In October, the balance of opinion seemed to shift towards markets becoming increasingly concerned that the current uptick in inflation would prove anything but transitory. Fears grew that inflation would spike higher for longer. Supply chain bottlenecks and a jump in natural gas, oil, and other commodity prices didn't help. Markets started to anticipate the Federal Reserve beginning to taper its bond-buying operation in November, and at a faster rate than previously expected. In the UK, the Bank of England signalled that it was likely to nudge rates upwards. Last week, it surprised markets by leaving rates unchanged; sterling weakened, which itself is inflationary, and the cost of government borrowing rose. The US 10 Year Treasury yield rose to levels last seen in the early summer. The 10 Year Gilt yield rose to 1.2 per cent in the UK, the highest since May 2019 – well before we had even heard of Covid-19. The price action of gold does not indicate that the market is that concerned about inflation. It was up just 0.9 per cent in October. The other explanation might be that gold does not do so well when bond yields rise or Bitcoin, up 42 per cent, is the new inflation hedge.
The Nasdaq was up 7.3 per cent, and with the S&P 500, +6.9 per cent, ended the month at all-time highs. A solid third-quarter (Q3) results season helped. In Continental Europe, the ECB continued to be very accommodating – the French CAC was up 4.8 per cent, the Italian MIB +2.9 per cent and the German Dax +2.8 per cent. The FTSE All-Share (TR) was up 1.8 per cent, driven higher by the strong performance of FTSE 100 companies – especially the banks and commodity majors. Mid and smaller companies fared less well, with the FTSE 250 up just 0.3 per cent and FTSE Small Cap and Aim down 0.5 per cent and 1.7 per cent, respectively.
Zinc was the most robust industrial metal, up 12.5 per cent over the month as higher energy prices constrained supply. Nickel gained 7.8 per cent, hitting its highest price since 2014, and copper was up 7.0% per cent. Brent oil touched its highest price since 2018, up 6.6 per cent to $83.5 per barrel. The main story in the UK was the spike in natural gas prices. The price of natural gas, having averaged around 55p per therm in the first half of 2021, started to rise, reaching 250p per therm in mid-October. It has come off a little since then, but the futures market shows prices staying above 150p per therm through the winter.
Another positive month for both portfolios but still behind the indices. The JIC Portfolio was up 1 per cent vs +1.8 per cent for the FTSE All-Share. That leaves it up 12.3 per cent this year, some 3 per cent behind the All-Share. Since its inception in January 2012, the JIC Portfolio is up 359.7 per cent (16.8 per cent annualised) compared with +105.9 per cent (7.6 per cent annualised) for the All-Share.
In my June column, I covered the seasonal effect, where the evidence points to it having a marked impact on UK equity market returns. Since 1966 the FTSE All-Share has returned an average total return of 7.9 per cent during the six months November to April inclusive and -0.6 per cent in the summer months of May to October. This year's summer return of 5.4 per cent for the All-Share will have nudged those figures up very slightly. Coming up to its 10th anniversary, the JIC Portfolio has completed 10 "summer periods", only one of which, 2016, was down. This year the return was +1.5 per cent, reducing my average "summer return" to +6.1 per cent. After nine completed "winter periods", I'm hoping the next six months will at least achieve my average returns so far for the winter periods of +11.4 per cent.
Overall, my commodity exposure positively contributed to performance, with Sylvania Platinum up 18 per cent, Central Asia Metals +10.8 per cent, BlackRock World Mining +7.6 per cent and Lundin Energy +3.8 per cent. Anglo Pacific was off 2.4 per cent, and after some profit-taking in the last few days, Serica Energy was off 11.4 per cent.
The best stock was Calnex +24.1 per cent, which reacted to the publication of robust first-half results. Recent purchase CentralNic was not far behind, gaining 15.4 per cent after issuing a solid quarter-end trading update. Surface Transforms -11.4 per cent led the list of decliners. It's my smallest position, so not too damaging. SigmaRoc was off 10 per cent despite the company reassuring shareholders in a positive update that it was succeeding in passing on higher costs. Aggregates and cement production is very energy intensive. Bioventix fell 9.4 per cent after publishing results, and De La Rue -9.1 per cent remains friendless.
The JIC Funds' Portfolio was up 1.1 per cent, leaving it up 8.8 per cent this year. Since its inception in July last year, it is up 33.8 per cent compared to +26.4 per cent for the FTSE All-Share and +31.0 per cent for the FTSE All-World (GBP, TR) Index. The best was BlackRock World Mining +7.6 per cent, and the worst, Baillie Gifford Shin Nippon, which along with the rest of the Japanese market, was weak ahead of the Japanese election last weekend.
