Mackenzie Resource Team
- During the quarter, oil prices pulled back over concerns of higher inventory levels. Oil prices dipped below US$50 briefly during March but ended the quarter marginally over $51. Our holdings in California Resources and Whiting Petroleum both pulled back materially with oil prices coming off. The two companies remain levered to higher energy prices. We believe the firms remain undervalued in an environment of $60 oil prices.
- Gold prices increased over US$100 during the quarter to reach US$1,254 which benefited our gold holdings. In particular, Randgold Resources and Pretium Resources were key contributors to our resource funds during the period. On the other hand, Detour Gold underperformed the precious metals sector due to its need to change future mining plans in view of long-term community opposition of its expansion plans. Detour remains a core position in our funds due to its industry-leading gold reserve position.
- Glencore contributed positively during to our resource funds during the period thanks to its success in rapidly deleveraging its balance sheet. Management has committed to not spend all cash flow on new growth projects but rather return money to shareholders through dividends and share buybacks.
- First Quantum, a core holding in our funds for many years, benefited from higher copper prices. Recent strike actions and other supply disruptions woke up investors to the realization that supply and demand balance was likely turning into a deficit.
- West Fraser Timber and Canfor benefitted from sharply higher lumber prices. Strong seasonal construction activity in the U.S. and market fears of potential duties in the U.S. lumber industry supported prices during the period.
Outlook & Strategy
- The U.S. economic growth is on a steady path of 2 to 2.5%. Most age classes and income classes of society are now sharing into the benefit of the economic recovery with some of the broadest measure of employment showing new highs in a decade.
- EM markets have now clearly put their 2015 slowdown behind them. China continues to perform economically well, while the rest of Emerging Markets (EM) seems to have re-sync with China: the economic recovery is broadening throughout to the rest of the world.
- Employment trends in Europe are notable. As we have previously indicated, Europe is approximately following the U.S. economic recovery with a two year lag. While we have not witnessed wage inflation yet, further employment gains should follow and eventually translate into higher income gains for most.
- Similarly to the U.S., the ECB’s monetary policy is likely to see some form of tapering in 2017, which should be seen as a reflection of better times ahead for the Eurozone’s three main economies.
- With EM, U.S. and European economies now improving, the global economic activity is now “in-sync” boding well for commodities. This view is confirmed by consistently higher PMIs globally, which has historically been a reliable indicator of future economic activity and commodities demand.
- With commodity prices trading at their low-mid to mid cycle levels, and global economic PMI rising, the odds of seeing higher commodity prices in 2017 are improving. However, as a reminder, the premise to rising prices relies on good demand (i.e. good economic activity) as only improving consumptions will allow inventories to be drawn to levels low enough to push prices higher.
- Specific to the oil market, following a surprise production boost from OPEC in late 2016, we expect a stabilization of worldwide supply in Q2 and Q3. Combined with good demand trends in most markets, this should lead to declining oil inventories throughout the year.
- Year on year natural gas supply growth turned negative after several years of positive growth. While we expect supply growth to return later in Q4/2017, we also expect natural gas demand to run at approximately 1 to 1.5 times GDP growth for 2017 and 2018 due to continued power burn, Mexican export and LNG growth. All of which, supporting prices above above $3 in the medium term. The fund continues to be exposed above benchmark weight to natural gas producers.
- Lumber prices increased dramatically during the quarter, a reflection of continued strong U.S. housing starts but also restrained lumber production by Canadian mills in the face of pending export duties. The fund continues to hold several Canadian lumber producers.
- Inflation expectations trends continued to creep up (up from 1.95 to 2.15%), in line with increasing wage growth in the U.S. However, nominal bond yields also have accelerated (from 1.78% prior to the U.S. election up to 2.39% at the end of the quarter on the U.S. 10 year treasury). Net/net, real yields have remained modestly in positive territory an so since the election of President Trump, putting a damper on gold prices. Gold has historically delivered limited return when real yield were positive. We nevertheless believe that central banks will continue to attempt to keep rates below normal levels in order to foster economic expansion; opening the possibility that inflation expectations start running above 10 years bond yields and push hard assets such as gold to higher levels, and paper assets such as bonds lower.
- In sum, after a rapid rise from very low levels in 2016, most commodities have now reached just below mid-level prices. But with the backdrop of steady global economic activity, we suspect that higher prices are being digested, and that inventory are being drawn down. The second half of 2017, is likely to bring the prospect of much lower inventory, and the need to provide incentive pricing to stimulate supply. This backdrop has historically been a good precursor for natural resources outperformance. The portfolio remains well-diversified across the energy and materials sectors. As always, the portfolio remains constructed of companies generating strong sustainable free cash flow available for growth, or return of capital.