Q3 2017 Commentary – Mackenzie Resource Team | Mackenzie Investments

Q3 2017 Commentary

Mackenzie Resource Team

Highlights

  • The number of countries now participating in the current global economic expansion reached levels last seen in the mid-2000s. With such breadth, the global economy is now lifting PMI and other leading indicators higher, confirming the early sign that the global economy has reached a point where growing capital expenditures can be sustained.
  • Commodity prices continue to be well supported by global demand growth with steel, lumber, copper, aluminum and many other minor metals leading the way. As in prior commodity cycles, the ability of supply to match demand will be tested after several years of underinvestment. We expect that in 2018 the majority of commodities will be in a supply deficit and hence support prices.
  • We believe the oil market is in a substantial but also underappreciated deficit, with inventories rapidly declining towards normalized long-term levels. While most commodities tend to perform in sync with inventories (i.e. inventory down, prices up), oil prices seem to be suppressed by some superseding factors. We surmised that the EV growth may be part of the explanation. Hence, we would expect the market to wait until oil inventories reach lower than usual levels, before responding with higher prices; something likely to happen in the next few quarters.

Market Review

  • With no dark clouds on the horizon, the portfolio managers believe the global economy to be entering last third of its expansion. None of the typical end-of-cycles indicators have been manifested by the economy. More specifically, wage growth has not meaningfully accelerated, the yield curve has not inverted, and global consumption indicators (e.g. auto sales, housing) have not peaked and - importantly - inflation remains subdued.
  • Real interest rates (e.g. nominal interest rates minus inflation) have edged higher but are still operating within a very tight band of 0 to 50 basis points as modest increases in the long term treasury yields have been offset by steady, albeit fairly low inflation. We continue to be of the view that central banks will err on the side of caution in raising nominal rates, and that long rates are likely to rise slowly at a pace no too different from inflation. Gold remains nevertheless a good insurance against an out of sync movement by either accelerating inflation or too-low rates.

Outlook & Strategy

  • After several years of forced capex discipline, a drought of large resource-scale resource projects is on the horizon; just when demand is inflecting upwards. For 2018, most commodities are anticipated to be a supply deficit which should be supportive for prices.
  • We believe the oil market is in a substantial but also underappreciated deficit, with inventories rapidly declining towards normalized long-term levels. While most commodities tend to perform in synch with inventories (i.e. inventory down, prices up), oil prices seem to be suppressed by some superseding factors. We surmised that EV growth, OPEC discipline and shale growth explain much of this break in relationship. We do not foresee EV growth, nor discipline, nor shale oil to be meaningful enough to change the supply rebalancing underway. Nevertheless, we now expect the market to wait for oil inventories to reach lower than usual levels, before responding with higher prices; something likely to happen in the next few quarters.
  • Minor metal markets, especially lithium and cobalt, continue to benefit from the broad social acceptance that the global car fleet will transition towards battery powered vehicles. Our modest investments in lithium equities benefited from this trend during the quarter. The team will continue to seek other investment opportunities related to the electric vehicle thematic that meet their stringent investment criteria. Copper seems well placed to benefit from the need to strengthen electrical power grids and accommodate the anticipated electrification of transport.
  • With the global economy showing no signs of overheating, and raw materials supply remaining largely constrained, inventory rebalancing is well underway. The Portfolio Managers continues to expect commodity prices to spend the next several quarters above "mid-cycle" levels; an environment supporting above-average returns for resource equities.

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