BlackRock World Mining (BRWM) has announced its annual results for the year ended 31 December 2022. During the period, which the chairman David Cheyne describes as “another year of excellent performance”, BRWM provided an NAV total return of +17.7% and a share price total return of +26.0%. In comparison, over the same period, BRWM says that its reference index, the MSCI ACWI Metals & Mining 30% Buffer 10/40 Index (net total return), returned +11.5%, the All-Share Index returned +0.3% and the UK Consumer Price Index (CPI) increased by 9.2%. The strong performance reflects a very supportive macro backdrop during the year.
Revenue earnings and dividends
2022 was the second best year in BRWM’s history for income and only marginally short of 2021’s record. Cheyne says that, collectively, the balance sheets of mining companies have never been stronger, reflecting tight financial discipline and strength in commodity prices. By prioritising financial stability and investor returns over growth, the mining sector has enabled investors to continue to share in the fundamentals benefiting the underlying companies.
BRWM’s revenue return per share for the year amounted to 40.68p compared with 43.59p for the previous year, representing a slight decrease of 6.7%. During the year, three quarterly interim dividends of 5.50p per share were paid on 30 June 2022, 30 September 2022 and 22 December 2022. The Board is proposing a final dividend payment of 23.50p per share for the year ended 31 December 2022. This, together with the quarterly interim dividends, makes a total of 40.00p per share (2021: 42.50p per share) representing a small decrease of 5.9% on payments made in the previous financial year. As in past years, all dividends are fully covered by income. In accordance with the Board’s stated policy, the total dividends represent substantially all of the year’s available income.
Subject to approval at the Annual General Meeting, the final dividend will be paid on 26 April 2023 to shareholders on the Company’s register on 10 March 2023, the ex-dividend date being 9 March 2023. It remains the Board’s intention to seek to distribute substantially all of the Company’s available income along similar lines in the future.
Sector driven by macro backdrop
BRWM’s manager says that, looking at the year more broadly, it was driven by a shifting macro backdrop and a sharp uptick in geopolitical tensions. The former saw interest rates rise across the world causing equities to derate on the back of both a higher cost of capital but also fears of recessionary impacts to profit margins. These issues were further compounded by the invasion of Ukraine by Russia which triggered a range of consequences from spikes in oil prices, huge volatility in European power costs and shortages of natural resources from oil/gas/metals/fertilizers etc. China was also impacted by its zero COVID-19 policy which badly damaged its economic growth.
The manager says that 2022 was a complicated year for the mining sector in many ways. If one had known beforehand about the big macro headwinds such as slower growth in China, rising rates and recessionary conditions across the developed world, most people would have expected mining shares to have delivered negative returns for the year. Therefore, to see the leading sectoral gains in financial markets for the year coming from natural resources shares, with energy leading the way on the back of supply disruption following Russia’s invasion of Ukraine, makes it easy to understand why generalist investors missed the opportunity. It is also easy to understand their reticence to buy after such a long period of outperformance.
The manager believes that the trends of prior years, such as capital discipline and strong balance sheets, have built strong foundations for the sector and it is these factors that drove the outperformance in 2022. For example, if mining companies had gone into the year with large capital spending plans and high levels of debt, share prices would have fallen as sharply as in similar periods from the past.
Another output of the improved capital allocation decisions has been a lower level of reinvestment into production. This has allowed free cash flow to grow, but, more importantly, it has meant limited new supply growth across the industry. Given that the world economy now needs commodities to build the projects for the energy transition, the absence of new supply has left commodity markets extremely tight. In fact, at the end of 2022, inventories at London Metal Exchange warehouses were at 25-year lows. Available inventories for aluminium, copper, nickel and zinc decreased by over two-thirds during the year. The low levels of stockpiles reflect a tension that has kept traders and consumers gripped as demand weakened (due to China economic slowdown and recessionary fears in developed markets), but constrained supplies kept prices at levels higher than expected.
