Where the sell-offs have brought opportunity

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George Cheveley, co-manager of the Investec Enhanced Natural Resources Fund, speaks to Warren Dick.

WARREN DICK: Good day, I’m Warren Dick, the editor of Mineweb.com and joining me on the podcast from London today is George Cheveley. He’s the co-manager of the Investec Enhanced Natural Resources Fund. It’s good to have you with us today George.

GEORGE CHEVELEY: Good to be with you Warren.

WARREN DICK: Are you making the annual trip out to Cape Town for the Mining Indaba this year?

GEORGE CHEVELEY: Actually I’m not. I’m leaving that to my colleague in Cape Town Hanre’ Roussouw who looks at some of the miners down there. So I will not be down there this year and very sorry not to be.

WARREN DICK: We wanted to just discuss a little bit more about the Investec Enhanced Natural Resources Fund, this fund has some characteristics that sets it apart from a traditional equity only resources fund, can you just tell us a little bit more about that?

GEORGE CHEVELEY: Yes the idea that we called this fund in many ways – what we called it is managed Beta. The idea of the fund is to give people exposure to a diversified resources portfolio, but to try to manage the volatility which comes with that. Clearly it doesn’t mean to say it’s a low volatile portfolio at all. It still has quite a bit of volatility but we do try to manage the volatility to some extent within the portfolio. We do that by – we are able under the rules to take short positions in individual stocks using contracts for differences. So we will do that in stocks which we believe will underperform and go down and we can also use options, so traditionally we will use good options on indices like the mining index or energy index to provide protection in case of sudden market drawdowns. We don’t have to do these, we’ll only do it at times when we think there’s a lot of volatility but we will use those also to protect the fund.

The other way we can lower the volatility in the fund is to hold high levels of cash as well at times, though typically we like to keep them pretty well invested. And finally, the final way we can do it is we do at times hold commodity positions as opposed to just equity even though our benchmark is equity positions, we will invest in commodities by various instruments and they typically actually are less volatile than the actual resource equities.

WARREN DICK: Right so and where are we now…we obviously are aware of the sell-off but how much volatility is there in the stocks and the commodities at the moment?

GEORGE CHEVELEY: Well in the equities in the first part of this year we’ve seen extreme volatility. We’ve seen major moves both ways in the last few weeks. What is interesting about that is I haven’t – the volatility we’ve seen in the last couple of weeks, we have not seen really since 2008-09 and typically though, people do point to areas of extreme volatility as marking sort of turning points or at least being close to turning points. So you’re seeing very uncertain markets, people not sure which way they’re going and particularly in the equities. In fact what’s been very noticeable on the commodity side, we’ve seen far less volatility.

WARREN DICK: That’s quite interesting, so the equities seem to be more volatile than the underlying commodity prices?

GEORGE CHEVELEY: Yes and that’s pretty typical, we do see that. I’m talking about resource equities because people talk about commodities being very volatile but resource equities are even more volatile in many instances. And you see that particularly with companies with balance sheet issues and a lot of debt. And that makes sense, if you’re looking at the enterprise value of the company being its market cap plus its debt, and if they have a large amount of debt that clearly doesn’t really change every day. So people’s view of the company becomes more bearish or bullish, you get a huge amount of leverage within the equity price around that.

WARREN DICK: Right and that explains some of those large moves. I think last week we saw the likes of BHP Billiton and Anglo American moving greater than 10% in London?

GEORGE CHEVELEY: Yes and I’ve not really seen that for several years. The last time we really saw that on a regular basis was around 2008 and 2009.

WARREN DICK: So we’ve got balance sheets that are distressed and obviously the equity values and the enterprise values are adjusting quite rapidly because of that but another source of uncertainty has been what is the underlying steady state demand from China in the next few years? What are your views on that?

GEORGE CHEVELEY: Yes I think that’s a very interesting question because really what we saw is we had a sell-off in the third quarter last year, round August – September. We then actually saw some production cuts being made as Glencore made some but also others around September or October and people said, ooh this is a sign that things could bottom. What actually happened in the fourth quarter was we saw, what we actually saw then was people then revised down their demand for casts. So a lot of analysts said the production cuts were good but in fact we now see much lower demand going forward, particularly out of China.

That means these markets that deal in surplus prices have to go lower just to get production corrections. What is interesting though is that there’s a not a lot of evidence yet that demand really has changed very much, so people are forecasting and brought down much lower demand numbers for China and elsewhere but if you talk to physical traders right now, they’re saying demand is pretty similar to what they saw in the second half of last year. And in fact some are even pointing to a slight improvement in demand this year.

WARREN DICK: That is quite interesting so is it very much still a supply side problem at this point?

