Morningstar's "Perspectives" series features investment insights from third-party contributors. Here, James Sutton, Client Portfolio Manager, JPM Natural Resources Fund discusses the natural resources sector.
It’s been a rocky summer for global equity markets with escalating geopolitical risk, concerns over sanctions on Russia destabilising the world economy, the Argentina debt default and weak European inflation data all significantly affected investor sentiment. Against that backdrop, it is interesting to note that the natural resources sector has actually strongly outperformed global equities.
Base metals prices for example have moved higher across the board driven by positive macroeconomic data points from China and further signs that their economy continues to stabilise. It has been a positive for commodities that China sentiment is improving on the back of the government’s continued reform measures. In particular, relaxation of restrictions in the China property market has eased pressure on the iron ore price. Platinum and palladium prices have also fared much better in recent weeks as those markets have remained tight.
When we look at the commodity equities investment strategies that have worked for investors in recent weeks, holdings in base metals and diversified mining companies have been strong performers of late. At the stock level, that includes iron ore producers such as Fortescue Metals, Rio Tinto and BHP Billiton as well as cooper producers such as First Quantum Minerals and Antofagasta. Diamond producers have been another standout sector of late, benefiting from a continued structural rise in demand from China consumers and continued supply constraints. Names such as Gem Diamonds have seen significant gains on the back of operational improvements to their mining operations.
When we turn to consider the outlook for commodities, a number of issues on the supply-side have reminded investors how precariously balanced many commodity markets remain despite a muted demand backdrop. It is tightness in base metal markets in particular, notably copper, nickel and zinc which gives us a preference for base metals over bulk commodities such as iron ore and coal.
Meanwhile, supply disruption could become a theme in the oil & gas subsector if the ISIL (Islamic State in Iraq and the Levant) forces move further south where the majority of Iraq’s oil production is located. We are actively monitoring our holdings with assets in semi-autonomous Kurdistan to ascertain whether there have been any disruptions to operations.
Within the energy subsector, which is predominantly made up of oil & gas producers, we think investors continue to be best served to focus on high growth exploration and production companies.
We remain nervous about the outlook for the gold price given the trajectory of US monetary policy and have made sure that our holdings in gold remain skewed towards higher quality, lower cost producers. That said, there are still plenty of bottom-up opportunities within the gold sector. We hold those companies which have low-cost production, unlevered balance sheets and exploration upside.
As natural resources equities investors, we believe that companies able to grow production and successfully replace depleting reserves will outperform over the long-term. We know that the supply side drives industry margins and as a result we look to own producers of supply constrained commodities.
Global production of many commodities is expected to struggle to keep up with demand, leaving supply shortages in many key commodities and keeping natural resources markets tight. We continue to invest with a small/mid cap bias, with a preference for identifying interesting prospects when they are just moving from the exploration phase of their development to the production phase. Nevertheless, we think diversification is important and remain balanced across gold and precious metals, base metals, energy, uranium and diamonds, as well as other more esoteric minerals.
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