Supply constraints unlikely to ease
BRWM’s manager says that supply constraints are unlikely to ease during the next few years due to the scarcity of “shovel ready” projects and high permitting barriers. This has left companies focused on growth needing to revisit mergers and acquisitions (M&A), as producing assets valued in the equity markets often trade below the cost of building new capacity. In Australia, BHP managed to agree terms to buy OZ Minerals after many months of discussions. The deal looks set to complete in 2023 and the Company has benefited materially from this deal due to having a large holding in OZ Minerals. It is hard to see other deals happening due to the small number of listed copper producers and fears of resource nationalism that continue to add risk to moving capital into more remote regions e.g. the threat of closing First Quantum’s new Cobre de Panama mine.
Outside of sector specific issues, the geo-political tensions caused by Russia’s invasion of Ukraine further tightened markets due to the sanctions imposed by other countries. This disrupted commodity supply chains at a time when markets were already tight, further supporting prices at a time when economic weakness would normally have seen them fall. As the year developed, prices did cool during the summer, only to recover in Q4 2022 as China started to ease COVID-19 restrictions.
Price weakness but strong margins
2022 saw prices generally down for the year as a whole, as well as lower average prices versus the prior year. However, BRWM’s manager comments that it is important not just to look at the moves in isolation. For example, the average price of copper in 2022 was down 5.2% compared with 2021 but the actual level of US$4.2/lb was the second highest average price ever, leaving companies enjoying healthy margins. The opposite is true for nickel where the prices were up year-on-year but the average price was not as high as it had been in the past, but still at extremely profitable levels for producers.
In precious metals, gold was the standout as the average price was flat for the year compared to silver, platinum and palladium which were all lower. However, gold companies seem to have suffered more from cost inflation as they did not go into the inflationary environment with levels of profitability as high as their industrial peers.
The standout commodity for the year was lithium, as the price soared driven by demand exceeding estimates as electric vehicle (EV) adoption rates increased across the world. In fact, the whole battery material suite looks set to see strong demand as the transition away from the combustion engine gathers pace.
Energy transition
The energy transition continues to gather pace. The manager comments that EVs are taking market share away from combustion engine vehicles at levels well in excess of expectations. The roll out of renewable power projects and related infrastructure is happening far quicker than planned. This has in part been driven by a desire by European countries to diversify away from Russian supplied fossil fuels and the fact that with fossil fuel prices so high renewable power is substantially more cost effective, not to mention helping countries/companies to meet their net zero commitments.
Despite the positive news from 2022, it is clear that we remain very close to the start of the energy transition cycle given the enormous scale of investment that is going to be needed over the coming decades. Looking at the data for renewable power, it is increasingly obvious how much more resource intensive it is. On top of this there will also be commodity demand from battery storage needs and the buildout of the hydrogen economy.
The manager says that it is also essential for mining companies to embrace the need to decarbonise their own operations as future demand is likely to seek out supply from companies that do not just meet quality but also have green credentials. This move from “Brown to Green” presents a range of investment opportunities for the Company both in trying to reduce the heavy discount rates applied to carbon intensive production techniques, as well as new technologies that could solve some of the more damaging historical processes.
Manager’s comments on base metals
“It was a volatile year for base metals with prices starting the year well on strong western world demand and risks around supply amplified with the invasion of Ukraine. However, as we approached the middle of the year, the macro-outlook began to deteriorate with COVID-19 lockdowns in China, further weakness in the Chinese property market and interest rate increases to tame inflation which led to concerns around global growth, particularly in Europe as energy prices became an increasing toll on consumer and economic activity. This resulted in peak to trough declines of 30% to 40% across the base metal complex, which combined with supply challenges, cost inflation and royalty increases created a difficult environment for the producers. Given this, share prices fared far better than might have been expected, a reflection of the balance sheet strength of the producers and improving outlook for demand.
