Private Investor's Diary: Commodities to the rescue but be wary of inflation

Holders of US Government Bonds had the worst quarter in decades as markets started to price in higher inflation and interest rates. In the US, the yield curve inverted for a short time. This is when the yield on the US Treasury 2-Year Bill moves higher than the 10-Year. Without going into the intricacies of this indicator, it has proved a good predictor of recession over the years. Many commentators, including the Federal Reserve, went into overdrive to explain why it would be different this time. We will see.

Oil prices were volatile, with Brent Crude spiking to $130 (£98.51) per barrel before settling 7.6 per cent up at $106 per barrel. Metals prices were robust, with nickel up 31 per cent, zinc 14 per cent and copper 5 per cent. Copper traded at its highest price since 2011 and looks set to go higher given supply shortages. After a poor first 10 days, equity markets staged an impressive recovery, although they are mostly still down this year. The Nikkei 225 was up 4.9 per cent, closely followed by the S&P 500 3.6 per cent and NASDAQ 3.4 per cent. Continental European markets didn't do as well, with the CAC flat, the DAX down 0.3 per cent and the MIB down 0.8 per cent.

The FTSE All-Share ended the month as the only major equity market to record a positive return during the first quarter. It was up 0.8 per cent, with the "defensive" nature of the FTSE 100 coming to the fore. Smaller caps did not do so well, with the FTSE Aim down 14 per cent year to date, the FTSE 250 down 9.6 per cent and Small Cap  down 6.9 per cent. Gold did its job, up 2.2 per cent in March and 5.9 per cent in 2022.

Commodity exposure powers outperformance

A good month for the JIC Portfolio. It was up 5.6 per cent in March, nicely ahead of the FTSE All-Share (TR) Index's 1.3 per cent and the FTSE-All World's (GBP, TR)  4.1 per cent. Since 1 January, the JIC Portfolio was down 0.3 per cent vs -0.5 per cent for the All-Share and -2.4 per cent for the All-World. Since its inception in January 2012, the JIC Portfolio is up 350.7 per cent (+15.8 per cent annualised), comparing favourably with the 111.7 per cent (+7.6 per cent annualised for the All-Share and 261.6 per cent (+13.4 per cent annualised) for the All-World.

Although I have had too much exposure to small-cap and not enough to large, I have been rescued by holdings in commodity companies. I had built my exposure throughout 2020/21 in anticipation of higher prices driven by demand for metals required in the transition to a lower carbon-intensive future. I started the month with 45.7 per cent in my six commodity positions. A strong performance meant that I had 43.2 per cent at the end of the month, even with trimming my two energy positions. Last September, my exposure to commodities was around 29 per cent, which I considered bullish. 

Serica Energy (SQZ), my second most significant position, was the standout performer, up 43.6 per cent in March and 65 per cent this year. Having first added it to the portfolio in April 2018 at 70p, it is turning out to be my best investment so far. Serica produces 5.0 per cent of the UK’s gas from its North Sea fields. Results last week showed operating profit of £246mn, compared with a loss of £18.7mn in 2020. Such is the strength of cash flow that its net cash position has risen from £218mn on 31 December to £364mn on 20 April. It increased the dividend from 3.5p to 9.0p. In truth it could do more on this front but is balancing its need to reward shareholders with its requirement to retain funds for potential corporate activity. Further consolidation in the North Sea is likely. Anglo Pacific (APF) gained 25.2 per cent, helped by record metallurgical coal and cobalt prices. Lundin Energy (SW:LUNES) gained 14.5 per cent. It is not perhaps the most sensitive to oil prices due to the high tax charged by the Norwegian government but nevertheless looks good value on a prospective dividend yield of more than 5 per cent. Global X Copper Miners ETF (COPX), bought on the last day of February, was up 11.1 per cent as copper moved higher. Blackrock World Mining (BRWM) was up 2.3 per cent but was ex a chunky final dividend of 27p. The only commodity stock to buck the trend was Sylvania Platinum (SLP). It fell 12.1 per cent and is now up only 30 per cent this year. K3 Capital (K3C) was the other holding that fell by more than 10 per cent. Having added to my position on 28 March, it was good to see Bioventix (BVXP) up 10 per cent.

The Funds' Portfolio was up 3.2 per cent, a little behind the 4.1 per cent gain in the FTSE All-World (BGP, TR) Index. Sterling's weakness held back the GBP index compared with the All-World US$ Index, up just 2.2 per cent. This year, the Funds' Portfolio is down 2.9 per cent, a little worse than the All-World's drop of 2.4 per cent. Since its inception in June 2020, the Funds' Portfolio is up 31.1 per cent, compared with 31.4 per cent for the All-World. My exposure to commodities helped with L&G Gold Mining ETF (AUCO) leading the way. It was up 14.6 per cent, closely followed by the Global X Copper Miners ETF up 11.1 per cent. Blackrock Energy & Resources Income (BEEI) gained 5.4 per cent, and Blackrock World Mining gained 2.2 per cent. Keystone Positive (KPC) change took part in the rally in equity markets, up 9.3 per cent. The worst position was Temple Bar Investment Trust (TMPLL) which was down 5 per cent.

Time to trim?

