Mike Dragosits, CFA, Associate Portfolio Manager, Harvest Portfolios Group Inc.
CHANGING ECONOMIC NARRATIVE
Resources are at the center of the global economy. In the beginning of 2018, the global economic narrative was focused on truly synchronized and elevated growth, a weakening USD and higher inflation – typical of late cycle dynamics. However, during the course of the summer the narrative shifted, as realities of an uneven global growth rate prompted economists to further downgrade expectations. The notable exception was the U.S., where the economy remained resilient, along with rising U.S. interest rates supporting a strong dollar. At the same time headline inflation remained in line with expectations and in some cases well below central bank targets. These dynamics helped to weigh on resource stocks.
Real GDP – Forecast Revisions
Source: JP Morgan Forecast Revision Index data obtained through Bloomberg as at October 15, 2018
US Trade Weighted Broad Dollar January 2017=100
Source: Bloomberg, October 15, 2018
PRESIDENTIAL RHETORIC, RETALIATION AND THE REAL TARIFF IMPACT
China has emerged over recent decades to become the second largest economy in the world by nominal GDP. As developing economies industrialize, they tend to be high consumers of raw materials, which is still the case for China, a dominant source of consumption in absolute terms for many raw materials.
Much of the changing nature in the global outlook through the summer of 2018 can be traced back to the new language out of the United States administration which quickly became more targeted and even more aggressive toward its trading partners. While Canadians can appreciate the rhetoric that surrounded the NAFTA renegotiations, the reality is that the discussions with China are far more likely to show real impact from a global economic perspective.
At this point, it seems growth targets have been revised and the beginnings of a real impact of the broader tariffs is starting to get priced in. Most recently, for example, both US and Chinese auto sales indicators have seen significant decline in YoY growth, suggesting that the tariffs are at least having some impact.
Auto Sales Tariff War Impacts?
Source: Bloomberg, October 15, 2018
SENTIMENT CONCERNS DRIVE OVER-REACTION – POTENTIAL FOR OPTIMISM
Concerns about the snowball effect that tensions might have on business spending decisions have caused prices of most materials to come under more pressure. However, the reactions appear to have been too swift and likely an over-reaction, especially considering the emerging scenarios estimating a relatively limited impact to global GDP. If the tensions do dissipate, then sentiment should also be lifted and will once again be positive for metal prices.
Recently there are some signs for optimism: Metals prices appear to have found a bottom, even as other assets and areas of the market have moved lower. Cost support levels are coming into play for many of the metals. China is expected to ease, both monetarily and fiscally, with potential boosts to infrastructure spending, which is metals intensive, while leading economic housing data has also recently turned positive.
China Property Development Strengthening Once Again
Source: Bloomberg, October 15, 2018.
Supply side growth levels have remained low for the metals sector, with capex taking a backseat to investor returns and, lastly, inventory levels continue to remain low and falling, while physical premiums suggest physical demand has increased.
Metal Stockpiles at Cycle Lows (Base Metal Inventories)
Source: Bloomberg– Total known Global Stocks of Aly & Copper, plus Global Exchange Stocks for Zinc, Lead, Nickel, September 30, 2018
STRUCTURAL GROWTH OF STRATEGIC RESOURCES
Meanwhile, one area of the materials sectors that exhibits great promise is the specialty metals sector. The current trend and increasing consumer demand for electric vehicles is a key driver. It’s a trend that has the capacity to be a long-term driver of structural growth in materials such as lithium, cobalt and nickel markets. There are several large global players in these markets that are listed and operate outside of Canada and are under-represented comparatively in Canada. This segment of the market offers particularly compelling medium-term growth prospects.
GLOBAL MATERIALS OFFER SCALE, DIVERSITY AND ATTRACTIVE VALUE
Canadians are familiar with resources as they contribute meaningfully to the broader economy. However, looking outside of Canada there is a significant opportunity in many of the global materials companies that offer significant scale often with low cost operations around the world.
Source: Bloomberg, September 30, 2018.
Global Materials Market Cap >20x Larger Than TSX
Source: Bloomberg, September 30, 2018
STRATEGICALLY POSITIONED & ATTRACTIVE INCOME:
HARVEST GLOBAL RESOURCE LEADERS ETF – HRES:TSX
Given the current backdrop, it is important to have flexibility to tactically adjust and be properly allocated for the quickly changing environment. The Harvest Global Resource Leaders ETF is heavily weighted towards the dominant global materials companies (ex-energy and precious metals) outside of Canada, as well as companies that are best positioned to benefit from the positive structural growth in strategic resources. The Fund also has exposure to unique chemical companies, and other materials-based companies, that offer diversity and differing demand drivers than traditional metals & mining, an area where the Fund focuses in on the low cost dominant global producers. Lastly, with more cyclical commodity moves expected, rather than secular, covered calls add yield generation to a lower yielding sector. HRES employs an active & flexible covered call strategy – providing for enhanced income as investors wait for the next leg of the cycle.
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