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  • Natural Resources

    Early Cycle Pause Motivated by Skepticism, Not Data

    Shawn Reynolds, Portfolio Manager
    July 20, 2017

    2Q 2017 Hard Assets Equities Strategy Review

    During the quarter, VanEck's hard assets strategy returned -13.35% (measured by VanEck Global Hard Assets Fund, Class A (GHAAX), excluding sales charge). On a relative basis, the strategy underperformed its commodity equities-based benchmark index, the Standard & Poor's® (S&P) North American Natural Resources Sector Index (SPGINRTR),1 which returned -7.09% over the same period.

    Market Review

    The most significant impact on the natural resources market and the strategy came from lower crude oil prices, which ground down through the quarter. In addition to these low prices, we believe that continuing dysfunction in Washington, DC had a significant impact on the market. Although 2016 drew to a close with the deflation/inflation "conversation" having shifted to include the prospect of forthcoming inflation, the general feeling of optimism with regard to both inflation expectations and infrastructure spending faded rapidly by mid-year.

    Fundamental: Demand for most commodities has remained resilient. The long talked about cuts in capex continue to weigh on supply growth. Even in the U.S., despite a sharp increase in crude oil supply since the beginning of the year, the most recent data points indicate a drop in the rate of new U.S. rigs and at least some signs of lower oil production. This could be a very early response to weak oil prices. In addition, we are now seeing strategic asset allocation decisions being made by companies, whether through acquisitions and/or dividends.

    Technical: In terms of relative performance, although energy may have had its worst ever first half, we still consider this to have been an early-cycle pause in the commodities rebound, which began in early 2016.

    Macroeconomic: We see various supportive data points that suggest there is at least some synchronization in global growth. The latest Euro Purchasing Managers' Index2 (PMI) predict solid second quarter GDP expansion (see chart below), and China's economy still appears to be improving. Given these factors, as well as continued resilient demand for most commodities, we believe we are well positioned as we emerge from this stage of the rebound.

    Manufacturing Purchasing Managers' Index (PMI) Values

    Manufacturing Purchasing Managers' Index (PMI) Values Chart

    Source: Bloomberg. Data as of June 30, 2017. Not intended to be a forecast of future events, a guarantee of future results or investment advice. Current market conditions may not continue.

    Natural Resources Sub-Sector Review

    Energy: We believe that OPEC's (Organization of Petroleum Exporting Countries) November meeting, and subsequent May agreement to extend quotas, can be described as "historic". The outcome has, though, been somewhat disappointing up to this point. However, we still think that the production quota system and long-term supply constraints from non-shale, non-OPEC producers, in conjunction with continued resilient demand growth, will bring the market back into balance.

    Metals and Mining: Corporate restructuring in the global mining sector, we believe, has been successful. We are now starting to see real results from optimized operations, especially in terms of productivity. Broadly speaking, balance sheets are where companies said they would get them. Returns have improved and cash flows are definitely increasing. We believe that mining companies, including gold miners, have found a new foundation from which they can start to generate growth again (this time, hopefully, more prudently) and create sustainable shareholder value.

    Agriculture: While healthy South American crops of both soy and corn limited any upward movement in prices, this was positive for proteins. The nitrogen fertilizers market benefited from the fact that, contrary to expectations, corn acreages increased at the expense of soy.

    Top Quarterly Contributors/Detractors

    Top Quarterly Contributors/Detractors Chart 2Q 2017

    Source: FactSet; VanEck. Data as of June 30, 2017. Weights denoted with "0.0%" indicate a position sold during the quarter. Contribution figures are gross of fees, non-transaction based and therefore estimates only. Figures may not correspond with published performance information based on NAV per share. Past performance is not indicative of future results. Portfolio holdings may changes over time. These are not recommendations to buy or sell any security.

    Outlook: Still in the Early Stages of Recovery

    We continue to believe that we are still in the very early stages of coming out of a downturn that was characterized by considerable oversupply. It is, therefore, going to take a while to rebalance. In the oil market, we remain surprised by the skepticism that currently exists in the face of data that could not, we believe, be more compelling.

    Even if one is of the opinion that U.S. shale oil is going to oversupply the market, this still implies that there are a number of E&P companies that are going to grow at very fast rates for a couple of years. We believe those will remain very good investments.

    Perhaps what the industry is not communicating is that it has evolved. For example, now, from a multi-year, strategic standpoint, and in contrast with traditional oil exploration companies, U.S. shale oil companies can actually "throttle" production on and off and really focus on returns.

    One of the main pillars of our investment philosophy continues to be to look for long-term growth. Since we remain convinced that positioning for the future and not just reacting to current circumstances is of paramount importance, our focus remains on companies that can navigate commodity price volatility and help grow sustainable net asset value.