You launched the Perennial Global Resources Trust in April quite fortuitously, avoiding the COVID sell offs of February and March and have had fantastic performance to date – almost 50% in its maiden quarter. Can you speak to this a bit?
It was definitely a bit of good fortune in terms of timing. This is a product that we’ve been working on in the background for a while as it does take some time to launch this sort of thing. The broader commodity space has been very much unloved for a long period of time. We saw an opportunity to bring my expertise to this space.
I’ve been a portfolio manager within the MicroCaps Trust for four years, and part of my responsibilities there within the commodity space were to take that and apply it in its own right to a global resources trust and try to exploit some of the opportunities therein.
What did you see in the market which made you think that this was the time to launch a mining fund?
Perennial has always been a value house, so we’re naturally contrarian investors. We are looking at a sector which has been so desperately unloved for such a long period of time, not only in an absolute sense, but also in a relative sense. When you plot the various commodity indices versus the S&P 500, they are at all-time lows – and this is going back over 50 years. It is a space that has been horrendously starved of capital.
As a result, investment expertise has been leaving the sector, both on the buy side and on the sell side. This increases market inefficiencies and most funds are essentially just exploiting market inefficiencies.
I’ve been operating within this space as a geologist, and then as an analyst, and then as an investment professional for 15 years and had a reasonable investment track record there. So it made sense to dive in and try and exploit some of those inefficiencies.
What are your current assets under management and what are you targeting?
At the moment it’s just the seed investors in the fund, which includes myself, with total funds under management sitting at circa $13 million.
That has grown both organically and inorganically over the last couple of months since we kicked off. We are aspiring to a figure of $500 million, but we’ll see how we go in terms of FUM and how that impacts performance.
I think the age of funds being asset aggregators and hoovering up as much cash as they can just to live off the management fee – those days are over. You really need to outperform consistently, to have a viable through-the-cycle business and we apply that philosophy across all our products. As long as we can move capital into and out of the market without too much friction, then we will allow the fund to grow. But as soon as we feel there’s undue impact on performance, we will shut the doors. Don’t forget, it’s my money in there too.
How many stocks do you currently have in your portfolio and which commodities are they weighted to?
We have 37 in the portfolio at the moment and there is a skew towards gold and mining services as you’d probably expect. The ballpark figure is around 18 to 20% weight in gold and roughly 30% towards mining services as well. We do get some questions as to why as a commodity fund we include commodity services. It goes to the point of setting the fund up in the first place, which is to make money out of exploiting market inefficiencies.
I visit a lot of mine sites – prior to the COVID period, I was averaging one every two weeks for the last four or five years. You go and visit the mine, you speak to the mining contractors, you speak to the service providers, you get some feedback from the miners as to who’s doing a good job and who’s not. You get an earlier look at expansion plans and volumes which may then apply to the earth mover or the drilling company or whoever may be on site. There is also a great deal of mining tech which has really emerged as a sector in its own since 2016. So as a result of this bottom-up interaction with the sector, I feel I have an advantage there vs the wider market.
Aside from mining services, we have got a sprinkling of exposures across nickel, metallurgical coal, and are just starting to get into a bit of lithium at the moment as well.
And which have had the best performance so far?
Coming out of COVID, the whole market has rallied pretty sharply. Certainly, the gold stocks have performed very well and gone on with the gains they showed throughout the June quarter. One sector which popped quite hard but then has stagnated is the mining services space. A lot of these companies are reporting earnings which are very much in line with what they were saying back in January before the COVID pandemic kicked off. And yet share prices are as much as 50% below where they were for the same earnings nine months ago. So we certainly see that as an opportunity and it has been a good area of success for the June quarter. We expect it to do pretty well throughout the September quarter, particularly into reporting season in February 2021.
There seems to be an awful lot of activity going on despite the COVID-19 crisis – particularly in the drilling space with companies announcing drill hole results almost every day.
That is 100% correct and it is amazing. There is a lot of money being raised, and a lot of it is going to the junior explorers. That money is going straight into the ground via the drill bit. The outlook for exploration drilling rights is remarkably bullish. There’s anecdotal evidence from the mining companies themselves, in that the labs, which were achieving circa two to three weeks turnaround for their assays three or four months ago; this is now pushing out to three, four, and five weeks at the moment, which is indicative of elevated levels of activity in the drilling and exploration space.
What sort of companies and what size do you typically invest in? Are you looking at explorers or are you looking at the larger companies?
We have a pretty broad spectrum, but as a general rule, we won’t touch the greenfield exploration companies. I worked as a geologist for about six years and I know that you can have the best geological target you could imagine, you can have the geochemistry, you can have the geophysics, you can even have some early stage drilling above it. And then you go and drill it and 50% of the time, there will be nothing there. So that binary outcome is of no interest to us. We do not go that far down the spectrum.
We have had some great success just above that space. Quite often, you get situations where an existing resource that sits within a larger company is deemed to be non-core and gets flicked out into a much smaller company. This is a situation with very limited exploration risks. These resources might have 200-300 drill holes through it already, so there is no exploration risk there. But we find that with the asset, when you assess it on its merits, quite often it is mispriced. That is probably is as far down the spectrum as we go in terms of risk and reward. Further up the market cap spectrum, with the existing producers and the larger mining services companies, there are opportunities where companies are mispriced or there’s a catalyst that we foresee which might lead to a bit of outperformance.
What are your thoughts on the gold price at the moment?
In the medium term, it is going higher. We have only just passed the highs of 2011. If you have a look at the structural reasons why the gold prices have been on a tear for the last year and a half or so, I don’t think those reasons are going to be resolved in the next six months. We had a very sharp run from $1,800 up to $1,900 an ounce. The gold price is probably due for a little bit of consolidation or perhaps a small pullback from where it is now. But in the medium term, the outlook for real rates is negative and it looks like it will stay negative for a while. How various governments around the world end up tackling the huge amounts of debt they’re racking up in response to this COVID pandemic — that remains an unknown. Until all those questions are answered, I think gold’s likely to grind higher.
