An interesting way to analyse market risk is to look at the ratio of gold to copper. In times of fear and uncertainty, the ratio spikes upwards as investors rush into gold. A falling ratio is the result of either gold weakness or a rise in copper. A falling gold-copper ratio is a proxy for economic vitality.
Since Donald Trump won the US election in November last year, the ratio spiked sharply down as gold dropped and copper surged 23% in less than three months.
The accompanying chart, prepared by George Herman of Citadel, shows how sharply sentiment has shifted to the good since Trump’s election. Over the previous two years, the gold-copper ratio edged upwards, driven by a recovery in gold and a weak copper price. Trump’s promise of massive infrastructure spending has given a push to other base metals such as aluminium, lead and zinc.
Cannon Asset Manager’s chief investment officer, Andrew Dittberner, says stocks most likely to benefit from Trump’s promised infrastructure spend are commodity-facing, and this includes construction. A second chart below shows a high correlation between mining and construction.
“The key question is whether bulk and base metal prices will remain supported at current levels,” says Dittberner. “The market is forward-looking by nature, and thus any indication of softening commodity prices will likely see commodity stocks come under pressure.”
Dittberner adds that construction returns are often highly correlated with the returns of general mining companies, and thus some offer interesting alternatives to the more traditional mining investments.
The third sector receiving attention following Trump’s victory is US technology stocks. One company that ticks all the right boxes – mining, construction and technology – is Master Drilling.
Master Drilling is the global leader in raise boring, a process used usually in underground mining to create a circular hole between two levels within a mine. This method eliminates the need for explosives. “As the global leader in raise boring, Master Drilling has exposure to commodities. What they sell to their clients is essentially a hole in the ground, which is the construction aspect. They have developed their own intellectual property, resulting in their equipment being next to impossible to copy, giving them a sustainable competitive advantage.”
The share price has already doubled since 2013, the result of stable top-line results in an otherwise depressed mining and construction environment. A recovery in these sectors will only support the valuation of the business. It is a globally diversified business, with US dollar-based revenue and a local currency cost base.
Another company that has been overlooked too long is Group Five. Like most construction companies operating in a sluggish economy with next to no infrastructure spending, not to mention the Competition Commission’s finding of collusive behaviour between companies bidding for the World Cup and other major projects, Group Five has struggled to find its feet.
“While it will not necessarily benefit from Trump’s victory, it is a business that has been largely ignored by the investment community for a number of years, and as such it provides a great opportunity,” says Dittberner. The crown jewel in its business is the long-term concession contracts for the management and maintenance of toll roads in Europe. The present value of these contracts make up a sizeable portion of Group Five’s total market cap.
Group Five could be viewed as a European property company, rather than a construction business. “Corporate action, as we are currently seeing, would afford value to be unlocked from the rest of the business,” adds Dittberner.
Diversified miners such as Glencore and Anglo American should benefit directly from Trump’s infrastructure spend. “A year ago no one wanted to touch these businesses, and it is times like these that investors should be buying. If you were waiting for a recovery, you missed a large portion of it, because it happened so fast. Today, investors are treading carefully as they feel the prices may have run ahead of themselves.”
It may be premature to call a recovery in commodity prices, the indications so far are positive. Construction, mining and technology businesses are in a far healthier position today than they were five years ago. They have paid down debt, streamlined their businesses, and sold off non-core or marginal assets. Even at current spot prices, there is value.