Global Natural Resources: turning point ahead?

10/03/2016

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With pessimistic media commentary and commodity prices currently at multi-decade lows, many investors are avoiding or are underweight the natural resources sector. David Whitten, Head of Henderson’s Global Natural Resources Team, explains the reasons why now may be an opportune time to invest in a sector that has fallen out of favour.

Natural resource equities and commodity prices are cyclical in nature and history suggests that resource equity turning points are often sudden and explosive events. Many investors wait for a sustained large recovery before investing. The danger of this approach is the risk of missing out on substantial initial investment returns.

The downturn in the current natural resource cycle has been driven by issues on the supply side. There are numerous ill-disciplined mining and energy projects with high operating costs, built by management teams reliant upon unsustainably high commodity prices and optimistic forecasts. In our view, many of these projects should never have been financed by the banks and bullish equity investors. The good news is that supply issues can and will be fixed – and the market will ensure it happens.

Mining – recovery on the horizon

The global natural resources strategy has moved from an underweight position in the last few years to an inline market weight in mining. We think the mining sector is rapidly becoming a ‘value play’.

There are a number of investment opportunities as we see them:

  • The upside of weakening currencies: the Australian and Canadian gold sectors are currently enjoying very attractive gold price margins as a result of the relative currency weakness.
  • Quality acquisitions for fast movers: nimble players are acquiring quality projects from large companies at attractive prices.
  • Benefits from iron ore producer cost cutting: Iron ore producers are challenged in the near term but capital expenditure rundown and aggressive cost reductions should drive volume growth, free cash flow and reasonable dividend yields for quality companies.
  • Capitalising on a battery-powered future: we have built a position in lithium stocks. Global carmakers are finally stepping up to mass production of lithium-ion battery powered electric cars as demand gains momentum and scale. We believe that the consumer trend in car purchases will head towards highly competitive electric vehicles, powered by lithium-ion batteries.

Agriculture sector – technology and innovation driving efficiency

The strategy remains overweight the agriculture sector, investing in large, global companies that use technological advantage and innovation to increase crop yield and decrease agricultural input costs.

There is increasing corporate activity in the agriculture sector. Monsanto received a merger approach for Syngenta last year, and more recently Syngenta received an acquisition offer from China National Chemical Corporation. Syngenta, a Swiss-based agribusiness company with leading global businesses across crop protection and seed technology, is one of the largest holdings in our strategy. The proposed acquisition highlights the ongoing interest in the global agricultural sector and the growing importance of secure and reliable food supply by China and other countries.

Energy sector – deep capital expenditure cuts becoming the norm

The strategy remains underweight the energy sector and is cautious towards upstream exploration and production companies. However, the rapid fall in the oil price is now starting to have a major industry impact, which may sow the seeds of an eventual recovery. As a result of low oil prices, we are likely to see meaningful falls in overall supply production later in 2016.

Although production in countries such as the US has been resilient, we believe that the easy operating cost cuts have been made, oil price hedging is tailing off and banks that lend to energy companies will be very conservative. Political events and actions by the Organization of the Petroleum Exporting Companies (OPEC) as always, are unpredictable. Anticipated upstream merger and acquisition activity may well pick up over the next couple of years if history is a guide.

Our team believes that the growth in alternative energy will be an ongoing long-term trend, and has recently invested in some very interesting alternative energy companies in wind and hydro.

In summary

In our view there are some extremely compelling opportunities currently presenting themselves in shares of high quality natural resource companies. Distress creates opportunities and the eventual supply/demand balance rebound may be brought forward faster. Companies with sustainable natural resource advantages combined with prudent balance sheets can expect to take advantage of acquiring cheap assets.

What others may see as danger signs, we in fact welcome within the sector. We expect more aggressive industry-wide production cuts; project delays and closures; large capital expenditure reductions; asset sales; dividend cuts; write downs; and forced equity raisings by the natural resource sector especially in the upstream mining and oil industry sectors. More often than not, these are the catalysts that confirm an approaching recovery.

These are the views of the author at the time of publication and may differ from the views of other individuals/teams at Janus Henderson Investors. Any securities, funds, sectors and indices mentioned within this article do not constitute or form part of any offer or solicitation to buy or sell them.

Past performance is not a guide to future performance. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested.

The information in this article does not qualify as an investment recommendation.

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