CQS Natural Resources Growth & Income’s strong precious metals weighting a silver lining – The year to 30 June 2019 was challenging for CQS Natural Resources Growth & Income (CYN). At the financial year-end, the NAV was down 13.9% year-on-year. The company says that since the end-of-the-period, it has outperformed peers, with its exposure to precious metals a driving force (gold has been performing well for some time: see QuotedData takes a look at gold after its best performance in years).
CYN said that the year to 30 June 2019 was challenging and was largely affected by the savage sell off in global equities in the last quarter of 2018 (calendar). In the post-reporting period, they add that the allocation to precious metals and its benefit to the fund has not been reflected in the share price due to several factors such as US / China trade wars, geopolitical tensions, the Woodford fall out and Brexit uncertainties to name but a few.
Commentary from managers Ian Francis, Keith Watson and Rob Crayford
“Outlook
Beyond the headlines of trade wars and central banks reducing interest rates globally, again addressed in more detail later on, the underlying simple fundamentals of supply and demand continue to look constructive. The valuations of the underlying producers look favourable versus historic levels and especially against other sectors. This discount is even more extreme when looking at smaller companies (<$1bn) with many of our names trading at 0.5x & 0.6x P/NAV for gold and base metal miners, due to an additional discount by virtue of not meeting liquidity requirements for large funds and passive ETF’s. CQS Natural Resources does not try to emulate or track any of the major ETF’s or indices, instead focusing on the opportunities in which we see the most attractive value opportunities. This is a strategy that has been difficult for the last few years, as we have been left fighting a tide of capital flow from active to passive strategies and hence flows out of smaller cap equities more generally.
Against this geopolitical events have also weighed on the sector raising demand concerns, deferring the broader sector recovery we expect. Put simply, commodities and mining especially have been out of favour for over 5 years, this has led to a greater focus on capital discipline which has resulted in a dearth of new capacity additions now and for the next few years.
Against this background of muted supply growth even a low level of demand growth would tighten the market and support higher pricing. The key question is therefore demand, with increasingly negative sentiment resulting from the prolonged US-China trade war. We believe this sentiment has overshot to the downside, with a greater risk that any improvement or resolution could lead to a recovery in demand growth and a scenario where the world is in supply deficit for many commodities, an environment that would lead to better pricing. China still looks to grow by 5-6% per year, and though stimulus has been thus far limited we believe a slowing beyond this could prompt more action.
We have no crystal ball as to how the trade war will develop, in part due an unpredictable US president. We have opted to position for this backdrop with a large weighting to precious metal miners as useful portfolio insurance. We are comfortable with this weighting as gold equities have recently shown their ability to act with a negative correlation to the broader market, thus offering protection against weakness, but also because we believe they are attractively valued, even at a gold price lower than the $1520/oz we see today (24.9.19), so can perform well under either scenario.
Geopolitics
The most significant of these is the US/China trade war, with commodity markets driven by daily tweets from US President Donald Trump. There is a strong argument to suggest President Trump may become more amenable to negotiating given the slew of negative global growth data that is now having knock on impacts on US domestic growth. This is especially poignant coming in to 2020 as an election year. The US continues to see a trade deficit despite the tariffs, with the deficit at $55.2Bn in June, or $662Bn annualised, which compares to $621Bn in 2018. It is notable that $419Bn was with China in 2018, which is why President Trump is so focused on it, although it could be easily reduced via major agricultural and energy imports, which will likely form part of any solution.
If the current uncertainty extends materially leading to continued negative global growth data, China will likely respond to any domestic slow down through a pickup in stimulus. This is a fine balance for China, as reducing rates would act to lower the Yuan relative to the USD, a key focus of President Trump, risking an escalation of a currency war.
US sanctions curtailed supply in Iran and Venezuela which initially supported the oil price. This was further compounded by tensions as Iran impounded a UK flagged oil tanker and threatened to shut down the key shipping route of the strait of Hormuz. Whilst their threat is unlikely it highlights the potential for an escalation of the wider Middle East region, a key supplier of oil globally. In the second half of the financial year oil has pulled back on demand concerns from fall out from trade conflicts on global growth and more recently the expectation of growth in US oil supplies, which we have well flagged and a key reason for our low weighting to energy producers. On the 14th September we saw an attack on a major Saudi oil facility, impacting 5M barrels per day of oil supply, with Iran the most likely perpetrator. In the days that followed Saudi reported being able to add back much of this production with the intention of returning to full production by the end of the month. The relatively muted response in oil prices, ending the week up by 7% highlights the spare capacity within the global oil system. We remain cautious on the oil price, but are increasingly less so, noting that US production growth is slowing and increasing Middle East tensions add to the potential for supply shocks. We will gradually look to add to our current low level of energy weighting within the fund.
