This article appears in the April 2021 issue of Investment Executive. Subscribe to the print edition, read the digital edition or read the articles online.
Following a sharp pullback last year, most commodities prices have regained some lustre and are expected to remain relatively strong in 2021.
Massive U.S. stimulus measures and Covid-19 vaccinations are expected to spur demand for commodities. In addition, favourable economic conditions in China — the world’s largest importer of commodities — and a weaker U.S. dollar will also contribute to heightened demand.
While oil prices have picked up appreciably this year, largely due to OPEC’s supply restrictions, the energy industry is coming off one of its worst years. Demand for oil fell dramatically last year, creating a glut in supply that briefly sent prices into negative territory. This reduced profit margins and cash flows for oil producers and forced operators to consolidate to reduce their average costs.
Benoît Gervais, senior vice-president, investment management, portfolio manager and head of the resources team at Mackenzie Investments in Toronto, is lead portfolio manager of the Mackenzie Global Resource Fund. He is optimistic about a rebound in commodities.
“We are back to where we were a year ago in the natural resources sector, when we were anticipating a period of synchronized global growth,” Gervais said. Resources companies are now showing “more commitment than ever to capital discipline” by paying down debt following a year in which “it was hard to generate positive earnings,” he added.
Gervais uses a sustainable free cash flow model in combination with a disciplined quantitative risk-management overlay to select companies for the Mackenzie fund. This process ranks companies based on their estimated free cash flows over a given period, using high and low projections of commodity prices.
Companies must typically have a good growth profile, pay dividends and have a share buyback program to be included in the Mackenzie fund, Gervais said. The decision to invest is based on “a combination of dividends and growth,” he noted. Companies in the Mackenzie fund must also meet established environmental, social and governance (ESG) criteria. Gervais suggested that regulatory developments in the ESG space will favour “natural gas over coal, lumber over cement, copper over iron ore and natural fibres over plastic.”
Consequently, the Mackenzie fund is overweighted in ESG themes. Gervais said he favours the use of renewable lumber and natural fibre–based containerboard instead of cement in the construction industry. He also favours replacing plastics in packaging with sustainable alternatives, as well as a shift to zero-emission electric vehicles (EVs) and greater use of wind and solar power.
The Mackenzie fund, which had $490 million in assets under management (AUM) as of April 7, has about 56% of its holdings in the materials sector and over 40% in energy. According to data from Morningstar Inc., Series A of the fund returned 96.9% for the year ended March 31, outpacing the Morningstar Canada Nat Res NR CAD index by 59.4 percentage points.
In the materials sector, 15% of the total portfolio is allocated to precious metals; 10% to construction materials; 5% to chemicals (primarily paint and paint pigments); 3% to packaging, mainly cardboard; and 17% to base metals and mining, including copper and aluminum.
In the oil and gas sector, approximately 15% of the fund’s holdings are in natural gas; about 10% of the holdings are in integrated oil companies and another 10% are in pipelines. The remainder is in transportation companies and refineries.
Gold-based equities gave up some of the gains they made last year as economic conditions improved, Gervais noted. Consequently, over the past six months, he reduced the Mackenzie fund’s exposure to precious metals by more than half by trimming holdings across the board and selling holdings in companies such as Cayman Islands–based Endeavour Mining Corp., a multinational mining company.
The Mackenzie fund was recently reinvested in Toronto-based Labrador Iron Ore Royalty Corp., as well as a number of oil and natural gas producers, including Oklahoma City–based Devon Energy Corp. and Calgary-based Canadian Natural Resources Ltd.
Curtis Gillis and Hoa Hong, both vice-presidents and portfolio managers with CI Global Asset Management in Toronto and portfolio co-managers of the CI Signature Global Resource Fund, expect 2021 to be a strong year for natural resources.
Hong said demand for commodities fell by “several deltas from the norm” to a historical low in the wake of the onset of the Covid pandemic. However, she said she anticipates a rebound in demand and an increase in prices, triggered by monetary and fiscal stimulus, vaccine developments and a pickup in economic growth as the world returns to normalcy.
Covid not only had a negative impact on the demand for commodities, Gillis noted, but also on mining output and paper supply. He said he anticipates production will ramp up gradually — making now a good time to invest in certain mining and paper stocks.
As part of Gillis’s and Hong’s investment strategy, they identify secular and cyclical trends that will drive individual sectors before looking at individual companies. Gillis and Hong invest “across the capital structure” and “may delve into smaller resource sectors,” such as agriculture, Hong said.
Although Gillis and Hong are “big believers” in the transition to low-carbon energy, Hong said she thinks the demand for oil will stay strong in the near term. She noted there “are currently 1.4 billion cars in the world today, but only 10 million electric vehicles.” As a result, she said, she is “bullish on oil demand coming back.”
Oil prices, Hong noted, have been supported by OPEC supply cuts. OPEC’s move sent prices higher at a time when the price for oil had fallen to below US$45 per barrel, mainly due to a glut in supply. Hong said she anticipates oil attaining a mid-term price of US$60.
The CI fund has a globally diversified portfolio, with 41% of its holdings allocated to Canada, 36% to the U.S., 9% to the Netherlands and 3% to the U.K., with remainder in other countries. The fund had $102 million in AUM as of April 7. According to Morningstar, the Class A version of the fund returned 83.7% for the year ended March 31, outpacing the Morningstar Canada Nat Res NR CAD index by 46.2 percentage points.
The CI fund is currently overweighted in energy stocks, including renewables; the largest energy holdings include multinational producers such as Netherlands-based Royal Dutch Shell PLC, California-based Chevron Corp. and Texas-based Exxon Mobil Corp.
In the materials sector, the CI fund has a 12% allocation to copper, a 10% allocation to gold and an 8% exposure to lumber, in addition to smaller positions in chemicals and industrial gases.
In the alternative energy space, the CI fund had a healthy position in Charlotte, N.C.-based Albermearle Corp., one of the largest providers of lithium for EV batteries, and Santiago-based Sociedad Quimica y Minera SA (SQM), one the world’s lowest-cost lithium producers. However, Gillis and Hong sold their holdings in SQM and trimmed their position in Albermearle.
“It’s not that we don’t like EVs, but the growth that was being implied in the valuations was well beyond what we think is achievable,” Gillis said. “There was a bit of euphoria around the electric vehicle manufacturer Tesla [Inc.]and, as a result, lithium prices went up.”
The team recently added holdings in Amsterdam-based Akzo Nobel NV (a paint and coatings company that provides exposure to an improving European economy) and renewable energy names that are more reasonably priced (such as Toronto-based offshore wind producer Northland Power Inc.).