For many investors commodities are a no-go area, and this is reflected in the prices of the mining companies which invest in them. However, far from avoiding the area, fund manger David Hutchins believe it's an opportune time to launch a investment trust focused on small and micro-cap mining companies.
"The sector is completely unloved, especially in the small-cap space where companies have suffered the most," says Mr Hutchins. "But unless you believe in the end of the world it is an opportunistic time because people continue to use commodities and usage is increasing: as emerging markets grow they need infrastructure, and this requires commodities.
"Cyclical businesses have been in a down cycle for four to five years, and cycles traditionally last about six to seven years. Things could bounce along for another 18 months to two years, or we could be the bottom - we just don't know. The only time you know you are at the bottom is with the benefit of hindsight."
Small and mid-cap resources stocks are under pressure, and trading at a periodical and cyclical low valuation point. Many development stage companies with good resources have no access to cash to support their projects and cannot generate income - but Mr Hutchins hopes Global Resources Investment Trust (GRIT) can bridge the gap.
"In general, these stocks are under researched and do not attract the investment attention of the large international investment institutions," he says.
Mr Hutchins and his investment team seek shares which are undervalued for reasons including management issues, pricing anomalies and political risk. They also look for growth opportunities through the development of low-cost reserves and application of new technologies to convert marginal deposits.
"There are companies which own large resources but are starved of capital so can't bring it into production," explains Mr Hutchins. "These include world class assets such as Anglo African Minerals, which focuses on Bauxite. It has acquired a number of projects in Guinea both inland and near the coast, and Bauxite should be in demand as some of the existing deposits are nearing the end of their lives, so this company is well positioned to take advantage."
Global Resources mostly invests in listed shares but can put up to 10 per cent of its assets in unquoted investments. It currently holds one, Siberian Goldfields, which at the end of August accounted for 7.2 per cent of assets. It has invested debt into this in the form of convertible notes. If Siberian Goldfields does an initial public offering (IPO), Global Resources will be able to convert its loan notes to shares at a 25 per cent discount to their price. Siberian Goldfields is developing a gold and iron ore deposit in Russia and has outlined significant high grade resource. It hopes to start production in the third quarter of 2015.
"The only negative is that it is in Russia, which could have a downward effect on the valuation of an IPO, however, we will get in at a 25 per cent discount," says Mr Hutchins.
Siberian Goldfields had been considering an IPO but doesn't consider it appropriate at the moment due to political tensions surrounding Russia.
Although Mr Hutchins and his colleagues mainly seek companies according to their individual attributes they do take a view on commodities, and look at the geopolitical areas the projects are in. "I don't want much exposure to companies involved with iron ore, an area that is controlled by only a few companies, while I like to have high exposure to gold because there are always lots of opportunities," he says. "Gold production is also easy to finance, and it has a relatively short lead time from exploration to production."
Gold accounts for around 41 per cent of assets, coal accounts for 21.5 per cent, copper accounts for 8 per cent and oil for 7.6 per cent.
"Some of the 41 companies in the portfolio won't make it but some may go up five times," says Mr Hutchins. The trust is diversified globally - in both developing and developed areas, although more than half are listed in Canada. "But it is not designed to be safe and secure - it's high risk/high reward, he says."
Since its IPO in March, Global Resources's share price has experienced a steep decline and it trades at around 33p. It is also on a very wide discount to net asset value (NAV) of more than 50 per cent.
"The share price decline is partly symptomatic of the NAV which has fallen, while in the summer months share prices tend to drift lower, and the sector is unloved," says Mr Hutchins. "However, it provides investors with the opportunity of a double discount (the underlying shares and the trust's price)."
Mr Hutchins and his colleagues ran a similar fund called Resources Investment Trust between 2002 and 2008, and although its share price initially dipped it then appreciated steadily, so that at wind-up the shares were worth more than 300p, up from 100p at IPO.
"During its life cycle Resources Investment Trust also went from a discount of around 30 per cent to one of between 5 and 10 per cent," says Mr Hutchins. "So in the next cycle that Global Resources could also move in to a discount of 5 to 10 per cent." He adds that both trusts have been launched at a similar stage in the cycle and valuations.
Resources Investment Trust was wound up after investors were given a continuation vote, and Global Resources will also put a continuation vote to its shareholders after five years. "If things pick up and valuations start getting a bit silly, and liquidity improves, we will have no hesitation in going back to shareholders to propose winding up - we have to make money," he says.