“Encouragingly, as we approached the year end, several measures announced by the Chinese government to support the economy, including relaxation of its zero COVID-19 policies, buoyed sentiment with prices rallying from their Q3 lows. Interestingly, when we look at the overall price performance for the year as shown in the table in the Annual Report and Financial Statements, while the majority of base metal prices finished the year lower, with the exception of nickel, the average price received in 2022 was higher than the prior year, supporting earnings for the producers. As we look forward into 2023 and the potential impact of China re-opening, not only do we expect to see a year-on-year pick-up in underlying demand, but also a re-stocking of commodities such as copper and aluminium assuming China reverts back to its pre-COVID-19 levels of inventory cover. Given the tightness in physical markets and low level of base metal inventories today, this creates upside risk to commodity prices over the next two years if Chinese growth stabilises and the slowdown in the US economy is not protracted.
“The copper price started the year strongly reaching US$4.85/lb in early March, to subsequently trade between US$3.25/lb to US$3.70/lb for much of the second half before rallying to US$3.79/lb at the end of the year as China looked to stabilise its economy. Whilst the absolute copper price is high versus history, the cumulative impact of cost inflation over the last five years has seen a step change in the operating cost base of the industry with several mines operating at cash breakeven levels during the low copper prices of Q3.
“Copper is a clear beneficiary of the energy transition with more than 65% of copper used for applications that deliver electricity, whilst at the same time the industry is facing mine supply challenges resulting in a material deficit in the market longer term. This is driven by a lack of new greenfield copper projects, as well as deteriorating performance at existing assets, particularly in Chile. The expectation was for 2022 to deliver a step-up in copper supply with new projects such as QB2 (Teck Resources) and Qualleveco (Anglo American) due to come online. However, as we approached the year end, a swathe of production cuts has delayed growth until 2023/2024, leaving the physical market tight with a lack of inventory becoming an increasing issue for industrial users. Given the significant copper supply gap estimated longer term (3.5Mt gap estimated by Macquarie Bank by 2030), we continue to believe that copper prices need to remain above incentive prices to induce new supply into the market which is an attractive position for existing low-cost producers.
“As at the end of December 2022, the Company had 22.0% of the portfolio exposed to copper producing companies which modestly detracted from performance for the year. The Company’s second largest copper exposure Freeport-McMoRan (4.0% of the portfolio) continued to deliver operationally at Grasberg, as well as executing on their US$3 billion buyback which they announced in late 2021. Among our other copper producers, Ivanhoe Mines (1.8% of the portfolio) have continued to surpass the market’s expectation on the ramp-up of Kamoa-Kakula, underpinning our confidence in the management team’s ability to deliver value from their other assets including the Western Forelands in the future. Among our mid-cap holdings in the portfolio, there was exceptional performance from Ivanhoe Electric which held an IPO during the year delivering close to a 100% return from our pre-IPO investment, as well as Jetti Resources which raised US$100 million at a substantially higher level than our entry price. Both are discussed in detail in the unquoted section of the report. The portfolio has also benefited from M&A activity during the year following BHP’s cash offer for OZ Minerals (1.2% of the portfolio) that was recommended by the OZ Minerals Limited board in December 2022. Strategically the transaction brings significant benefits to BHP given the proximity of OZ Minerals’ assets to BHP’s Olympic Dam operation in South Australia and supports the build-out of an Australian based copper basin for BHP in the years ahead. OZ Minerals have been an exceptionally strong performer over a number of years where the Company benefited from the re-rating of the company as they delivered operationally, and they were also the operator of the OZ Minerals Brazil Royalty when they acquired Avanco Resources in 2018.
