June was a miserable month leading to the S&P 500's worst first half since 1970. In the UK, it was the worst month since March 2020. Fears mounted that the impact of inflation on confidence and consumer disposable income would lead to recession. The Federal Reserve, and other central banks, continued to increase interest rates to reduce demand for goods and services. They see this as the only way to suppress inflation; sadly, it is starting to inflict pain. The upside is that it might successfully reduce inflation sooner than currently anticipated. The sell-off spilt over into commodities, with industrial metals such as nickel, copper and aluminium enduring sharp declines of 20.1 per cent, 13.7 per cent and 12.2 per cent, respectively. Oil also fell back, with Brent crude down 6.0 per cent to $109 (£91) per barrel on 30 June. Wheat was down 17 per cent to levels last seen in early March, after the start of the Russian invasion of Ukraine. If these falls in commodity prices do not prove temporary, they should bring some relief to inflation in the coming months.
Equity markets had a bad month – H1 returns in brackets. Continental European markets were the worst, with the Italian MIB down 12.1per cent (20.1 per cent), German DAX down 11.2 per cent (19.5 per cent) and the French CAC down 8.4 per cent (17.2 per cent). In the US, the tech-heavy Nasdaq was down 8.7 per cent (29.5 per cent) and the S&P 500, 8.4 per cent (20.6 per cent). The FTSE 100 held up relatively well, down just 5.8 per cent (2.9 per cent). Mid and smaller companies, which are more sensitive to the UK economy, had a torrid time with Aim down 10.2 per cent (28.0 per cent), FTSE 250 down 8.6 per cent (20.5 per cent) and FTSE Small Cap down 6.7 per cent (16.4 per cent).
Sterling weakened further against the US dollar; at 1.199, it is down 11.6 per cent this year. Gold is down 6.1 per cent in 2022, although to a sterling-based holder, that translates into a 5.9 per cent gain. The 57 per cent fall in bitcoin during H1 will have disabused those who thought it would protect against falling markets or inflation.
The only comfort I can take from June is that it was a relatively good month for the JIC Portfolio. It was down 3.7 per cent compared with a drop of 6.0 per cent for the FTSE All-Share (TR) Index. Since its inception in January 2012, the JIC Portfolio is up 304.6 per cent (14.2 per cent annualised), comparing favourably with +101.1 per cent for the FTSE All-Share (6.9 per cent annualised) and +231.7 per cent (7.3 per cent annualised) for the FTSE All-World (GBP TR) Index. Year to date, the JIC Portfolio is down 10.5 per cent, some way behind the All-Share's return of -4.6 per cent. Exposure to small and mid-caps has hurt. There is much to do in H2!
With commodity prices down, Blackrock World Mining Trust (BRWM) took a beating, falling 20 per cent. Thank goodness I booked some profits at the end of May but considering the 20 per cent drop, I should have sold more. Things 'adjust' very quickly nowadays, and I'm looking to add back at these lower levels. The medium-term case for copper and other metals required to move to a greener economy remains in place, whatever the short-term economic travails. SigmaRoc (SRC) was hit 14.5 per cent and is now down 27 per cent from when I halved my position in early May. I should have sold more, although again, it is one where I think it is now too late to sell, and I anticipate my next move being to add. I like management and strategy. Other small caps to be hit for no apparent reason except there being more sellers than buyers as people raise cash were K3 Capital (K3C) -11.4 per cent, SDI Group (SDI) -9.8 per cent, Renew Holdings (RNWH) -7.5 per cent and Anglo Pacific (APF) -6.9 per cent. The few bits of blue were Serica Energy (SQZ) up 9.2 per cent – it’s recovering from share price weakness following the introduction of Rishi Sunak's North Sea levy in May. Supreme (SUP) was up 5.0 per cent, Worldwide Healthcare Trust (WWH) up 3.0 per cent and Next Energy Solar Fund (NESF) 0.9 per cent.