How various governments around the world end up tackling the huge amounts of debt they’re racking up in response to this COVID pandemic – that remains an unknown. Until all those questions are answered, I think gold’s likely to grind higher.
With gold prices this high, is there a risk of that being a bit of a bull market in gold?
It’s amazing how many newspapers have been sticking gold on the front of their finance section over the last month or so. This is indicative of a market that is perhaps getting a little bit ahead of itself, which I can see from the capital raisings and the deals that have crossed my desk. The quality of some of these assets and businesses is certainly declining as we are getting more and more genuine greenfield explorers trying to raise money at elevated evaluations, which represents mispriced risk in my view.
The last thing you want as an investor in the gold space is getting your call on the metal correct, then taking on too much risk via your equity exposure to that metal price, and having it blow up. Instead of making money out of a rising gold price, you end up losing money. That is a risk that people lose sight of in a red-hot market. But it is something that we are very cognizant of and we try not to get too caught up in the excitement of these one-drill hole wonders.
So I still need discipline in my stock selection?
As an investor in the mining space, whether you avoided it or not, you are going to end up pretty skeptical after any extended period of time. And that skepticism is hard earned. You see these companies going up 100% on a good drill hit, but in reality, trying to predict these outcomes is very, very difficult to do. So for us, those opportunities are never there. We go and look at the resources and if we can get a free option on that expiration upside, then that’s the sweet spot for us. Exploration upside is something we won’t pay for, but if we can get a free option on it, then great.
But there must be producers at the moment who are making some good margins?
I think they are making good margins, but you always need to balance expectations versus the actual delivery. Just over this quarterly reporting season we saw a few examples where gold companies have run up quite strongly on a rising gold price, but then you get to the quarterly report and the production for next year isn’t quite what the market expected, and companies get sold off as a result. You need to balance what the market is expecting versus the absolute achievements of the gold company itself.
Are you expecting cost inflation to take place? Because typically when the gold price gets high, the costs go up as well. What is happening on that side?
There is a lot of skepticism from generalist investors. Quite often through a commodity boom, mining companies historically have not been great at maintaining their margins, harvesting that cash, and ultimately returning it to investors. That said, so far in this cycle gold companies have been pretty good at maintaining their costs.
It seems as though management teams that are now in charge of the larger mid-cap producers are very cognizant of some of the hard lessons learned from the last commodity price boom, in which there was a huge amount of capital torn up, costs increased lock step with the actual commodity price, and there was no margin expansion at all. When commodity prices rolled over, stretched balance sheets and rapidly evaporating margins resulted in a huge amount of value destruction. Thus far, the miners have been pretty disciplined, both on the cost front and also on the M&A front. We’ll see how long that lasts.
Whilst there is a huge projected demand for lithium, the mining industry is very good at ramping up when it needs to.
Looking beyond gold, what other metals do you see holding promise at the moment?
I think coking coal is holding a lot of promise. It has been bumbling along at circa $107 – $110 a ton at the moment. Capacity has been cut all over the place, but coking coal is a key requirement of steel production and it is very rare to find new resources. Even if you find those resources, it is harder and harder to then develop them because various countries are making it more difficult. Thermal coal is a very different matter. As steel production around the world recovers with the aid of these stimulus packages, we should see coking coal prices start to recover.
Beyond that, copper has run pretty hard, but it’s a bit difficult to get excited about. We’re more positive now on nickel, but I’m just a little bit mindful that there are quite a few years before the dominant use for nickel – which will be the transition from stainless steel towards the forecast battery demand. I think people are assuming that the nickel demand for batteries is going to kick earlier than it probably will.
Probably last worth touching on, is lithium, which has seen a large number of new companies spring into existence over the last five years or so. Lithium’s prices have been falling for a year and a half now and are well and truly into the cost curve. Production is being cut left, right, and center, and the market is well and truly through the rebalancing phase. The equities have started to price in a lithium price recovery, but we still see some opportunities there.
It has certainly been an unloved sector for the past year or so but, one would think, with a big potential in the future.
You just need to look at the number of auto companies and the range of new EV models they are bringing to market. Stimulus measures are all going to accelerate this trend. There are certainly a few tail winds in the space and the cost of these cars will keep coming down. So you can see the upside there.
What people need to keep in mind longer term is whilst there is a huge projected demand for lithium, the mining industry is very good at ramping up when it needs to. We saw that with the last lithium cycle, where there was a huge increase of production just out from Australia in a very short space of time. I think there is plenty of lithium to go around. But the mining companies might take 12 or 18 months to get their act together once the price incentivizes them to do so. I am quite confident over the longer term that demand will be met.
What do you look for in a company to potentially add to your portfolio?
It depends on what stage of life this company is at. We have a value bias, so any company must have a decent, tangible asset to support its value. If they’re selling a dream or a concept, then that’s not for us. But as far as the producers are concerned, we look at them the same way that you’d value any other company, whether it’d be priced to earnings, priced to free cash flow, or EV/EBITDA, etc. Over and above that, we have a slightly different value methodology to assess companies which have depleting resources. We model full mine life, net present value or cashflow forecast with a net present value and compare that to how the company is currently being valued by the market. We then assess the risks and how they compare to upside opportunities which may be present. From that we decide whether the risks are worth the potential rewards and invest accordingly.
If you are speaking to the mining services space, then we use traditional industrial valuation metrics to assess value. We then compare that to various trends or opportunities we can see in the sector and the potential for those opportunities to result in upside earnings surprise.