Over CQS Natural Resources Growth & Income’s (CYN) annual results period to 30 June 2020, the company returned (10.6%) and (5.9%) in total NAV and share returns.
In the sections that follow, we include commentary from the fund’s managers, Ian Francis, Keith Watson, Rob Crayford, on precious metals, base metals and gold.
Precious metals – ‘Low (and in many cases negative) real yields drive gold rally’
“The fund’s position in gold, owned as cheap insurance, has paid handsomely during this period of uncertainty and the Fund’s precious metal exposure currently stands at almost 30% (of which gold is 25%). As we write, fears of a second wave of infections are providing a further boost to gold. Following a brief initial wash out of margin calls in March, as lockdowns were rolled out across the OECD, there has been little to hold gold back and year-to-date it has registered a 27% increase and is approaching US$2000/oz.
The primary driver of the gold price is real yields, which is the return received from interest rates minus inflation. When real returns are low (or in today’s world increasingly negative), gold has historically performed strongly. The fallout from COVID-19 has led to coordinated rate cuts globally, the economic impact of which is yet to be fully understood. We see no evidence to suggest any risk of an increasing rate cycle in the near term. Typically, there are two sources of inflation – either demand-led or supply led. While trends are recovering demand is currently weak, though pent-up demand may surprise. It is on the supply side where the biggest impact may be seen, as the huge deflationary pressures experienced from China Inc. over the last two decades may reverse as they find themselves increasingly politically and economically alienated from the global stage. Reconfiguring supply chains, to reduce the current heavy reliance on low-cost Chinese manufactured goods, may raise prices.
Driven by this the largest physically backed ETFs funds monitored by Bloomberg have added over 28 million ounces this year to take aggregate holdings to 106 million ounces. A corollary of this, however, is that gold is now far more expensive in the major demand economies such as India, China and Turkey, particularly when denominated in local currencies that have weakened against the US dollar. Similarly, central bank buying has paused as they contend with their response to COVID. Consequently, the pick-up in physical ETF buying has essentially only offset weakness from these segments. According to the World Gold Council, overall gold demand was up only 1% in the first calendar quarter of 2020.
Against this helpful gold price backdrop, equities have performed extremely well. Of note, the Fund’s holding in West African Resources, 7.4% of the fund as at end June, which has successfully transitioned into production within budget, has been particularly pleasing. Though the company remains attractively valued and is gaining investor traction as its size and liquidity improve, having doubled year-to-date the exposure is being managed to control concentration risk. Americas Gold and Silver, 4.1% of the fund at end June, benefitted but to a lesser extent, but after some minor delays in bringing its Relief Canyon mine into production, looks set to reach commercial production in Q4.”
Base Metals – ‘easily stored and far more dependent on China than crude oil’
“Industrial base metals have undoubtedly experienced a demand shock, but unlike crude oil, these are easily stored, so do not see the same infrastructure restrictions. They are also far more dependent on China, which constitutes approximately 50% of demand so are better placed to respond as the region, which was first affected by COVID, leads the reopening process and prices have been well supported by Chinese state-owned enterprises seeking to build metal inventories into summer, ahead of an expected pick-up in economic activity. Indeed, having declined nearly 30% at one stage, the price of economic bell-weather metal copper has recovered strongly and has moved above levels at the start of the calendar year. In contrast to gold, copper prices trade at a premium in Shanghai versus western exchanges.
The US election, set for November, looks likely to be supportive for base metals, with both Trump and Biden running investment heavy campaigns. This will be important as a surge in US unemployment, which stood at over 11% in June having jumped to nearly 15% in April from 3.5% earlier in the year, has been accompanied by the largest drop in consumer confidence since 1973. In addition, there is increasing speculation of a US$1trn pre-election fiscal stimulus programme, to help bolster the country’s economic recovery.”
Oil – ‘industry beholden to the marginal cost of US produces caps sector’s upside for the time being’
“Oil prices plunged during the period suffering from the twin effects of demand collapse, as a global lockdown reduced daily demand by approximately 35%, together with a shift in strategy by OPEC and Russia to defend market share rather than price. The combined effects of the demand collapse and a surge in OPEC+ output as they opened their pumps caused substantial inventory builds to levels approaching global storage limits. This dynamic had the extraordinary impact on oil for prompt delivery, driving the May WTI contract price negative for the first time in history. This price correction has prompted a sharp reduction in US onshore rig deployment and a corresponding sharp correction in regional oil output. Nevertheless, though oil prices have recovered to the more balanced situation the industry still appears beholden to the marginal cost level of US producers which we believe to be in the US$40-50/bbl range, limiting upside potential in this sector for the time being.
The Fund continues to underweight the E&P sector and related equity exposure remains minimal at just 4% of NAV. Given the much needed and substantial US production cuts required to restore crude markets to balance, the Fund has instead increased exposure to Diversified Gas & Oil which should benefit from reduced output of gas, a by-product from onshore oil production, whilst paying a healthy 11% dividend.”
CYN: Gold exposure provides a buffer in tough year for CQS Natural Resources Growth & Income