“The aluminium price finished the year down by 16%, facing similar global growth headwinds as the copper market. In the first half of the year there were fears that Russian exports of primary aluminium might be impacted by sanctions which supported prices. However, whilst certain companies have chosen not to purchase Russian material, there have been no sanctions imposed directly on Russian aluminium exports and these tonnes have still entered the market. With power a major cost component for aluminium smelters, higher energy costs have resulted in 1.2mtpa of capacity curtailed in Europe. At an aluminium price of US$2,500/tonne, WoodMac estimates that 30% of smelters are loss making on a full cost basis, which provides a level of downside protection to the price. However, increasing aluminium exports from China this year has largely capped the price. As China’s domestic demand improves into 2023, we would expect exports to moderate, which in turn should support prices. The Company has exposure to two aluminium producers Alcoa (1.2% of the portfolio) and Norsk Hydro (2.1% of the portfolio) both of which have access to renewable, low cost energy for the majority of their production, leaving them well positioned in the current environment of high energy costs and longer term as the market places a greater cost on carbon.
“Nickel prices have been very volatile this year where a short squeeze temporarily drove prices above US$100,000 a tonne before the LME suspended the market and cancelled some trades in March. Similar to aluminium, Russia is also a significant producer of nickel, but we are yet to see any supply disruptions. Overall, the nickel price finished the year up by 43% with the market becoming increasingly aware of the longer-term deficit building for high grade nickel used in batteries. In Q4 2022, the Company made an investment in Lifezone which announced a business combination with a Special Purpose Acquisition Company (SPAC) GoGreen Investments which is listed on the New York Stock Exchange. Lifezone has a controlling shareholding in Kabanga, the largest and highest-grade undeveloped nickel project globally, located in Tanzania. The project has significant backing from BHP the world’s largest mining company which has invested US$100 million into the asset at a see-through valuation of US$627 million to acquire 14.3% of the project, with the option to acquire a 51% interest once the feasibility study is completed by the end of 2023.”
Manager’s comments on bulk commodities and steel
“It was a challenging year for the iron ore market with average prices 24.5% lower year-on-year, with demand undermined by China’s zero COVID-19 policy and ongoing weakness in China’s key steel intensive property sector. Whilst the market enjoyed a post Beijing Winter Olympics restock in first quarter seeing prices hold a healthy range between US$120-140/tonne during the first half of the year, they subsequently averaged below US$100/tonne during the second half of the year bottoming at US$80/tonne in the third quarter as Chinese steel margins turned negative and uncertainty around China’s COVID-19 policy saw further de-stocking by customers.
“China’s shift in COVID-19 policy and further support announced for the property sector at the end of the year, has seen prices rally back above US$100/tonne as the market looks to price in the impact of China re-opening. As we look into 2023, we expect to see a recovery in construction activity, which combined with first quarter seasonality in the iron ore market with both Brazilian and Australian tonnes exposed to weather events, it provides a constructive backdrop for the price during the first half of the year. Among the ‘big 4’ producers there is modest (~1%) growth in supply this year which will be second half weighted and we continue to see the producers being disciplined around volumes which should be supportive of the price over the medium term. During the course of the year, we had the opportunity to visit BHP’s and Rio Tinto’s key iron ore assets in the Pilbara Region of Western Australia which enabled us to learn more about the world class size and grade of these assets, their approach to ESG and the focus on decarbonising their operations.
“The Company’s exposure to iron ore is in the diversified majors BHP, Vale and Rio Tinto, which have performed well this year returning 30%, 35% and 19% respectively. In addition, the Company has exposure to two pure play high grade iron ore producers Champion Iron and Labrador Royalty Company which have returned 41% and -6% respectively, as well as Mineral Resources which is looking to grow its iron ore business alongside its lithium, mining service and gas business which finished the year up by 45%.
“Coal markets have been one of the most interesting commodity markets over the last couple of years with record prices achieved for both metallurgical and thermal coal during 2022. Thermal coal markets have benefited from tightness in global energy markets particularly in Europe due to the ban of Russian coal imports, limited supply growth due to ESG pressures and higher than normal levels of rainfall in Australia which accounts for 60% of seaborne supply. With levels of gas storage in Europe above average levels at the end of 2022, we have seen European gas prices decline which poses a risk to thermal coal prices. However, given the tightness in the market for high grade Australian thermal coal, prices have held at a record level of ~US$400/tonne at the end of 2022. As we look into 2023, we continue to see a tight market for thermal coal given much of Europe’s coal and inventory build was sourced from Russia, but with supply from Australia expected to recover in 2023 after record rain impacts in 2022, a moderation in thermal coal prices from record levels is likely.
