If you have clients looking for a mutual fund with pure exposure to the rallying base metals sector, you’ll probably have to cobble something together for them. Unlike precious metals funds, which consist mostly of gold-related investments, “natural resources” funds tend to be heavily weighted in oil and gas producers, with base metals miners receiving only minor attention.

Fund managers attribute the imbalance to a number of factors, the most obvious being the relative strength of the energy sector compared with the base metals sector, the latter of which is wounded and broken after slogging through a prolonged bear market.
Energy just gets way more respect.

“There’s a massive evolution underway in the oil and gas industry in Canada that is not happening in the mining business,” says Michael Waring, president of Galileo Equity Management Inc., a Toronto-based firm specializing in growth-style equities. “The oil and gas business is overflowing with prosperity, whereas the mining business has been through something verging on a depression for 20 years. And it’s only
recently started to turn up.”

Two years ago, Waring, a former vice president and portfolio manager at KBSH Capital Management Inc., positioned himself ahead of the upturn by launching a natural resources fund with significant exposure to base metals. The rationale behind the RRSP-eligible Galileo Natural Resources Fund was based on Waring’s travels in China, where he witnessed the beginnings of that country’s robust economic growth. Instead of buying Chinese equities directly, he would expose his investors to lower-risk junior commodity producers that would benefit from China’s restructuring.

The strategy worked but, despite the fund’s average annual compound return of 55% for the past two years, investors aren’t biting.
Waring now finds himself in the unusual position of having to wind up the fund during one of the greatest commodity rallies in recent memory because he doesn’t have enough investors to make it worthwhile.

“For whatever reason, whether people are
scared of commodities as a concept or whether they are fearful that China is a shooting star that’s going to fizzle out, the risk tolerance of investors has shifted quite dramatically in the past four years and people have become quite risk-averse,” says Waring. “It’s very frustrating.”

Waring is not alone in his frustration.
Although income-oriented products were wildly popular in 2004, according to statistics from the Investment Funds Institute of Canada, sales of Canadian equity funds remained muted. As for natural resources funds, net new sales dropped for five consecutive months following the 2004 RRSP season, despite an average fund return of 20.4% in 2004.

When it comes to resource stocks, market sentiment can often override fundamentals, says Robert Cohen, portfolio manager at Toronto-based Dynamic Mutual Funds Ltd.
He uses the copper market as an example.
Copper inventories on the London Metal Exchange have plummeted from one million tonnes a few years ago to about 50,000 tonnes today, resulting in a critical shortage of the metal that will not be resolved anytime soon. An event such as the Chinese New Year — when demand slows for a few days — can throw the copper market into a panic and spawn widespread selling. Investors frightened by such a degree of volatility end up shunning the sector entirely.

Cohen is one of the few resources fund managers with a heavy weighting in metals, including uranium (not technically a base metal), in his Dynamic Global Resource Fund. The fund had a three-year average annual return of 38% as of Dec. 31, 2004, but, he admits, it’s been a tough sell lately.
In 2004, the fund had net redemptions for all but three months of the year, IFIC statistics show.

Besides the popularity of oil and gas stocks, another factor that explains the underweighting of base metals stocks in most natural resources funds is the sheer lack of product. After a 20-year recession and heavy consolidation in the industry, there are very few base metal producers left.
For fund managers with well-defined
investment criteria, the pickings can be very slim indeed.

“You have a handful of really big majors that are diversified in a bunch of metals, then you have to go way, way down to find the smaller companies,” says Waring. “It’s tough to find quality names that have actual production.”

Included in Waring’s recently defunct resources fund were copper producers Amerigo Resources Ltd, Anvil Mining Ltd.
and First Quantum Minerals Ltd;
nickel-producing hopeful Canico Resource Corp; developer Ivanhoe Mines Ltd.;
uranium explorer UEX Corp.; and diversified explorer Altius Minerals Corp.