The Funds' Portfolio had a dismal month, principally due to its exposure to commodities through Blackrock World Mining (down 20.6 per cent in June) and Blackrock Energy & Resources Income Trust (BERI) (down 24.6 per cent). The Portfolio fell 7.4 per cent, leaving it down 12.9 per cent this year. The FTSE All-World (GBP, TR) Index was off 10.4 per cent. Other notable fallers were Keystone Positive Change Fund (KPC) -15.4 per cent, Blackrock Throgmorton (THRG) -14.0 per cent and L&G Gold Mining ETF (AUCO) -13.3 per cent. Only Worldwide Healthcare Trust and Next Energy Solar Fund were up in June.
I made just one trade in the JIC Portfolio and none in the Funds' Portfolio. I added a new position, Lucara Diamond (LUC), to the JIC Portfolio. Listed on the Swedish and Toronto stock exchanges, Lucara was founded in 2012 by Lukas Lundin, Catherine McLeod Seltzer and Eira Thomas, CEO, to buy the Karowe mine in Botswana from De Beers. De Beers considered it a peripheral asset, but De Beers' loss was Lucara's gain. Since 2015, Lucara's Karowe mine has yielded four of the largest 10 diamonds ever found. After the 3,106-carat Cullinan diamond, discovered in 1905 in South Africa, the Karowe mine has produced numbers two (1758 carats in 2019), three (1174 carats in 2021), four (1109 carats in 2015) and six (998 carats in 2020). No.2, named the Sewello Diamond, was acquired by LVMH for an estimated $50mn in January 2020. Graff bought No.4, the Lesedi La Rona (the second largest when discovered), for $53mn in 2017.
Diamond prices were subdued during COVID but are now back up to the levels last seen in 2011, according to www.diamondse.info.
The company is investing in extending the mine life until at least 2040. Approximately $4bn in additional revenues, starting in 2026, is expected from extending the mine life for a total Capex of $534mn.
Historically 'specials' (diamonds over 10.8 carats) have contributed 70 per cent by revenue but just 5 per cent by volume. The finding of "specials" significantly boosts earnings. It still has the Sethunya diamond (31st largest at 549 carats) to sell. Lucara discovered this diamond in 2020 but deferred its sale due to the impact of Covid-19 on prices.
Forecasts for 2022 were upgraded after Q1 results, leaving the shares valued at 6.3x 2022 earnings, falling to 4.7x 2023 earnings. That looks like excellent value to me. Those forecasts are before considering the discovery and sale of any "exceptional diamonds", which has been a regular occurrence. On 31st March, it had net cash of $39mn. Q1 results saw revenue increase by 28 per cent over Q1 2021 to $68mn. It found 186 "specials", including ten diamonds greater than 100 carats. I'm looking forward to the H1 update in August. If it repeats the Q1 numbers in Q2, then full-year forecasts will have to go up again.
Serica Energy published a reassuring update in early June regarding the new North Sea levy and its impact on the business. Since then, it has emerged that it approached Kistos (KIST) regarding merging the two businesses. Kistos had made its own approach a few weeks earlier. At this stage, both sides say that the other's terms do not fairly value their business. Hopefully, they will agree on a mutually beneficial deal, as the merger of the two companies makes sense.
Somero Enterprises (SOM) also gave a reassuring H1 update, but the market is worried about H2 as the US economy slows. Last week it followed up with a more detailed update, which reassured the market, prompting a 15 per cent rally in the share price. Supreme added to its vaping business with a small acquisition. The company expects it to enhance earnings per share by 3.0 per cent in the current year ending March 2023 and by 6.0 per cent to March 2024. In early July, it published its full-year results accompanied by a warning about current trading. The market punished it with a 40 per cent drop in the share price – it has subsequently made back much of the fall. K3 Capital issued a robust year-end update that saw earnings forecasts increase by around 10 per cent. That leaves the shares valued at around 13.0x and a yield of 4.8 per cent for the year just ended, 31 May.
