In a Critical Resource Q&A, Neil Gregson – head of JPMorgan’s Global Natural Resources Fund – considers the prospects for prices bottoming out and potential bright spots in the market.
The new year brings challenges for former market darlings – but also opportunities
“Everybody falls into the same trap with the start of a new calendar year – expecting things to change, expecting better prospects ahead. Typically, one would see at least a December/January rally in the sector, whereas of course at the start of this year we’ve had the reverse of that, with yet more sell off in the oil and gas and the commodities space. Clearly 2016 has not started off on a good note. I think we are in a ‘bottoming out’ process now – just look at the headlines.
I’ve got an expression, the ‘over 90’s’ club. Basically, it’s the share prices of former market darlings, Anglo, First Quantum, Freeport – Glencore’s not far away – where prices are down 90 percent plus since the peak. If we went back 4-5 years, and I’d said to you ‘well, these shares are going to fall over 90 percent,’ you would have said ‘I don’t believe you – if that happens surely we’ll be in some sort of massive global depression.’ We’re not. Demand has been there, but it’s not been sufficient – supply has simply been too great. The companies that have been hit hardest – whether in the oil and gas sector or in mining – are clearly the ones that took on significant debt to fuel the supply-side response to the China-driven super cycle. While we’re still in a clearing out process now, all we need is for some stability in commodity prices to restore investor confidence. We could see some fairly significant share price gains driven by those highly leveraged companies that people are currently worried about.”
It’s a buyers’ market, but who are the buyers?
“I think this year there will clearly be a theme of balance sheet repairs and asset sales. The sales we saw last year and the year before, whether in copper or gold, were generally at decent prices. Now, Glencore has assets up for sale, Anglo American has assets up for sale – what are we going to see in terms of price point? That’s obviously going to be a big theme, along with the question of who benefits from those deals.
In previous downturns – and this is my fourth down cycle as an investor – the big guys always had the balance sheets to chump up more leveraged firms. We do not have that this time. If assets are sold cheaply, is it some of the midcap companies that benefit? So far, we’ve just seen some – like Lundin Mining and some of the gold companies out of Australia – that have had the ability to take on assets. The Chinese have been doing some purchases. But even that is insufficient if the large, multinational, multi-commodity companies are not in a position to make any sizable acquisitions.
I don’t think there are many other buyers. Is it private equity? Do they want to run mines? Probably not. Would they do it in partnership with a midsize mining company? Maybe. So, midcap appetite will shape the market. But there’s not much left – it’s hard to list the companies remaining that have the capacity to take on assets. Sellers want cash and are not going to be happy with equity, unless it’s liquid.”
With the commodities trade increasingly interconnected, oil may lead the recovery
“The whole commodities suite has become more and more linked and is now just one big macro trade. So we are unlikely to see strong recoveries in say, base metals, with no recovery in the oil price. We need to see a recovery in oil to help the rest of the commodities basket along. So we think that even though oil was last into the downturn, it’s more likely that any sort of sustainable recovery will be helped along, and perhaps even led, by an oil price recovery. We really see oil as key.
Inventories are high and the lifting of sanctions on Iran has made everyone worried about extra oil – Libya could also still surprise on the upside. But overall production is falling. Oil remains a finely balanced market. You’ve only got a percent or so of oversupply and we see that being worked through in the course of 2016. More importantly, we’re seeing all these capital projects being shelved, so when the recovery comes it will be a bit more sustainable.”
Uranium, diamonds, lithium: a few bright spots in the commodities sector
“Last year was tough in many regards. It was tough because of the share price collapse in the larger mining companies, but there was also nowhere to hide in the ‘dig it out of the ground’ or ‘pump it out of the ground’ commodities space – everything got slammed, as opposed to 2014 where diamond stocks did very well. Usually there are pockets in some areas, where the supply-demand dynamics are better.
So, obviously, when we’re talking about bright spots in the commodities market, we keep coming back to the great debate over China. Yes, some of the data is improving, but it’s still uncertain. In terms of all commodity-intensive sectors it remains challenged. It may be up a bit in aluminium, but then, we’ve got lots of aluminium around.
One of the secular longer-term markets we’re seeing is uranium. That’s the one area where China clearly still has a lot of growth, with one nuclear reactor being commissioned every quarter. Possibly diamonds as well, in terms of the US retail market. What is also getting attention outside of the mainstream are areas like lithium, in terms of battery technology, and some graphite stocks are picking up. We’d also probably stay with the consensus that when you look at depletion rates and grades, copper will be a medium/long return, and zinc looks like it’s starting to tighten up.”
Governments need to work with multinationals to weather low prices
“Obviously, we went through the normal cycle of great commodities prices driving governments to increase taxation in whatever form. One country that was particularly guilty of that was the UK. Where in the past companies have paid advance taxes to help support the budgets of smaller states, with commodities prices where they are now, that’s not a viable proposition. So, while over the course of the cycle we saw a fairly marked increase in royalty rates, recently there has been some backtracking. The Zambians are cancelling the corporate tax and stepping back from the 20% royalty because the industry was, in general, going to have to shut down. There are other reversals as well – Guatemala has put off a royalty increase, for example. It waxes and wanes, but in other countries it remains a challenge.”
J.P. Morgan Asset Management is part of JPMorgan Chase & Co. and is a global asset management leader providing world-class investment solutions to clients. With US$1.7 trillion in assets under management (the Asset Management client funds of JPMorgan Chase & Co. as at December 31, 2015) and offices in 41 locations around the world, J.P. Morgan Asset Management offers global coverage with a strong local market presence, and leadership positions in most asset classes. The JPM Global Natural Resources Fund invests in natural resources equities.