CQS Natural Resources Growth & Income shoots the lights out in turnaround year – CQS Natural Resources Growth & Income (CYN) has posted its full results for the year to 30 June 2021. During the period under review, its NAV increased by 83.1% while its share price was up by 109.6%. This compares with its composite index return of 27.5%. The EMIX Global Mining Index (sterling adjusted) was up by 32.4%.
The discount between NAV and the share price reduced as a result of the rising share price and as at 30 June, CYN’s shares were trading at a discount of 6.9%. The board decided to continue to pay quarterly dividends this year totalling 5.6p per share, which is an equal payout to the previous year. In the current year to 30 June 2021 earnings per share were 3.10p per share which meant that 2.5p of dividends were covered by the company’s capital reserves. The yield on CYN’s shares was 3.5% as at 30 June 2021.
At the end of the year under review, gearing stood at 11.37% and the drawdown amount under the Scotiabank facility was £16m. The facility has been renewed for a further two-year period on similar terms and as at 25 October the gearing was 9.3%.
Manager’s report
Introduction
This past year proved a strong one for commodities as the world recovered from the global Covid-19 pandemic. The initial collapse across all asset classes in March 2020 shifted to a rapid and sustained increase in pricing across the sector.
The Company’s Net Asset Value materially outperformed global mining and energy indices over the financial year to end-June rising 83.1% over the period in total return terms. Synchronised global Covid-19 stimulus programmes and the rollout of vaccines supported an easing in lockdown measures across the sector. Together with lingering supply side constraints these factors contributed to the strong performance. Towards the end of our financial year a shift in expectation for a tightening in central bank monetary policy, in an attempt to contain inflationary pressures, began to weigh on the sector.
Supply struggling to keep pace with demand surge
Metal prices have benefitted from a release of pent-up demand and a catch-up on deferred work boosted by an increase in consumer spending afforded by a higher savings rate during lockdown. This was aided as working from home became common place and outgoings on services, commuting and holidays were curtailed. Demand was augmented by largescale Covid-19 relief programmes implemented globally and in unison, directed at resource intensive infrastructure programmes with a noticeable tilt towards the green energy transition. In addition to such investment, house sales and home improvements increased worldwide. Even as the balance of consumer spending shifts back towards services, expectations are that infrastructure programs will continue to support demand for resources.
While demand was impacted as economies went through lock-down so was supply with related mine shutdowns, border closures and logistics disruptions all impacting the flow of materials, products and labour. This caused production across most metals to decline. While production is now returning, the recovery in output has lagged booming demand growth and pricing of industrial commodities remains encouraging.
Over the last few years we have previously highlighted the lack of new supply in the pipeline, as shareholders push for dividend returns over expansionary capital expenditure. This is a very powerful tailwind for resources, as supply discipline remains across most parts of the sector. In addition, corporate Environmental, Social and Governance, or ESG matters are also having a significant impact on corporate strategies, requiring companies to thoroughly examine and address any changes necessary to clean-up current operations and ensure sound asset governance at the expense of investing in expansion. This is also relevant in China, where such movement is more socially than shareholder led, as a result of which polluting capacity is being shut or curtailed, effectively reducing domestic supply. This is especially prevalent in smelting, with the likes of energy intensive and predominantly coal powered aluminium amongst one of the most polluting industries.
The environmental theme is perhaps the most powerful trend in commodities today. It is harder than ever to permit a new mine. Of note, China’s environmental focus is not driven by a need to win votes over the next election cycle, but by a longer-term drive to the support the general population’s health and standard of living. China’s prior policies that had focused on growth at any cost are now heavily tilted to cleaning up the environment that their population live in. China has been the factory for the world, but they are now tightening regulations on polluting industry, limiting supply.
