Following a soft performance for the sector in H1 2017 (the JSE resource index declined 6%), August continued the recovery seen in July, due to delivery of strong cash flows reported by the diversified miners, easing of growth concerns in China for H2 and generally a weak base which can in part be attributed to regulatory risk associated with the messy mining charter release and challenge. We continue to see depressed long-term valuations (specifically on the EV/Sales metric) despite healthy margins, specifically for the general/diversified miners, as well as attractive short-term earnings valuations. The balance of risk to our investment case is slowing earnings momentum but continued healthy cash flow and debt reduction, and for now we view the latter as attractive support within the resources sector and within the equity market in general.
Exposure to precious metals cannot be ignored despite poor earnings and cash flow, and magnified regulatory and labour risk. Elevated global geopolitical risk is supportive for gold; our preference is for Gold Fields due to geographic diversification and low value attached to the long disappointing South African South Deep mine.
Platinum is a derivative beneficiary of gold’s safe-haven status in the short term. In the long term there is little doubt that the electrification of the automotive drive train is a major disruptive force for the decades to come, but generally the negative implications of the shift to battery electric vehicles on internal combustion engines and thus the demand for platinum group metals appear overstated on a five-year view. While we are disappointed with the supply response, presented through reporting season, to weak industry economics we maintain a position in Impala Platinum Holding Ltd and Northam as companies that have continued to invest in portfolio improvement, with the former offering operating leverage to a potential metal price recovery, and the latter building a strategically attractive portfolio away from the labour intensive Rustenburg hub.
During August we added slightly to African Rainbow Minerals Ltd and Sappi Ltd and trimmed BHP Billiton plc, Mondi Ltd, Sasol Ltd, the palladium ETF and exited Kumba Iron Ore following its expected share uplift from positive dividend declaration.
The Nedgroup Investments Mining and Resource Fund gained 5.4% (gross of fees) over the month of August 2017. The biggest contributor to the Fund’s performance was the large exposure to Anglo American plc that delivered 12.0% over the month, followed by Exxaro Resources Ltd and Impala Platinum Holdings Ltd that enjoyed strong returns over the month.