Brexit also remains a key uncertainty and whilst significant to us in the UK, its impact is limited on the wider commodity market. The key impact on the fund is in the reference currency for the NAV. A weaker sterling has benefitted the NAV as most assets are held in other currencies. As we approach the 31 October 2019, the date set for the UK’s exit from the EU, we will continue to see volatility in sterling. This is something we are closely monitoring, noting that a swing in either direction may provide either a headwind or tailwind to future NAV performance in sterling.
Precious Metals
Gold and silver have been the notable out performers in the commodity space. The performance of the fund has been a key beneficiary given the circa 25% weighting to precious metals. The declining interest rate outlook has been the main cause of improved sentiment, leading to $16Trn of negative yielding bonds, but this has been caused by slowing global data due to the trade war between the US and China.
President Trump’s enforcement of sanctions and tariffs on countries which he wishes to exert leverage upon has elevated the risk for many to rely on the US dollar as a settlement mechanism. This has led to strong Central Bank buying, adding 374t in the first half of 2019, the largest addition in the 19 years of the World Gold Councils’ data series. This is encouraging for the sake of gold and precious metals, as it suggests we will see continued purchases for the foreseeable future from a number of very large and sticky buyers. The physical ETF’s for comparison have shown meaningful physical additions, but they also present a risk if these typically faster money acquirers were to switch to selling.
Base Metals
Base metals were weaker on global demand concerns due to the US/China trade war. The fund has a meaningful exposure which has weighed on performance. We had not expected trade talks to be so protracted and lead to such a negative impact on global growth. President Trump is now very motivated to strike a deal as it has started to impact US equity performance, on which he partially grades himself. The true knock on implications are now being felt with warnings from the likes of Apple as to their reliance on parts delivery. At the time of writing President Trump had just extended the period which US companies are allowed to trade with Huawei. This trade war has offset what we had believed was a positive fundamental back drop of constrained supply, following a 5 year period of minimal capex on new projects and thus there is a lack of new supply. Base metal prices today are implying a very bearish outlook for demand which we believe is too negative, although this is clearly dependent on trade war developments. The uncertainty that has come from the present situation has extended this period of reduced development activity, with very few new projects being sanctioned. If we do see anything better than a very bearish outcome it could lead to a strong rebound in the underlying metals and equities.
Oil
Oil was very weak over the period. The initial weakness came from demand concerns on slowing global growth, but this latterly became more focused in increasing US production. We have repeatedly referred to this risk as the US adds new pipeline capacity, with the Permian basin adding 1-2M barrels per day of capacity over the next few months, which is why we maintained minimal exposure, which has benefitted the fund. The Fund has been well placed in Hurricane and Diversified Gas and Oil which are relatively defensive due to low production costs.
Shipping
The Fund’s shipping exposure is partly to gain exposure to the energy themes we see. Both BW LPG and Euornav stand to benefit from increased US shale production growth. As shale oil is increasingly exported from the US to Asia, Euronav stands to benefit where the longer shipping routes increase utilisation for the entire fleet. BW LPG transports propane, again primarily from the US to Asia. Propane is produced as a by-product of shale production, so the increased production will increase flows and the spread between pricing which supports higher day rates for their vessels.
Additionally all shipping looks likely to benefit from a new ruling, IMO 2020, requiring shipping vessels to use less sulphur in their shipping fuel. The impact of this is to elevate the fuel price which is worn by the customer, but therefore encourages slower steaming to increase efficiency. This will act to increase the utilisation across the sector overall, benefitting day rates. At normal day rates all of the shipping names held in the fund would pay meaningful double digit dividends.”
About CYN
CQS Natural Resources Growth and Income (formerly City Natural Resources High Yield Trust) seeks to provide shareholders with capital growth and income predominantly from a portfolio of mining and resource equities and of mining, resource and industrial fixed interest securities. CQS Natural Resources Growth and Income invests predominantly in mining and resource equities and mining, resource and industrial fixed interest securities (including, but not limited to, preference shares, loan stocks and corporate bonds, which may be convertible and/or redeemable). Ian Francis, Keith Watson and Rob Crayfourd are responsible for the day-to-day management of CYN’s portfolio. Keith and Rob focus on CYN’s equity holdings while Ian primarily focuses on its fixed income holdings.
CYN: CQS Natural Resources Growth & Income’s strong precious metals weighting a silver lining