Mackenzie Resource Team
- Synchronized global economic growth firmed through all four quarters of 2017. We believe growth could accelerate in 2018 to nominal growth rates not seen since the 2000s.
- Resource securities generally appear undervalued relative to their underlying commodities. Some of the largest components of our Funds, (e.g., energy E&P and base metals) do not appear to reflect the spot price, let alone the potential for higher spot prices if global demand continues to accelerate.
- In our opinion, the oil market remains in a material (seasonally adjusted) deficit, with inventories now sitting close to normalized long-term averages.
- Energy equity prices offer the potential to rerate to reflect increased oil price realizations.
- Synchronized global growth persisted and firmed through the four quarters of 2017; with broad participation across both developed and “first tier” emerging markets. While the U.S. continues on a tightening path; global monetary conditions remain accommodative, whereas consumer confidence is aided by strong asset markets. Tightening labour markets have to date only resulted in modest wage growth; however, wage demands appear to be accelerating. Government tax receipts are anticipated to improve accordingly, whereas private sector investment might shows tentative signs of a new capex cycle, which would further stimulate demand for resources.
- As discussed in our previous commentaries, this business cycle continues to unfold in a normal sequence, albeit at a slower pace – with the notable absence to date of meaningful inflation. Globalization, technology, latent production capacity, and widespread “underemployment” of the workforce post-2008 have all contributed to stubbornly low inflation. The world economy continues to grow into its excess labor and goods capacity it inherited at the start of this cycle. But in the absence of ‘bad’ inflation; it is the portfolio managers’ view that the current late-cycle economic expansion might have more time. Resources and other cyclical industries are now sitting at an interesting juncture, where individual, government, and companies will soon make large capital commitment and take inflation, capital expenditures, and commodity prices to new highs. Experience from previous cycle, would suggest that resources typically deliver the bulk of their absolute and relative outperformance during those periods.
- Oil prices belatedly responded to a structural decline in inventories. Oil demand, boosted by strong economic global growth, has surprised consensus to the upside whereas production discipline from OPEC/Russia has resulted in a substantial market deficit. Equities, however, did not participate during the quarter and there is a resulting gap between actual oil prices and equity-implied oil prices.
- Gas prices remained depressed in late-2017 despite severe cold weather conditions gripping large parts of Canada and the US. Although gas inventory levels are now below their historical average, pricing pressure persist, mostly caused by infrastructure bottlenecks. We expect to see new pipelines completion to first contribute to continued excess, but to be equally match with demand given the low price and environmental benefits.
- Industrial metals such as aluminum and steel traded higher in the fourth quarter due to solid demand combined with production discipline, particularly from China as a result of the country’s drive towards lower environmental emissions, and rising trade barriers. Copper prices remain supported by a tightly balanced market and increased vulnerability of the supply chain to political and labour-related production interruptions. Medium term, copper prices should remain supported by the lack of new mining projects which have very long lead times and thus cannot timely respond to accelerating demand.
Outlook & Strategy
- Global leading indicators continue to point towards solid economic growth; with capital expenditure intentions building. The lack of inflation and the lack of accelerating loan growth to date suggest there might be more time to the current economic state. This should provide a strong backdrop for commodity demand at a time when supply is remains constrained from years of reduced investments. Notably, the portfolio managers continue to monitor several key indicators for warning signs that the cycle would be reaching maturity: wages growing at >4% rates, accelerating inflation, peaking capital expenditures, peaking global home & auto sales, and yield curve inversion. Until some of those indicators manifest themselves, more growth should be expected from the world economy.
- Resource Securities generally appear are broadly undervalued relative to their underlying commodities, suggesting that the market believes that the latest commodity price surge may only be temporary. Some of the largest components of our Funds, (e.g., energy E&P and copper, base metals, fertilizers and energy E&P) do not appear to reflect spot prices, let alone the potential for higher spot prices would global demand accelerate.
- We expect oil markets to remain in a supply deficit for 2018. We would expect limited inventory reductions in Q1, the weakest quarter of the year. Inventory should continue to decline in the remaining quarters of 2018. The disconnect between energy stocks and oil prices, is at level only seen in a few occasions in the past 20 years. We suspect the latest EV’s trends to be acting as suppressant. As we have shared in the past, EVs are real but should only have a material impact beyond 2030. This underperformance should resolve to the upside, as higher prices persist. Watch for our whitepaper for more on the topic.