Mackenzie Resource Team
- Inventories are continuously drawn down across the full commodity complex. We believe that any potential supply constraints, even at the margin, will put upward pressure on prices.
- In the energy complex however, inventories were drawn down at a slower pace than expected resulting in a substantial underperformance by energy equities. While we remain optimistic about energy stocks over the next 1 to 3 years, performance could time out until inventories clear out.
- Contributing to Fund performance, broadly, were our lumber producers. Lumber prices have continued to trend higher due to increased duties and tariffs imposed on Canadian lumber in the United States.
- Detracting from Fund performance was AngloGold Ashanti. The company continued to face challenges with its relatively minor South African operations due to government proposed changes to mining laws.
- During the second quarter, expectations for global growth tempered from exuberant December highs. This softening stance was quickly reflected with pro-cyclical sectors largely underperforming the market and more specifically growth sectors over the period. Resources sectors were not spared from that trend, underperforming not only value sectors but cyclical sectors.
- Economic activity in China and Emerging Market countries continue to trend upward, while fears over potential Chinese monetary tightening have, to date, proven unwarranted.
- Developed market economies are experiencing low to moderate inflation, below the 2% threshold which, seems to be the “new” level central bankers seem to fear. We believe that central banks are correctly positioned for the current lukewarm economic environment and will avoid the risk of triggering an unnecessary slowdown by getting too far ahead of the curve. Central bankers’ attempt at striking an appropriate balance between rate hikes that will provide policy makers flexibility in future recessions, and rates that will allow tepid economic growth remain the mostly likely outcome for the next few quarters.
- Inventories across the full commodity complex continue to draw down, although at a slower rate than we expected. The 2015 emerging market recession, likely allowed “unofficial” inventories to climb beyond where most “official” record would show. Hence, official inventories declines are likely slowed by the unofficial inventories coming back to the official world. We continue to assess commodity price levels to be at or below mid-cycle levels, would expect prices to exceed their mid-cycle levels once inventories are depleted to below average levels.
- AngloGold Ashanti detracted from performance as the company continued to face challenges with its South African operations due to the government proposed changes to mining laws. Despite their challenges in South Africa, we believe Anglo-Gold Ashanti’s international operations represent the bulk of the value, hence we assess the stock as dramatically undervalued relative to its international peers.
- Contributing to Fund performance, broadly, were lumber producers as lumber prices trended higher. Increased duties and tariffs imposed on Canadian lumber in the United States were pass through to customers. To date, despite these higher prices, demand remains strong as housing starts in the US climbed, supported by strong employment numbers and wage growth. We remain overweight lumber stocks in the Fund.
Outlook & Strategy
- Our in-house views on demand-supply trends remain unchanged. Most commodities continue to work through a period of inventory rebalancing. However, as commodities continue to benefit from solid demand growth, we believe that any potential supply constraints, even at the margin, should put upward pressure on prices. The pricing pendulum is being swung by market expectations for global growth as markets trudge forward. After surging higher in the fourth quarter of 2016, mostly on exaggerated expectations, pro-cyclical massively underperformed in the first half of 2017. From here, we would expect a medium term period of outperformance by pro-cyclical as fundamentals finally catch up to expectations.
- Lumber markets, specifically, illustrated the fine balance between supply and demand as the imposition of export duties on Canadian lumber exporters to the US resulted in a sharp upward spike in prices, an incentive for Canadian exporters to continue exporting.
- We expect synchronized growth trends in the US, EU and Emerging Markets to continue. Most indicators are showing moderate consumptions trends across most if not all commodities. Specifically, for energy, vehicle miles traveled continues to trend up in developed markets. Despite solid demand trends, inventories have remained higher than expected. Demand seem to have finally caught up to supply. At current prices (circa $45), we expect US production growth to plateau or decline over time while demand continues to grow. Hence, we would expect oil prices to be well supported at current levels. We believe energy equities could normalize after a period of sustained underperformance until clear inventory trends are established.
- The Mackenzie resource fund remains position to benefit from continued synchronised economic activity. Several years have now passed since the last upcycle in commodity prices. Peak margins for resources companies in fact peaked 10 years ago. With the global economy showing no signs of overheating and supply largely constrained, inventory rebalancing well underway, we expect commodity prices to spend a sustained period of time above “mid-cycle” level while supporting above average returns for resource equities.