe in a commodity super-cycle or not I cannot help but be interested when I see funds down by such a margin. This doesn’t mean they can’t fall further or indeed just trawl along the bottom, but this is usually the time when experienced investors with a contrarian mind-set begin to look closely for that inevitable buying opportunity. This might just be the time to consider dipping a toe in the water.
That said, be aware there is definitely some correlation with the fortunes of emerging markets. Many mining companies are also listed in the UK meaning investors can have significant exposure through their existing UK funds, whether they are actively or passively managed. Investors need to make sure their portfolio is adequately diversified and isn’t just facing in one direction.
Mark Dampier is head of research at Hargreaves Lansdown