Mackenzie Resource Team
Funds managed by the Mackenzie Resource Team benefited from a rerating to energy equities during the quarter, whereas precious metal equities were roughly flat and materials equities were mixed.
Tightening labour markets, rising commodity prices and accelerating manufacturing activity, combined with marginally less dovish central bank commentary in the U.S. and Europe have been pushing global yields higher.
In the U.S., low unemployment rates and moderate job gains combined with reasonable income growth for workers, particularly in the lower income brackets, suggest that the U.S. economy remains on solid footing but is not accelerating.
Oil markets during the third quarter appeared to be seasonally undersupplied due to solid demand and continued non-OPEC supply declines. Latest U.S. 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. Non-OPEC oil supply continues to contract with the quarterly average U.S. production data showing year-over-year declines of nearly 1mmb/d. Unfortunately, OPEC production reached a record high during the quarter, pushing out the market balance to the end of the third quarter. OPEC signaled an intention to cut production by 0.5-1.0mmb/d; but will be finalized at the next OPEC meeting in November.
Outlook & Strategy
What are the key opportunities you see?
While macro risks remain, the portfolio managers believe there is near-term potential for global growth to reaccelerate towards longer-term trends, with developed market economies providing the demand pull for the Emerging Market (EM) economies. This sequence seems to be near, with several EM currencies now seemingly confirming that the “baton” has been passed down to EM economies. We believe the stabilization of commodity prices (especially oil) will further confirm better days ahead for EM.
In, China encouraging signs of a strengthening domestic housing market and a strong credit impulse are offset by concerns regarding structural overcapacity and non-performing loans. However, export volumes are picking up and producer price inflation has turned positive therefore China is also starting to notice the benefits of improving global economic activity. Centrally-coordinated supply discipline (in coal and steel, for example) and steps to deal with structural overcapacity in State Owned Enterprises affirm the Government’s focus to deal with ‘Zombie’ companies. China’s progress in embedding structural reform, while maintaining full employment and continued income growth, will remain crucial for the demand outlook of many industrial commodities.
Equity prices of resources companies continue to point to substantial undervaluation hence above average returns could be expected in long run; provided that developed market follow their “moderate” growth path while emerging markets successfully shift to consumerism while dealing with population growth and urbanization trends.
What are key risks that need to be managed?
Hopes for accelerating GDP growth in the U.S. have once again moderated; however, the consistent but moderate U.S. economic growth trend continues to persist aided by continued ultra-accommodative monetary policy. While the Federal Reserve might hike U.S. benchmark rates by a mere 25 basis points before year-end 2016, the portfolio managers believe that the Fed remains committed to remain ‘behind the curve’ and, by design, allow labour market conditions and inflation to “overshoot” before embarking on meaningful monetary tightening.
While the portfolio managers do not believe that any modest rate hike by the U.S. Fed would meaningfully increase real rates due the Fed’s desire to achieve inflation above 2%, market concerns regarding the path of tightening could weigh on gold sentiment in the near term.
How are you positioning portfolios in response to this outlook?
While an OPEC cut or freeze would accelerate the reduction of inventory back to a normal level, continued demand growth combined with limited supply growth would eliminate a market surplus perhaps over more time, but nonetheless eliminate it. It should be noted that the potential OPEC consensus comes at a time when many cartel member nations appear to be struggling to balance their national fiscal budgets, suggesting that some form of supply discipline is urgently required to avoid breakdowns in the fiscal, economic and political/social fabric of many OPEC nations.
Populist political platforms are increasingly pressuring incumbent governments ahead of upcoming elections in the U.S., France, the Netherlands, Germany and possibly Italy and Japan. A possible outcome would be that the majority of developed market economies could make the shift from fiscal austerity to fiscal stimulus. The producers of industrial metals and chemicals would stand to benefit from fiscal stimulus measures; especially if governments were to channel central banks’ “helicopter money” towards infrastructure programs, such as the $200B program that is under active consideration in Japan.
Real interest rates continue to be close to zero in the U.S. and heavily negative in Europe and Japan, due to low nominal interest rates and 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 the 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.