These forces are inflationary, for commodities at least. The wider debate on inflation continues, with the US FED claiming these pressures will be largely transitory. To some degree they may be but other aspects are more structural. Transitory drivers include the release of pent-up demand as economies reopen, virus related supply chain disruptions across mining and manufacturing and accommodative and coordinated government stimulus spending. Longer-term drivers focus more on environmental and green energy policies, delays in capacity expansion resulting from under-investment during a near decade long commodity bear market and China’s motivation to reduce industrial pollution. These long-term factors are powerful and will continue irrespective of economic conditions. It Is also worth acknowledging that too much inflation in the near-term could be negative for commodities given the potential knock-on effects to the general economy, thus measures to dampen short-term pressures such as the recent release of modest quantities of metals from China’s Strategic Reserve Bureau are not unwelcome.
The Drive for Electrification
It is important to differentiate the impact of these factors between commodities. We believe they are particularly positive for the likes of copper, which is key for all forms of electrification. Its properties as an electrical conductor, second only to silver which is prohibitively expensive for general use, with limited alternative substitutes point to an attractive demand growth outlook. Given the lengthening lead time to bring on a newly discovered deposit into production, typically upwards of 10 years, together with a decade of underinvestment, copper market conditions are likely to remain tight and metal prices attractive. Those few groups such as First Quantum or Ero Copper, that have been able to commission or restart new long-life operations during the bear market, which provided a more favourable setting to deliver projects on time and budget given limited competition for construction materials and labour, seem particularly well placed to benefit.
Other commodities such as nickel are often cited as a key inputs for EV batteries, but the fundamentals look notably different. Nickel is currently in a small surplus, whilst its primary source of demand is steel which represents a 90% share of consumption.
Precious metals remain a useful diversifier
Sentiment for gold shifted lower as the global markets focused on post-Covid-19 recovery trades, but there are notable areas of uncertainty. Covid-19 variants so far have not proven excessively resilient to vaccines, but this could change, whilst government borrowing globally has ballooned in order to fund Covid-19 relief programmes, with no clear plan of how we exit this extended period of easy monetary policy. US tapering and ultimately rate rises are now very clearly flagged by the US federal reserve, so arguably priced in. Whilst the market appears to have the US Feds transitory inflation message, the risks of inflation remain clear given current shortages of housing, commodities, gas/ electricity and labour. Inflation driven by supply shortages is bad inflation, and can hurt the global economy which is constructive for gold, given the negative implications to discretionary spend on the global economy. Precious metals remain well positioned as a hedge against this, as rates are ultimately likely to remain historically low, whilst inflation is increasingly a concern.
Outlook
Some banks have been calling for a new super cycle in commodities. We are more cautious on making such claims, but what we can say for sure is that supply looks constrained given years of underinvestment and a continued focus on ESG matters which continues to hinder commodity supply, which tightens markets and supports pricing.
The key question therefore is the level of demand, but absent another global shock the fundamental balances look encouraging. Increased environmental awareness by governments and consumers looks likely to support demand for cleaner energy and electrification while at the same time constraining supply. Continued capex discipline from the major miners is also holding back capacity expansion as they concentrate on investors returns and grapple with tightening regulations on production. Notwithstanding China’s moves to cool some commodity prices which it currently views as excessive, such supply side discipline is positive in extending the commodity cycle and also reducing the risk of overexpansion as global demand growth normalises following the rapid recovery.
The recent spike in energy costs is broadly supportive for commodities as supply from smelters is curtailed, whilst commodity intensive investment in the energy transition remains strong, helped by the upcoming COP 26 meeting. Conscious of the broader economic risks this creates, the fund reduced its weighting to copper miners, after a period of strong performance, reallocating more exposure to energy, with a specific focus on gas. We also note this has led to a notable positive sentiment change toward Nuclear as a source of zero carbon power, from investors and governments, supportive for the uranium mining exposure in the fund.
Energy costs are just one input to the current inflationary pressures we are seeing globally. These inflationary pressures more broadly look likely to persist beyond winter, but to what further extent is less clear. Whilst commodities are a major input to these pressures, they also perform well during inflationary periods, given the ability to pass costs through to consumers.
CYN : CQS Natural Resources Growth & Income shoots the lights out in turnaround year