Anglo Pacific said that the Queensland Government had announced three new royalty tiers, which should significantly increase the weighted average royalty rate applied to the Group's Kestrel royalty interest from 1 July. Forecasts for 2022 have increased to earnings per share of 56¢, leaving the shares on a pe ratio of 3.1x and a dividend yield of 8.4 per cent. Berenberg raised its price target to 300p on the news for what it's worth, but it seems no one cares! Gulf Keystone updated on a strong H1 at its AGM. Higher oil prices and increased production boosted revenue and cash flow. So far this year, it has declared $190mn (£156mn) of dividends, which isn't bad against a current market capitalisation of £534mn. It had net cash of $247mn on 23 June. Lastly, Circassia (CIR) announced that it would receive payments amounting to $10.5mn over the next two years due to the approval by the FDA of BeyondAir's LungFit device. BeyondAir had previously agreed with Circassia to make three annual payments should it gain FDA approval for the device.
Circassia is also entitled to a 5.0 per cent royalty of net sales of the Lungfit device, commencing on the second anniversary of approval, up to a maximum of $6.0m. Not massive in the grand scheme of things, but good news. Every penny helps.
Dividend income plays a vital role in the long-term growth of my Portfolio. I reinvest the dividends, thus contributing to the compounding growth of the portfolio year by year. In bear markets like the current one, reinvesting those dividends is even more critical. Pound for pound, it buys me more shares at more attractive long-term valuations than in the past. Therefore, it is pleasing to see that in H1 2022, the JIC Portfolio received an income of £11,910. That compares to £14,336 in 2021, £8,972 in COVID impacted 2020 and £10,552 in 2019. The most significant payments so far this year have been Blackrock World Mining £3,127, Somero Enterprises £2,133, Anglo Pacific £1,300, and Sylvania Platinum £983. With large payments on the way from Gulf Keystone (GKP), Serica Energy and Polar Capital Holdings (added in July) this month alone, I'm looking to a bumper second half. My calculations, which I think are conservative, suggest that the current Portfolio will give me another £14,975 in H2. That would be £26,885 for the year or 4.5 per cent of the current portfolio value. Reinvesting that cash should pay (more) dividends in the years to come.
H1 2022 – what went right? What went wrong?
It has been a very difficult H1. If I compare myself with FTSE Aim, Small Cap or FTSE 250, I can give myself a relative pat on the back. Unfortunately, I don't. First, I'm trying to make money and second, to beat the FTSE All-Share Index. It's a fact that no one will make money all the time and suffer periods of underperformance. This year looks like one of those, but it does not mean I'm giving up on the second half of 2022.
Exposure to small and mid-caps, which have served the Portfolio well over the last 10 years, caused much damage. FTSE 100 stocks were the place to be, but even then, there were huge disparities in returns. BAE Systems (BA.) was the best performing FTSE stock, up 51 per cent, followed by Standard Chartered (STAN) up 38 per cent, Shell (SHEL) 32 per cent, British American Tobacco (BATS) 29 per cent and Astra Zeneca (AZN) 25 per cent. A mixture of defensives, oil, and financials did well. The worst five stocks in FTSE were more economically sensitive or overvalued growth stocks: Ocado (OCDO) down 53 per cent, JD Sports Fashion (JD.) down 47 per cent, Scottish Mortgage Trust (SMT) down 47 per cent, B&M European Value Retail (BME) down 42 per cent and Ashtead (AHT) down 42 per cent. The JIC Portfolio did not have enough exposure to larger companies, although its exposure to commodities was helpful despite giving back some of the gains in June.
The good was my exposure to commodity stocks, with the likes of Serica Energy up 18 per cent and Anglo Pacific up 8.0 per cent. Adding NextEnergy Solar Fund added some stability and income to the Portfolio. Adding to existing positions after big falls in stocks such as Bioventix (BVXP) and reducing my exposure to BlackRock World Mining at the end of May was good, but I should have been bolder. That was perhaps a theme throughout – I made some good calls, such as reducing SigmaRoc, Baillie Gifford Shin Nippon (BGS), Biotech Growth Trust (BIOG) and SDI Group but should have been more aggressive and sold more. That is the nature of a bear market; most sales look good.