Last month's column concluded that a big decision facing me in the coming months would be how quickly to reduce my heavy exposure to commodity stocks. While the long-term outlook still looks positive, the risk in the shorter- to medium-term is that the spike caused by the war in Ukraine leads to lower demand as economic growth suffers. In that scenario, equity prices could be hit hard as investors scramble to take profits in what has become a "consensual" trade. In that vein, I trimmed Serica three times and Lundin Energy once.

I first reduced Serica on 7 March at 308p, second the next day at 355p and lastly on 25 March at 396p. Even though these reductions were made for risk management purposes, I might regret having reduced Serica too soon, considering broker Jefferies's new price target of 600p. Lundin Energy was trimmed on 7 March at 403 SEK (£30.78). They remain my second and third largest positions, with Lundin Energy at 7.8 per cent and Serica at 7.6 per cent. On 4 March, I added to SigmaRoc (SRC) on a spike down in the share price, buying at 66.7p. On the 7, I did the same with Supreme at 151.2p and on the 8 with Bioventix at 2,935p. At 2,935p, the prospective dividend yield on the ordinary dividends was 4 per cent. That looks attractive to me for a company with such strong free cash flow, especially as I expect another special dividend in addition to the final. It was reassuring to see the half-year dividend increase by 20 per cent, with results published on 28 March.

I participated in the CentralNic (CNIC) open offer, taking up to 5.5 per cent at 120p. On 11 March, I added to my position in Worldwide Healthcare Trust (WWH). It has had a poor 12 months, driven by its exposure to biotech companies. I think 3,066p will prove an excellent longer-term buying price with valuations of healthcare and biotech looking attractive relative to history and the broader market.

Backing corporate actions

CentralNic's open offer was in conjunction with a placing at 120p, which raised c. £45m. As mentioned last month, the money raised was to fund the acquisition of VGL Verlagsgesellschaft for €67mn cash. VGL is a "leading online marketing business used by the world's leading German e-commerce companies to acquire customers via high-quality content websites and using media buying technology." The acquisition looks consistent with CentralNic's strategy and previous deals. It expects a double-digit earnings enhancement for the current financial year ending 31 December 2022. At the placing price of 120p, the shares were valued at around 12.5x December 2022 earnings forecast, which looks attractive to me for mid-teens growth.

K3 Capital (K3C) was also on the acquisition trail. It acquired JE Consulting, a "full-service marketing agency specialising in digital and creative services to SMEs operating in the accountancy, legal and healthcare markets." It looks a good fit, and K3 Capital seems adept at integrating acquisitions. It paid what looked like a reasonable price, and it's not surprising to see it will be earnings enhancing in its first full year.

On 9 March, as anticipated, Somero (SOM) posted excellent results for 2021. It accompanied the results with a proposed final dividend of 22.02¢ and a special dividend of 19.7¢. The two combined amount to a dividend yield of around 6.5 per cent. It went ex-dividend on 7 April.

Circassia's (CIR) results were in line with expectations and showed the recovery in sales of its asthma diagnostics product was proceeding to plan. SigmaRoc's 2021 results came in slightly ahead of forecasts, with encouraging commentary on current trading and prospects. Bioventix results were in line with expectations. It had to weather the loss in earnings from one of its products where the royalty agreement ended last July. Underlying growth in sales was around 4 per cent. Sales of its new high sensitivity Troponin test for heart attacks were encouraging. The 20 per cent increase in the dividend reflects the strength and quality of the company and confidence in future growth.

SDI Group (SDI) announced the acquisition of Safelab Systems for £7.7mn, including a freehold property valued at £1.2mn. It looks like a classic SDI acquisition, fitting nicely with Monmouth Scientific. SDI expects the deal to enhance earnings in its next financial year ending 30 April 2023. It adds around 10 per cent to group revenue, and I would expect about 10 per cent to earnings per share. My calculations suggest that leaves the stock around 25.0x April 2023 earnings. I love the strategy and investment proposition, which is why I still have a position, but it still feels a little expensive for me to buy more at this stage.

In the Funds' Portfolio, Smithson (SSON) posted its 2021 results, which showed a strong recovery in the second-half performance.

Inflation concerns rise

There is alarming news on the inflation front, with increases in input prices starting to feed through. Equity markets seem remarkably optimistic about the outlook, perhaps looking through the gloom to better times. There is also the argument that there is no alternative to equities with negative real interest rates. In the UK, although unemployment is low, one can't help feeling that consumer confidence will come under pressure. From 1 April, energy bills went up and will do so again in October. Food price inflation is running at multi-year highs. What price inflation in a few months? Taxes are increasing, and I think there is a risk that even those who have done okay during the pandemic will be more cautious about making significant financial commitments.

As for corporate profits, the many companies that say they have pricing power better be right. Even if one can push up prices in line with rising input prices, there is still the pressure of increased national insurance payments and a higher living wage. I continue to believe caution is the order of the day and am resisting adding to holdings during the current rally. As I mentioned last month, I can see myself trimming my commodity exposure further in the coming weeks. I expect to park the proceeds in cash whilst waiting for tempting opportunities in quality long term growth stories. For example, I missed adding to SDI Group at 128p on 8 March (I had left a buy order on the system). Hopefully, I will get another opportunity, but other options will arise if not. I think patience will be rewarded.