Mackenzie Resource Team
What happened in the previous 3 months? What contributed positively to performance? What detracted from performance?
Global authorities are unwilling to let populist politics, deflationary forces and low productivity growth affect the fragile path of economic growth. Central Banks in Europe and Japan are intensifying their efforts to reflate their economies with quantitative easing; thus driving down nominal interest rates below zero. The U.S. Federal Reserve is forced into maintaining an accommodative stance and is unable to hike interest U.S. interest rates against a global wave of easing.
To date, Governments have not followed the lead of their Central Banks. But that might be about to change and fiscal stimulus programs could soon follow. Notably, Japan is preparing a $200B stimulus package. Elsewhere, the European Union is planning fiscal stimulus measures to convince its restless members of the benefits of staying in the European Union ahead of elections in 2017 in Holland, Germany and France. Lastly, the “bottom third” of the U.S. electorate is getting more vocal about the perceived need for policy change running up to the November 2016 U.S. elections.
With inflation expectations continuously reduced, bonds have performed well and beyond many prognosticators expectations. However, with income yields now negative, so low that any currency devaluation, inflation swell, or market volatility can wipe out several years of income gains, investors are increasingly being squeezed into other asset classes: “Hard” assets such as real estate, dividend-paying corporations and precious metals are the obvious beneficiaries.
Funds managed by the Mackenzie Resources Team benefited from tailwinds in hard assets, primarily through exposure to gold bullion and precious metal equities. In addition, the continued recovery in oil prices benefited the energy equity & fixed income investments. Lumber & Forest Products equities were held back by a looming trade dispute between Canada and the U.S.; notwithstanding strong lumber prices and an improving U.S. housing market.
Outlook & Strategy
What are the key opportunities you see?
The consistent but moderate U.S. Economic growth trends seem to persist and aren’t expected to change until economic softness elsewhere in the world improves. Nevertheless, low US unemployment rates, moderate job gains, combined to reasonable income growth for U.S. workers suggests that the U.S. economy remains on solid footings. The housing sector should continue to be a good proxy for how well the average U.S. household is faring.
With the stimulus emanating most developed economies such as Europe or Japan; the portfolio managers continue to expect accelerating growth from western economies to eventually pull emerging markets along and out of their current slowdown. This sequence seems to be near, with several emerging markets currencies now seemingly confirming that the “baton” has been passed down to Emerging Markets (EM) economies. We believe the stabilization of commodity prices (especially oil) will further confirm better days ahead for EM.
The bottom “one-third” of developed markets seems increasingly allergic to globalisation. Brexit, the rise of Donald Trump, and European political movements, all seem to be pointing towards higher trade barriers, less labor mobility, and ultimately higher inflation in some years from now.
What are key risks that need to be managed?
China continues to navigate its own path. Encouraging signs of a strengthening domestic housing market and a strong credit impulse are offset by concerns regarding structural overcapacity and climbing non-performing loans. A seasonally strong rebound in the economy during Q2 would logically be followed by normal seasonal moderation into the northern hemisphere summer months. China’s progress in embedding structural reform and dealing with ‘Zombie companies’, while maintaining full employment and continued income growth, will remain crucial for the demand of many industrial commodities.
How are you positioning portfolios in response to this outlook?
Oil markets appeared to have balanced in Q2 due to solid demand, continued non-OPEC supply declines and unplanned supply disruptions in Nigeria and Canada. Latest US demand numbers confirm a strong backdrop for oil with Vehicle Miles Driven in the U.S., a data set coincident with employment, reaching new highs. China and India also continue to show strong oil consumption figures. Non-OPEC supply continues to contract with the most recent US monthly production data showing year-over-year declines of near 1mmb/d combined with OPEC members running at close to maximum production. Markets should tighten further during Q3 as non-OPEC supply contracts and worldwide demand being seasonally strong. Not all countries are producing to their full capacity (e.g. Libya, Venezuela, or Nigeria), hence a return to political stability, if any, could push an oil price recovery to later on.
Real interest rates are falling sharply due to collapsing nominal interest rates and modestly rising inflation. Negative real interest rates have historically been positive for gold prices, as the opportunity cost of holding gold versus yielding asset classes is eliminated. In addition to this structural positive backdrop of low real interest rates, gold performed in its traditional role as a counter-cyclical insurance; counteracting severe volatility in global politics, currency, bond and equity markets. As previously highlighted by the fund managers, gold can play an important role in reducing the volatility and enhancing returns of a well-diversified portfolio in the long run and could therefore be seen as “risk insurance” against unforeseen market corrections.
The producers of industrial metals, chemicals and agricultural commodities would stand to benefit from further stimulus measures; especially if governments were to channel central banks’ “helicopter money” towards infrastructure programs. Equity prices of resources companies continue to point to substantial undervaluation hence above average returns could be expected in long run; provided that developed markets follow their “moderate” growth path while emerging markets successfully shift to consumerism while dealing with population growth and urbanization trends.