Now the bad. My three purchases early in the New Year of Somero Enterprises, Circassia and Lloyds Banking Group (LLOY) do not look clever. Somero Enterprises is a cyclical company, and although it looked good value, the following year could be challenging as the US economy slows. Hopefully, the fall in the share price is now adequately reflecting those concerns. Circassia is a unique situation that hopefully will prove a successful investment, even if my timing is awry. Lastly, the ugly. Supreme has been a dreadful investment. That happens, but I have put it into the ugly category because I failed to cut my position back in March when the share price broke down. I must get better at cutting earlier.
In short, I think my calls on the markets have not been bad, but I have failed to back those views with enough conviction. In the short term, that hurts, but in truth, in the longer term, it probably makes little difference. The most important thing is to resist getting more bearish the more the market falls.
The US 10-year Treasury yield has dropped dramatically from its mid-June peak of 3.5 per cent. It is now yielding under 3 per cent. To some extent, a flight to safety drove the drop in yield, but it also indicates that the market is sceptical that the Federal Reserve will increase interest rates as fast as they suggest. Recession looms, and the market is betting it will bring down inflation, forcing the Federal Reserve to change course. As far as equities are concerned, a slowdown will hit profits, leading to further weakness. However, if the bond market proves correct in its assessment, a change in Federal Reserve policy could be bullish. I think we will find out who is right in the next few months. As I concluded last month, I think it will be a testing summer with continued volatility and probably more weakness.
I think things are more difficult to call now. We have had a torrid first half, and although investor sentiment does not seem to have reached rock bottom yet, it might not be far off. Valuations are more attractive, and any indication of a loosening of Federal Reserve policy could see a marked rally in markets. For much of this year, my time horizon has been short, worrying about how stocks will perform over the next few months. I think it is time to extend my time horizon to a year or more. That means looking for stocks which I believe have attractive long-term fundamentals and are good value – even if the share price has not reached rock bottom yet, hopefully, in a year, I will be happy I made the purchase. So far in July, I have added three new stocks to the Portfolio, but more on that next month.
John Rosier’s portfolio 30 June 2022
|Name||EPIC||Market cap (£mn)||My risk rating||My reward rating||Target position %||Portfolio % at 30 June|
|Serica Energy PLC||SQZ||775||L||H||7.5||8.7|
|NextEnergy Solar Fund Ltd||NESF||642||L||M||7.5||8.0|
|Sylvania Platinum Ltd||SLP||235||M||H||5.0||6.3|
|BlackRock World Mining Trust PLC||BRWM||1077||L||H||7.5||6.2|
|Anglo Pacific Group PLC||APF||310||M||H||5.0||5.9|
|CentralNic Group PLC||CNIC||336||M||H||5.0||5.5|
|Gulf Keystone Petroleum Ltd||GKP||562||M||H||5.0||5.4|
|Lloyds Banking Group PLC||LLOY||29211||M||H||5.0||5.3|
|K3 Capital Group PLC||K3C||186||M||H||5.0||5.2|
|Circassia Group PLC||CIR||145||M||H||5.0||4.4|
|Somero Enterprises Inc||SOM||218||M||H||5.0||4.0|
|Worldwide Healthcare Trust PLC||WWH||2045||M||H||3.5||3.9|
|Biotech Growth Trust (The) PLC||BIOG||329||M||H||3.5||3.8|
|Renew Holdings PLC||RNWH||505||M||H||2.5||2.4|
|SDI Group PLC||SDI||150||M||M||2.5||2.4|
|Lucara Diamond Corp||LUC||184||M||H||2.5||2.2|
|Baillie Gifford Shin Nippon PLC||BGS||446||M||M||2.5||1.8|