CQS Natural Resources Growth and Income has published results for the 12 months ended 30 June 2022 and they are good, very good. Over the period, the trust generated a return on NAV of 20.6% and a return to shareholders of 14.7%, both way ahead of a 1.0% return on the trust’s composite benchmark (the EMIX Global Mining Index returned 1.2% and the Credit Suisse High Yield Index returned 0%). The dividend was maintained at 5.6p and more of it was covered by earnings as revenue per share rose from 3.1p to 5.2p.
Helen Green’s chair’s statement notes that “the investment managers made a timely switch in early 2022 by substantially reducing copper weightings and increasing the exposure to energy names. The result was that the company managed to have a positive total return for the first six months of 2022, which is to be commended in the face of such a volatile market.”
Extract from the managers’ report
The composition of performance has changed significantly. Strong gains by metals exposed to energy transition such as copper together with lithium and rare earth metal miners in the first half of the year latterly shifted more in favour of traditional sources of energy. Since the start of calendar 2022, and despite the pull-back from recent peaks, the strongest commodities price gains were all in the energy sector. At the time of writing crude prices are up 14% year-to-date while gas prices in Europe, the US and Asia are up 80%, 79% and 31% respectively. Still more impressive is the huge 250% rise in previously shunned thermal coal prices as regions have scrambled for energy in any form. As a store of energy, battery grade lithium prices have remained strong too, with Asian prices more than doubling in the calendar year-to-date. This contrasts with industrial metals such as copper whose price has fallen almost 25% over the same timeframe.
Despite slower growth the energy sector continues to offer strong return prospects and representing over 60% of Company assets energy exposure is still preferred over more discretionary industrial miners for the time being. Indeed, a broad theme of the recent reporting season was earnings misses from miners, whose earnings are being squeezed by significant cost pressures against a backdrop of softer revenue guidance. As an illustration Rio Tinto, whose earnings are dominated by iron ore, flagged 15% cost inflation in the Pilbara region and also cut their dividend, a move followed by Anglo American. In contrast, energy company results have generally exceeded expectations, been able to absorb cost increases and provided positive guidance.
A similar situation is evident with coal mining equities many of which may be able to sustain extremely attractive free cash flow to support a longer period of strong dividends. As an example, coal producer Thungela recently announced a quarterly dividend of 302p per share, equivalent to the price at which the position was initiated in 2021. Despite rerating to nearly £16 at the time of writing, the shares still offer a prospective dividend yield of approximately 20%.
At almost 7 % of assets at the time of writing, the largest individual Company position is a holding in Precision Drilling. The investment is highly geared to the increase in E&P activity as oil and gas producers seek to replace output from depleting wells to simply maintain production rates. Importantly, rising rig deployments and utilisation are beginning to feed through to rig lease rates and earnings would benefit further should commercial producers shift tack and seek to grow production.
The Fund is also positioned indirectly in other energy activity related sectors, notably crude and gas shipping which represented approximately 10% of NAV at the end of June. Limited new vessel builds are acting to constrain capacity while ship values have risen sharply with rising construction costs. Transportation needed to deliver energy to regions in deficit is beginning to benefit charter rates driving a substantial re-rating of the sector. Having traded at a significant discount to the value of vessels last year stocks now stand on reasonable premiums to their upgraded values. This rerating has recently been accompanied by some M&A activity and crude shipper Euronav, the largest holding in this sector, is currently in the process of being acquired by competitor Frontline.
Clean energy delivering
Despite the rush for traditional energy the most notable single contributor to returns over the year to end-June was Sigma Lithium whose share price doubled in the financial year to end-June year and which has risen another 80% since. Despite this, Sigma remains very attractively valued.
Elsewhere the energy crisis has also spurred a sea change in sentiment to similarly shunned nuclear power as governments recognise the benefits of a more balanced power generation mix. Japan’s announcement to accelerate its restart programme alongside much improved local community backing, China’s accelerated reactor build out and the US investment in domestically sourced fuel typify the shift in perceptions towards this sector. With much improved confidence in fuel demand and a requirement for higher prices to incentivise a significant increase in output needed to address the supply deficit projected towards the end of this decade, this clean energy sector which represented some 7% of assets, remains extremely well placed to deliver further gains.
Portfolio insurance premium, via gold equities, still cheap
Given increased economic sensitivity to monetary policy, central banks face a balancing act in their response to tame inflation. Potentially reflecting this, prospective mid-single digit interest rates remain below the levels necessary to quell inflation which are running at nearly double this level. As a result, the risk of more ingrained inflation or even stagflation has risen markedly.
Centred around energy security, geopolitical tensions remain high and international relations are especially strained with Russia and the Middle East. Signs of a US-China détente during the recent economic slowdown, have receded after US representative Nancy Pelosi agitated relations with her visit to Taiwan. US sanctions on Iran further aggravates increasingly fragile Middle East and Chinese relations. Such a situation raises the risk of central bank policy missteps. Gold remains a useful diversifier for investors, especially those in the UK where the sterling denominated price has latterly performed well.
Based on spot prices, gold equities trade at some of the lowest historical P/NAV valuations and continues to offer cheap portfolio insurance against such risks and further fiat depreciation. For this reason the Fund retains a healthy exposure to precious metals equities which accounted for around nearly 17% of assets at the end of June.
Exposure to base metals remains at historically low levels
Stymied by regional lockdowns resulting from a zero-covid stance China is also contending with problems in its over-leveraged property development sector which has also experienced a more protracted decline. This together with has rising costs, which have more recently pressured dividends from the main producers, has meant that there is little support for iron ore developers and producers and the Fund continues to avoid exposure to this sector.
For the reasons outlined above there has been considerable de-emphasis in the Fund’s base metal exposure, particularly copper exposure, which currently stands at a modest 8% of assets. While we believe limited mine development from this sector will present very attractive opportunities to add back to positions in the future, in the absence of a more positive backdrop for demand, relative valuations need to be significantly more attractive to justify a shift back into these equities.
CYN : Timely switch helps CQS Natural Resources to bumper year