16 July 2021
The commodity and broader equity markets remained volatile in June, 2020, as the market grapples with a two-fold macro issue, the US FED signaled a medium-term rate hike cycle, while China tries to massage its industrial base towards a lower level of activity. The Amati Strategic Metals Fund (‘ASMF’) was not immune to market movements, giving up most of its gains from the previous month.
Fund strategy and methodology
We did not introduce any new names to the fund this month. Rather, we slightly increased our weighting to existing Speciality and industrial names. The high cash weighting at present is a function of the inflows into the fund and a cautious approach to investing over this volatile period.
We aim to be fully invested within the next two to three months.
The Macro theme
The macroeconomic theme has been driving commodity prices this year, not real fundamentals, in our view. The evidence comes with all commodities rising during H1-2021, and Doctor copper correlating well with real rates. Up until May/June, commodity prices have generally been lifting on rising inflation and USD weakening. More recently, commodity prices are flat/down on Fed fiscal tapering talk (first announced in mid-June); and China trying to ease inflationary pressures (credit controls, taxes, restricting overseas investment, direct market interventions to dampen speculative commodity trading).
It has been nine months since the Federal Reserve committed not to raise short-term interest rates. The commitment was meant to be consistent with the Fed’s new monetary strategy, which is based on the idea that prices should rise 2% a year on average over time. This implies inflation could rise over 3% until 2030 to make up the averaged shortfall. We still hold the view that inflation could spike higher than the FED’s own projections (Exhibit 1).
Historically, negative real interest rates environments occur during times of economic turmoil and/or financial recessions - favourable environments for gold and silver to outperform. When real rates turn positive, there is a tendency for investors to migrate out of silver, gold and equities as interest returns on fixed income assets improve.
There are a few very interesting observations at present. Real interest rates are still making new lows while investors have largely already migrated out of gold and silver. Sentiment indicators towards gold indicate a record low level of interest and gold stocks are trading at historic lows when analysing valuation metrics at spot prices. Another interesting observation is that low real interest rates (sub 2%) are likely to persist for many years in the absence of economic turmoil due to the commitment of central bankers around the world to keep interest rates as low as possible to avert a debt crisis. While the base case for most investors is that the current inflationary pressure will prove to be transitory, there is a fear that inflation could overshoot on the upside, especially considering the rise in the oil price coupled with persistently high commodity prices and labour cost inflation.
We believe that the global economic environment remains very uncertain and the role of precious metals as a portfolio diversifier and safe haven is more important than ever. The fact that the shares are already discounting significantly lower gold and silver prices motivates us to keep a near maximum (70%) weighting in gold and silver shares in the portfolio at this point in time (Exhibit 2).
Apart from the royalty companies and some of the large cap companies, the gold mining companies are, on average, discounting around $1,200-1,400/oz. The developers are of particular interest to us as M&A activity is expected to increase over the coming years.
Commodity volatility continues to focus the global need (ex China) to secure critical metals
An evolving clean energy transition calls for an evolving approach to energy security; policy makers must expand their horizons and act to reduce the risks of price volatility and supply disruptions. The demand for critical minerals is set to soar over the next two decades as the world pursues net zero goals; overall mineral requirements could rise by as much as 6 times, but individual minerals, led by lithium, graphite and nickel could rise even faster. Production and processing of many minerals such as lithium, cobalt and some rare earth elements are geographically concentrated, with the top three producers accounting for more than 75% of supplies (Exhibit 3).
This geographical concentration of Chinese processing dominance is key to our investment decisions in investing in companies producing critical metals and adopting an integrated ‘mine-to-market’ strategy ex-China. Indeed all our 8 specialty metal equity investments have such a policy. IronRidge Resources (West African lithium developer) is the latest company to enter into a binding agreement with Nasdaq listed Piedmont Lithium to fund the development of the Ewoyaa Lithium project. Black Rock Mining (Tanzanian graphite developer) recently signed an MOU with US CleanTech Graphite processing company, Urbix, Inc, a transformational battery anode materials processing partnership, designed to secure a ‘mine-to-market’ strategy.