Navigating the “New Norm” in Natural ResourcesShawn Reynolds, Portfolio ManagerApril 16, 2020
A Tale of Two Commodities: Gold and Crude Oil
By the end of the quarter, the seeming glimmers resulting from greater political certainty in the U.K., a reduction in trade fears, the appearance of some “green shoots” of growth in China and a deemed “bottoming” in most long-term economic indicators, together with a weaker U.S. dollar, had been totally extinguished by both the COVID-19 pandemic and, going all the way back to 1927, the fastest major market decline—peak to trough—in the entire history of the United States stock market.
Within the natural resources space, this quarter, it has really only been a story of two areas: gold and crude oil. Gold has been the only commodity to receive any real benefit from the turmoil that has hit both the world’s financial markets and its populations, outperforming most asset classes so far in the market sell-off. While gold mining stocks have roughly tracked the broader stock market through the crash to date, this is normal gold equity performance in a crash and the drawdowns so far are less than that seen in 2008. We expect gold stocks to rise to reflect the underlying strength in the gold price once the panic has subsided and companies are able to return to full production. The portfolio’s gold exposure, at roughly 20%, is the highest it has been in years.
As at the end of the quarter, gold mining had only encountered a marginal impact from the pandemic. The miners were adhering to the health and safety protocols with which we have all become familiar. By that time (there have, subsequently, been changes since quarter-end), only a handful of countries that had declared lock-downs had included mining as “non-essential” business.
Bank of America Global Research estimates in a March 30 reported that 9% of global mine output had been temporarily idled.
However, most gold mines have maintained production and we don’t know of any so far that have been shut down due to the coronavirus outbreak. We believe gold miners are better positioned than many industries to handle this crisis. Mines are typically in remote areas, away from coronavirus hot-spots.
Many are in Africa and have experience navigating AIDS and Ebola epidemics while safeguarding employees and sustaining production. The sector is financially strong with low debt and strong cash flow. A BMO Capital Markets universe of 27 major and mid-tier producer have an average net debt/EBITDA (earnings before interest, tax, depreciation and amortization) of 0.34, compared to an average of 1.78 for S&P 500 companies. March 2020 Scotiabank estimates also indicate all-in sustaining costs averages of roughly $950 per ounce and drastically lower fuel prices should work to offset other cost pressures this year, in our view.
Unfortunately, the exact opposite has been true for crude oil. Oil has essentially been hit by a triple “black swan” event. Obviously, there is COVID-19, with its potentially long-lasting demand impact, and the OPEC+ supply issue, which started back in early March when Saudi Arabia and Russia could not come to terms on production cuts. But, then here is also the issue of energy transition, which started years ago and really began to ramp up this January with a letter from BlackRock CEO, Larry Fink, stating that the $7 trillion manager would be upping its sustainability initiatives and divesting from its more carbon-intensive assets. In over 30 years in the traditional energy and oil markets, I cannot remember a time when things have been anywhere close to as negative as they are now for this space.
Natural Resources Investing Outlook
It has been a historically challenging environment for natural resources and, while it is impossible to predict where we might be in either one quarter’s or, indeed, one year’s time, we do believe that opportunities still exist within the space.
While the unprecedented demand shock is hitting all commodities, consumption and prices of agricultural goods, gold and alternative energy assets are expected to be more resilient over the near term.
We believe the massive, coordinated global monetary and fiscal stimulus is likely to impact global demand beyond the extent of the current virus. On the other hand, capital expenditures on new supply have evaporated. Combined, this suggests that the supply/demand imbalance in place today may stabilize quickly, returning many commodity prices back to near pre-crisis levels. We see potentially compelling equity values given this outlook.
We also believe that identifying and investing in companies with the strongest fundamentals is even more vital right now. Many of the companies and industries we follow have spent the last several years restructuring their business models and strategy such that they entered this crisis with secure balance sheets, lower operating costs, and improving returns on/of capital (i.e., dividends and share repurchases) and thus are positioned to weather the current environment.
I should like to finish by echoing the sentiments of Jan van Eck, the firm’s CEO, and convey my wishes for the best to all and their families during this difficult time. And to say that we remain extremely grateful for the millions of healthcare and other essential workers out there who continue to battle on the frontlines of this global pandemic on a day-to-day basis. Thank you.
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