The Investec Commodity Fund appreciated by 10,8% over the last quarter of 2006, handsomely outperforming its benchmark, the JSE resources index, which rose by 4,5%.
The quarter saw a weakness in most commodity prices. The bellweather copper price, in particular, fell by 17% as demand-side concerns (a slowdown in United States housing starts, a decrease in Chinese imports and substitution in some applications) and increased supply from scrap led to a rise in inventory levels and the resulting sell-off.
We held the (correct) view that the copper price would fall and halved our holdings in Anglo and BHP Billiton, thereby greatly benefiting fund performance, particularly in the face of the sell-off during the last two months of 2006. While sector performance was flat over the final quarter of the year, the Investec Commodity Fund rose by 2,9%.
The fund also benefited from large holdings in platinum shares and the steel sector (industrial metals), a position we have maintained throughout 2006. We also held less Sasol, which came under pressure due to lower energy prices.
Looking ahead, the market is focusing on demand-side concerns (particularly for copper) and the possibility of a large surplus of copper during 2007. Copper sentiment is also influencing the other metals markets. We are still, however, positive on metal prices on the medium to long term.
Given the market’s greater concern over risk and volatility, we like BHP Billiton for its bulk commodity exposure (iron ore and coal are 36% of the portfolio), since prices for these commodities are contracted for the next 12 months and are therefore not subject to terminal market volatility. BHP Billiton is not expensive, trading at 7,5 x FY07 earnings, with very strong cash flow and likely more capital management to come.
In contrast, Anglo is trading on a more expensive forward multiple of 11,6x, even allowing for stronger precious metals prices. The market is probably already stripping out a soon-to-be-sold Mondi and AngloGold from Anglo’s valuation but, even so, Anglo then trades on a 9,7x multiple.
We fail to see why Anglo attracts a 30% premium to BHP Billiton when both businesses are equally exposed to the jitters-inducing copper price and have overlapping portfolios in terms of met coal, steam coal and iron ore. We also fail to believe that Anglo is a target for a buy-out.
For the year ahead, we are more bullish on precious metals than base. We believe that a weakening dollar, strong supply versus demand fundamentals, and diversification benefits should support precious-metals prices. Within precious-metals equities we currently prefer platinum to gold. The current forward P/E ratio for the platinum sector is in the order of 15x. This indicates that this sector still offers markedly less risk than the gold sector, priced at more than 20x.
Furthermore, given increased PGM prices and an expected increase in output, dividend yields for the platinum stocks exceed 5%, representing good absolute value. While we favour the sector in general, we believe Angloplats’s relatively higher gearing to the metal prices will drive its outperformance.
Daniel Sacks is a portfolio manager of the Investec Commodity Fund