I made just one trade in the JIC Portfolio. Last month I mentioned that after reading Richer, Wiser, Happier, I was going to revise how I determine my Risk rating on a stock. In future, it would not only include financial health (eg, the strength of the balance sheet, cash flow, etc) but also valuation risk and business momentum. After going through Bioventix's results to 30 June and looking at projections for the next couple of years, I raised the risk rating from Low to Medium. Coupled with Medium Reward, that points to a 2.5 per cent target weighting, which I reduced to on 19 June at 3,877p.
Using my previous method of rating Bioventix, it would undoubtedly be Low Risk. It has plenty of cash on the balance sheet, and cash flow far exceeds its requirements to operate the business and invest for the future. Last year, business momentum seemed to have paused, with Covid impacting clinical testing. Unfortunately, there is likely to be little growth this year. This lack of growth is mainly due to a loss of revenue from NT-proBNP, accounting for around 10 per cent of sales. FinnCap issued a note, available on www.research-tree.com, forecasting a drop in revenue in the current year ending June 2022 from £10.9m to £10.4m. Earnings per share (EPS) are forecast to drop from 132.8p to 127.3p. The following year to June 2023 sees revenue increase to £11.1m and EPS to 129p – still below June 2020's 134.4p.
Those forecasts value the shares at 30.8 times June 2022 earnings, falling to 30.4 times June 2023. Bioventix is probably the highest-quality company in my portfolio, with very high gross and net margins, cash flow and returns on capital. But the valuation looks full for a company whose earnings are unlikely to grow this year. A reassessment of the downside risk, given stalling momentum in the business, led me to adjust the risk rating.
I plan to add back at some stage in the next year if valuation and business momentum warrant lowering the Risk back to Low or raising the Reward to High.
On 18 October, I made four trades in the Funds' Portfolio. I increased my exposure to resources, funded by trimming my exposure to emerging markets and Continental Europe. I also wholly sold one of my smaller positions for a decent profit over the 15 or so months I held it.
It was a good month as far as company announcements were concerned. Central Asia Metals kicked off with a robust Q3 update. Next came a reassuring update from De La Rue, although it probably needed more than the outlook "is in line with the board's expectations" to get the price moving. The market fears that there is an overhang of shares that may hit the market. A continuation vote at Crystal Amber Fund is due in November. It requires 75 per cent in favour, but Saba Capital Management, which owns 26.2 per cent, has indicated it will vote against it. The market fears that the fund's liquidation will lead to its 10 per cent stake in De La Rue being dumped on the market. My view is that it's best to wait and see what happens. I think De La Rue looks fundamentally very cheap and that once we are through this short-term hitch, value will out.
K3 Capital issued a short and sweet update ahead of results on 1 November. It said it expects results to be ahead of current expectations. On 18 October, CentralNic and Supreme issued updates. CentralNic reported robust trading in Q3 and said it expects full-year results to be at or above its top-end expectations. The board of Supreme "was pleased with the group's strong performance in the first half of the financial year and remains confident in achieving expectations for the full year". SigmaRoc reported that the strong performance seen during the first half had continued into the third quarter. Anglo Pacific reported a strong Q3 with royalty revenue surging on the back of higher commodity prices. Lundin Energy reported a record Q3 with production ahead of forecasts. Coupled with higher prices, this led to free cash flow leaping to $1.6bn over the nine months, up from $448m for the whole of 2020. Net debt dropped to $2.6bn from $3.9bn on 31 December. Lundin Energy plans to increase next year's dividend by 25 per cent. Sylvania Platinum's first quarter to 30 September saw a substantial drop in revenue compared with the previous quarter. Q4 benefited from a spike in the price of platinum group metals. The share price reaction was instructive. Initially, it was off 14 per cent but ended the day down only 2 per cent as longer-term investors appreciated the strong cash flow and valuation even at lower PGM prices.
Long term trends underpin commodity position
October's reading was The World for Sale by Javier Blas and Jack Farchy. It is a history of commodity trading. It reads like a thriller, covering the growth and dealings of the large commodity traders such as Mark Rich + Co, Glencore, Trafigura and Vitol. It describes their importance to the world economy and how integral they have become as the middlemen linking suppliers and consumers of the world's commodities – while of course making themselves, and occasionally their shareholders, very wealthy.
It portrays the industrial revolution as being the first modern commodity super cycle. The second was triggered by rearmament ahead of the Second World War; the third by the economic boom of the Pax Americana and reconstruction of Europe and Japan in the late 1950s and early 1960s. The fourth, which the book covers in detail, began around the turn of the millennium as China and other emerging markets entered the commodity "sweet spot". Between 1998 and 2018, the seven largest emerging markets (Brazil, Russia, China, India, Indonesia, Mexico, and Turkey) accounted for 92 per cent of the increase in the world's metal consumption, 67 per cent of the rise in energy and 39 per cent of food.