GEORGE CHEVELEY: Yes and the interesting thing though is we’ve seen production cuts made sort of September last year and what happens of course by the end of the year, people said well demand is lower and we’ve seen no reaction in the market. Look, production is still oversupplied. What you have to remember is that if the mine cuts production it’s probably three or four months before you would see a cut in the refined metal production, because particularly if you take for example Glencore cutting mine production in Congo, you stop mining well then you’ve got stockpiles to work off, so you’re probably still processing materials for a month. You’ve then got a very long supply chain out of Congo through Dar es Salaam through to China, so you’re probably only seeing reduction in refined metals from those operations probably now hitting the market.

WARREN DICK: Right so that’s something to bear in mind, the delayed nature of the production cut at the mine because of the lengthy times to move the inventory to the east coast of China, effectively.

GEORGE CHEVELEY: Absolutely and so now we’re seeing the effect of some of those production cuts which people have forgotten about I would say to some extent. And so now the market suddenly gets surprised that things seem a bit tighter.

WARREN DICK: So George I think the question is now – and it’s been amazing the selloffs that we’ve seen and yes, I guess you can include oil here because I see some of the larger holdings the fund has is in oil and gas companies. Where are you seeing opportunities at this point?

GEORGE CHEVELEY: I think there are several areas within the commodity complex so you’re right this fund we invest in energy, metals mining, including precious metals and also agriculture and stocks. So we have a pretty broad remit. And if I go through those sectors I would say in the energy complex and even in mining, I think to buy very leveraged companies betting on a major recovery in prices immediately is probably a very risky process at the moment and certainly one we would be wary of because to sort of be certain we’re going to see aa recovery of prices particularly when theres so much uncertainty in China is very difficult to make at this stage.

Having said that though, I think some of the interesting companies I’m seeing are one companies who have strong balance sheets and will therefore be able to survive a downturn if it continues for a while and still have very good valuation and exposure to the upside. So they are good companies like that are always going to be part of the portfolio in the mining side if you look at companies like Rio Tinto who have very strong balance sheets. Some people worry about the deteriorating iron ore price, but we see them as very low cost and able to continue that. Look at some of the large oil and gas companies in a similar situation where even despite low prices they can generate reasonable cash flows and manage the debt. And they are always a core in some of these portfolios.

The next one is more interesting. And those are companies where you’ve seen their equity prices pushed down very hard because of worries about their balance sheets and debt levels. A classic of that I would say is something like Glencore where we saw it as one of the worst performers on the UK market last year, lots of worries about their debt level. What I think is interesting in a company like that is we actually see a very good earnings stream from their trading operations and we think they continue to perform, and certainly when they look at oil markets and the cantangos in oil markets we think they’re probably making a lot of money trading oil right now and storing oil.

We also think they have a huge asset – agricultural business they’re looking to sell part of. They’re looking to further streaming deals so we see a number of options for them to sell or generate cash to pay down debt. And at the same time with lower prices their working capital will be falling. So I think a company where we see the market perceives them as stressed but we see them as having a number of options in a way of reducing that debt. I think they’re quite interesting because as this year goes on prices don’t recover they should be able to reduce their debt and then that obviously the equity should rise if that debt reduces without selling too many assets, we should see an improvement in the perception of those companies, and I think they could provide very good upside this year, even if things don’t recover very strongly. And of course if things recover they’ve got super leverage to those prices.

The other area if I move forward, that’s on the mining side, obviously in gold. We like gold equities at the moment. We’ve obviously seen the gold price recover somewhat this year. We’ve got through the first US Fed rate rise we think it’s unbalanced. Theres a chance the US might slow rate rises rather than accelerate them so we think gold is well supported and gold equities certainly have a huge amount of upside. Again a number of these companies are reducing their costs. We’ve obviously seen in South Africa a major beneficiary from a weaker currency. We see that in Australia and Canada to some extent and they’ve actually – gold companies were hit earlier and they’ve been reducing costs for longer so we see a number of them generating very good cash flows, even at these prices. And any higher prices will perform very well indeed.

Finally on the agriculture side we actually don’t like the grains complex which is the backbone of a lot of agriculture. We think grain markets remain oversupplied. So we do see good opportunities in some of the trading companies because obviously they do better from higher volumes and also we like the protein space. So things like salmon particularly where we see very good prices at the moment in some very strong companies.

WARREN DICK: Ok great, I think we’re starting to run out of time. One last question – we ran an article about the Saudi’s possibly listing Saudi Aramco or certainly looking at the options. How likely do you think that is?

GEORGE CHEVELEY: Yes, clearly it was reported they were looking at the options. Our view is probably unlikely that they would list the upstream business. What we do think is they probably might be looking at options. Whether they do it or not is another matter, but they could be looking at options more in the downstream business so listing some of their refineries etc. where they do have some other shareholders as well. So we think it could be parts of it but not the whole company, if you see what I mean.

WARREN DICK: Ok great. George we’re going to have to leave it there. Thanks very much for your time. That was George Cheveley the co-manager of the Investec Enhanced Natural Resources Fund.




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