“The Company’s thermal coal exposure is via our 7.7% position in Glencore, which is using elevated thermal coal prices to deleverage the business and remains focused on decreasing its coal exposure overtime. Glencore has indicated that they intend to return excess cashflow above their net debt target of US$10 billion. This implies a 15% capital return yield for 2022 which is industry leading and will result in a circa 10% decline in their share capital outstanding. The Company has no exposure to pure play thermal coal producers.
“The seaborne metallurgical coal price reached a new all-time high during the first half of the year at circa US$500/tonne, supported by Russian supply concerns (5% of global supply), tightness in the thermal coal market, as well as the flooding in Australia which impacted supply. However, as we moved into the second half of the year, prices moderated as weaker steel demand in Europe began to bite with the metallurgical coal price finishing the year at US$295/tonne (Premium Hard Coking Coal, FOB). During the course of the year, we saw a number of production downgrades announced including Anglo American reducing volume guidance for its Grosvenor mine in Queensland and Teck Resources reducing guidance at Elkview due to operational issues. This, combined with limited investment into new supply and seasonal weather events, leaves the coking coal market susceptible to upside spikes in prices which has been a consistent feature of this market in recent years. The Company’s exposure to metallurgical coal remains in the two leading producers of BHP and Teck Resources which have been able to generate very strong levels of free cash flow from their coking coal businesses to support returns to shareholders. (All data reported in pounds sterling terms.)”
Manager’s comments on precious metals
“The last three years have seen a largely rangebound price environment for precious metals, with the average annual gold price between 2020 to 2022 within 1.7% of each other in US dollar terms. This is a remarkable level of stability for a commodity, with the gold price driven by two opposing forces over the last year. On the positive side we have seen rising inflation, elevated geopolitical and market risk, while on the other hand the impact of interest rate hikes to combat inflation which has seen real rates for Government bonds flip from negative to positive over the course of the year. As we approached the year end, we saw the gold price rally and breakthrough US$1800/oz on the back of China’s reopening news, the knock-on impact from a weaker US dollar and the potential for the Federal Reserve (the Fed) to slow the pace of interest rate hikes as inflation started to moderate.
“With positive real interest rates in the US and most global economies, the appeal for non-yielding gold in the short term is limited. The performance of gold over the next 12 months is likely to be driven by the Fed’s ability to tame inflation and whether they can effectively bring down inflation to their targeted level, or whether inflation remains at a structurally higher level than in the past which should raise inflation expectations supportive of the gold price.
“An encouraging feature of the gold equity market over recent years has been the increased focus on shareholder returns, free cash flow and dividends. However, results in 2022 have shown margin compression due to rising labour, energy and other input costs. Whilst the portfolio has continued to hold a lower allocation (13.0%) to gold companies versus a similar time last year (16.4%) we have maintained our strategy of focusing on high quality producers which have an attractive operating margin and solid production profile and resource base. This includes the Company’s exposure to the royalty companies Franco Nevada (2.6% of the portfolio) and Wheaton Precious Metals (2.3% of the portfolio) which outperformed the gold equities during the year given their stronger margins and lack of exposure to cost inflation. In addition, the Company’s exposure to Endeavour Mining (0.6% of the portfolio) and Northern Star Resources (1.2% of the portfolio), both mid-cap growth focused gold companies, added to performance as the benefit of volume growth helped offset some of the cost inflation in the sector.
“Demand for the Platinum Group Metals (PGMs) continues to be impacted by the weakness in global auto production and the share gains from electric vehicles (over internal combustion engines) which do not use PGMs. While Russia is a major producer of PGMs, accounting for 40% of global palladium production, there has been minimal impact to Russian PGM supply. During 2022 there was mixed performance from the PGMs with the platinum price (+11%) outperforming the palladium price (-9%).