I think there is enough evidence to suggest we are entering the fifth modern commodity super cycle, especially for metals. Metals, because the move to a greener economy, or net-zero, will generate unprecedented demand, not just in emerging markets but across the world. Demand is expected to be robust. For example, between 2010 and 2020, copper demand grew from 25m tonnes a year to 29m tonnes. Of the 4m tonnes increase, China increased usage by 5m tonnes and the ROW (rest of world) reduced by 1m.
Annual demand is forecast to increase by a further 12m tonnes to 41m by 2030. Five million of the increase is from China, but 7m is from the ROW. The coming years will see massive investment in electrical infrastructure to meet the demands of a net-zero economy. 27 per cent of copper demand is currently in electrical infrastructure and 12 per cent in transport. For zinc, 21 per cent is used in those two sectors.
In the short to medium term, the problem for the world is that there has been insufficient investment in new supply. This lack of investment means that prices will continue to increase for many metals, especially those required for the move to net zero. Copper stocks are the lowest they have been in the last 10 years for this time of year. Zinc stocks are also way below the levels seen up until 2018. Forecasts for both copper and zinc suggest an imbalance between supply and demand for the next few years. The projected lead times for new mining projects is around four years for zinc and 10 for copper. These times have lengthened over the last five years due to a lack of available capital, due mainly to environmental, social and governance (ESG) concerns.
In October, the zinc price hit a multi-year high due to production shutdowns caused by energy rationing and high prices. In the coming months, this is likely to impact other metals such as steel, copper, nickel and perhaps the most energy-intensive of all, aluminium. Energy shortages and high prices are especially acute in China, leading to it buying coal at any cost.
My exposure is through companies that have developed mines and are thus massively benefiting from selling at elevated prices. They have strong balance sheets and are hugely cash generative. I could probably find more exciting exploration and development companies, but I prefer positive cash flow and dividends to the disappointment of dashed hopes. I think BlackRock World Mining is a good way of gaining exposure across the range of commodities from coal through Glencore to copper through BHP and gold through Newmont. It is on a prospective 2021 dividend yield of at least 5.3 per cent. Sylvania Platinum had no debt and net cash of $132.6m on 30 September. It has just gone ex a 4.0p dividend giving a yield of 4 per cent. It is likely to pay another special dividend in the new year. Central Asia Metals has robust cash flow, allowing it to substantially pay down the debt raised to purchase Sasa, the Macedonian zinc and lead mine, four years ago. It's a low-cost producer of copper, zinc, and lead on a prospective dividend yield of at least 7.2 per cent. Lastly, Anglo Pacific focuses on royalties connected with the mining of natural resources and has transitioned towards metals that are in great demand in the green economy – nickel, copper, vanadium, uranium, and cobalt. It is on a prospective forecast yield of at least 5.4 per cent.
Outlook – equities preferred to bonds
We've entered the traditionally easier time to make money – the six months from November to April. Let's hope this time, it's no different. There is plenty to worry about, and with the risk that inflation will be more persistent than expected a few months ago, I would prefer to invest in equities rather than bonds. I will only look to substantially increase cash if it seems like interest rates will have to rise to the extent that it triggers a recession. I am focusing on companies that can pass on cost increases, and on that note, my exposure to commodities remains a central plank of my strategy.
|Name||EPIC||Mkt. Cap (£m)||Risk Low, Med, High||Reward Low, Med, High||% of Port.||My target %||Total return so far %|
|BlackRock World Mining Trust PLC||BRWM||1036||L||H||7.9||7.5||50|
|Sylvania Platinum Ltd||SLP||295||M||H||6.8||5.0||105|
|Lundin Energy AB||LUNES||8160||M||H||6.7||5.0||63|
|Serica Energy PLC||SQZ||553||M||H||6.5||5.0||69|
|K3 Capital Group PLC||K3C||254||M||H||6.3||5.0||53|
|De La Rue PLC||DLAR||326||L||H||6.1||7.5||14|
|Worldwide Healthcare Trust PLC||WWH||2405||L||H||5.9||7.5||35|
|Central Asia Metals PLC||CAML||432||M||H||5.2||5.0||27|
|Biotech Growth Trust (The) PLC||BIOG||496||L||H||5.1||7.5||73|
|Anglo Pacific Group PLC||APF||277||M||H||4.6||5.0||1|
|CentralNic Group PLC||CNIC||339||M||H||4.6||5.0||27|
|SDI Group PLC||SDI||188||M||H||4.5||5.0||155|
|Baillie Gifford Shin Nippon PLC||BGS||740||M||H||4.3||5.0||91|
|Renew Holdings PLC||RNWH||600||M||M||3.3||2.5||79|
|Venture Life Group PLC||VLG||70||M||H||3.1||5.0||-13|
|Calnex Solutions PLC||CLX||126||H||H||2.5||2.5||28|
|Surface Transforms PLC||SCE||114||H||H||1.9||2.5||3|