Navigating the resources sector in turbulent times with Simon Kendall

2019 was a tremendous year for the resources sector with market-leading returns of 28%.

The Nedgroup Investments Mining and Resource Fund returned 40% for the year, largely driven by its link to the Platinum Group Metals, with Impala Platinum up 300% and Northern up 185%. 2020 has been more of a roller-coaster for the sector since the outbreak of Covid-19. What is the outlook for resources now and in the aftermath of the virus?

Oil

Off the back of a bear market in 2014-17, we are now seeing demand destruction and an oversupply of 20-30m barrels a day. The oil market has never had this level of surplus, compounded by finite inventories and no storage capacity. The production cut of 10m barrels a day (10% of global demand pre-Covid-19) last weekend was a reactionary cut, but won’t be enough so we believe the oil price will continue to struggle until we get through this hurdle of the virus. As has been widely reported, the oil price could get to as low as $10/barrel if this oversupply environment persists.

What are the implications for Sasol?

Sasol is in the eye of the storm. While it doesn’t produce oil, its products are linked to the oil price, which together with the Rand drive much of its share price. The lower oil price has therefore been the biggest driver of its share price down to about R350/share. Below this level there is concern about the level of debt in the company from their Lake Charles ethane cracker project in the US, which cost in excess of $12b to build. In March, we saw their share price fall to 0.25 times price, which reflected the quantum of debt relative to market cap. The company responded with a cost cutting exercise and asset sales. A likely equity raise post their June financial year-end results and a broad strategy to contain the effects of a weak oil price and high debt will be needed.

We are currently slightly overweight on Sasol but keeping our right to participate in a capital raise, which we see as an attractive opportunity to increase our position at a discounted price on a discounted valuation.

Platinum Group Metals (PGMs)

2019 was an exciting year for the PGMs industry after many years of deficits, especially in palladium. As a result of countries, especially China, increasing their loadings of PGMs and aggressively ramping up standards on vehicle emissions, we witnessed massive moves in the share prices of palladium and rhodium. We took a view that those tight markets would sustain themselves for the next 3-5 years. The lockdown did not just slow down the demand for cars but the ability of companies to make cars. Many couldn’t source parts because of a breakdown in the global supply chain. This caused some shockwaves to the PGMs industry for a couple of weeks, but there has been a substantial recovery since then. With the current prices of PGMs plus the weak Rand, miners are looking very attractively valued. When markets normalise in terms of recovery of operations and recovery of vehicle volumes, the platinum sector would still have had a good run.

Gold

Gold is currently trading at about $1730. There are three broad drivers that are positive for gold:
• Periods of geo-political uncertainty;
• Macro-economic risks; and
• Financial contagion environment

We are definitely seeing these scenarios in the current world so we can understand why gold has performed well. We believe the current uncertainty, the quantity of stimulus and low global interest rates are all supportive for gold. Gold equities are relatively better positioned now to benefit from the higher gold price, making gold miners relatively attractive.

Industrial metals and prospects for Anglo American

We have a defensive position of 22% (the largest holding in the Fund) as a result of their low operating and financial gearing. Their margins have improved through operational improvements, the strengthening of their balance sheet and the diversity of their asset portfolio. The PGMs have been a significant driver of Anglo’s performance and our view of the stock. Iron ore is holding up well for now with Anglo being the 5th biggest producer. Iron ore miners are also relatively low on the cost curve so even if the iron ore price were to fall by 20%, they’d still be making very good margins.

Should we buy resource shares now?

The fundamental case for miners’ equities is attractive now but we caution against this period of uncertainty and recovery coming out of this economic slowdown. This is much more than a health crisis and more of an economic crisis. While demand may disappoint in the short term, this is the opportunity to be building a position. We are therefore constructive medium term and cautious short term.

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