“We continue to remain positive on the medium-term outlook for the PGMs and believe the PGM basket will remain high relative to history given limited new supply and increasing PGM loadings for auto catalysts to meet rising emissions standards. The Company has reduced its exposure to pure play PGM producers during the year which represented 2.0% of the portfolio at the year end. In addition, the Company has exposure to PGMs via its holding in Anglo American (5.2% the portfolio) which owns 79% of Anglo American Platinum. The standout performer among our PGM exposure during the year was our investment in Bravo Metals, a PGM exploration company focused on the Luanga project in Brazil which they acquired from Vale. As outlined in the unquoted section of the report, the company’s IPO during the year resulted in a 170% uplift from our pre-IPO investment made in early 2022 and finished the year above its IPO price with early results from its drilling campaign confirming and, in a number of instances, exceeding the historical drilling results from Vale showing previously unidentified rhodium and nickel sulphide mineralisation in the assay results.
Manager’s comments on energy transition metals
“Growth in battery electric vehicles (BEVs) continued in 2022, creating significant demand for the materials that enable that transition. Demand for pure battery electric vehicles grew 40% in 2022 to 267,000 units (16% of all new car registrations in 2022), with demand for plug-in hybrids also growing. This growth has been mainly driven by China, with Europe and the US lagging. We expect this structural growth to continue and accelerate particularly in the US, driven by increased model launches, strengthening consumer preference due to technological advantage and government policy. Of particular note in 2022, was the announcement of the US Inflation Reduction Act. As well as other climate change related measures, this policy supports EV demand through significant subsidies of up to US$7,500 per car. This is expected to support US BEV demand in 2023. The Company has exposure to the raw materials that go into EV batteries and the e-motor.
“Lithium is a critical component of an EV battery and demand for lithium has been strong this year with the market firmly in deficit and benchmark Chinese prices reaching all-time highs in November, finishing 2022 up by 101.6%. The Company added to its lithium holdings in late 2021, establishing a position in SQM and Sigma Lithium both of which have performed well in this environment returning 78% and 207% respectively (GBP returns). We also added a new position in relative underperformer Albemarle in June and Mineral Resources in October, as they too stand to benefit from the continued tight demand supply situation in lithium, as well as their own volume growth. The Company has a 2.1% position across its lithium holdings.
“A critical component of the electric car is also the e-motor, which most commonly uses a Praseodymium-Neodymium (NdPr) magnet, an alloy of two rare earth elements (REE). REE are commonly mined and processed in China and have been deemed of strategic importance by both Europe and the US. The Company has exposure to REEs through Lynas, a REE miner and processor crucially based in Malaysia and Australia. In 2022 Lynas equity fell by 19.1%, but the company announced in June that they had won a contract from the US Department of Defence to deliver a US rare earth separation facility, underscoring the strategic growth opportunity.
“EV battery raw materials include cobalt, where LME prices fell by 26.3% as supply increased faster than demand; the market is moving to lower cobalt intensity cathode materials with higher nickel or lithium iron phosphate chemistry (LFP). Supply growth is set to continue with cobalt being a by-product of many of the Indonesian nickel projects announced and currently ramping. In addition, 2023 may be impacted by the release of 10,000 tonnes of stockpiled cobalt from the Tenke mine in the Democratic Republic of the Congo (DRC) which has been unable to export in the second half of 2022 due to a government dispute. Glencore’s Mutanda mine in the DRC ramped-up production in 2022, supporting circa 50% growth in cobalt production in the first nine months of the year. Glencore, in which the Company has a 7.7% position, saw its share price rise by 47.3% during 2022. Glencore is a globally significant cobalt producer which produced 22% of mine production in 2020 and this is set to increase with Mutanda’s ramp-up.”