Commodities from coal to gold once traded in close correlation, but today the graph looks helter-skelter. This means Philip Richards of RAB Capital has had to think on his feet when choosing names for his company's Special Situations Fund. In this interview with The Gold Report, Richards explains how commodities markets have changed in recent years, and he lists companies of interest in the gold, silver, nickel, vanadium, zinc and oil and gas sectors.
The Gold Report: Philip, your March update on the Special Situations Fund showed a 4.21% increase during Q1/14, compared to 1.29% for the Bloomberg World Mining Index. You noted that cold weather and concerns about China, Ukraine and South Africa are driving commodity markets short term. Are you worried about the impact of a slowdown in China on commodities and your funds?
Philip Richards: A slowdown in China is a concern, but it's one of many, and it isn't an overwhelming concern. Ukraine has had an effect on the gas market. Strikes in South Africa drive the platinum price. Specific events in specific countries can drive specific commodity prices, but they don't drive all commodities.
In the boom years of 2005-2007, there was a correlation among commodities. Iron ore, coal, nickel and even gold and silver tended to move together. I attribute that to the amount of speculative money involved in commodity markets.
Today, that correlation is greatly reduced. For example, this year the nickel price has been extremely good due to the Indonesian export ban, but also because of extremely strong demand growth. On the other hand, while there's still reasonable demand growth for iron ore, the increase in supply has been enough to send the price down. In the energy sector, the coal price is down very sharply and the uranium price has been really bad, while the oil price has been relatively stable and may even be improving.
TGR: With commodities going in different directions, how do you decide what goes in the Special Situations Fund?
PR: The Special Situations Fund tends to invest in early-stage companies, which makes it hard to invest for the short term. Sometimes, you have a chance to take profits more quickly than you might expect, but you have to invest with the expectation that you'll be in it for the long term. Therefore, we look for long-term structural factors.
Among the metals, we particularly like zinc and nickel going forward. Both have positive demand profiles, with nickel being the stronger of the two. Both also are in short supply. The Indonesian export ban is hurting the nickel supply. Three big zinc mines will close between now and 2016.
We're less positive on copper and have much less exposure there. On the precious metals side, we have exposure to gold and silver, with the emphasis on gold. In the energy sector, we have quite a lot of exposure to oil, some exposure to uranium and very little exposure to coal.
TGR: The market seems to like it. The price is way up from January and the company just released Q1/14 results. Does the company have enough money in the bank to move forward until it finds a partner?
PR: Yes, it has enough money to continue through 2015. I expect it will soon have an industrial partner in place. The company has publicly stated that it is having material conversations with more than one party.
TGR: You also have some holdings in vanadium. What's the supply-and-demand story there?
PR: Vanadium has two main potential demand factors. The first, and most immediate, is in steel. Since the Chinese earthquakes, for example, the need for vanadium for building earthquake-proof structures has become very important there. As an alloy, it's also used in automobile and aircraft production, to reduce the weight of vehicles and planes. Longer term, vanadium will play a role in storage batteries. That could create a quantum leap in demand.
The total world supply market is about 127,000 tons [127 Kt]. Demand exceeds that slightly, at 136 Kt. Supply is concentrated in China, South Africa and Russia, with China being the biggest producer.
TGR: About 44% of the fund is in the oil and gas sector. What supply-and-demand fundamental for oil appeals to you?
PR: To some extent, our exposure is due to the return/risk profile on the individual stocks.
What is interesting about oil is the steadily rising demand, which now exceeds 90 million barrels per day [90 MMbbl/d]. Of that, demand from the Organisation for Economic Co-operation and Development [OECD] region-meaning North America, Europe and Japan-accounts for only 37 MMbbl/d. The balance of 53 MMbbl/d is demand from non-OECD regions. This is a huge change from 20 years ago, when the OECD was the only important demand source for oil. While demand for oil from the OECD area has declined from 42 MMbbl/d since 2007, demand for oil from the rest of the world has grown. That growth has offset some of the decrease in OECD demand. If demand in both areas were to increase in tandem, we should see an increase in demand overall.
On the supply side, although there are some increases in supply coming through, we think shale oil production from the U.S. will not exceed 4 MMbbl/d, given that shale oil fields tend to decline at a faster rate than traditional oil fields.
In a nutshell, one could say while demand is likely to continue to grow, the same is not true with supply.
There could be price wobbles. Ramped-up production in Libya or more onstream production in Iraq might depress the oil price. Longer term, we think the oil price should do very well.
TGR: Are you worried about the Ukraine situation?
PR: Not very worried, but if something went wrong, it would only increase the pressure on oil supply.
TGR: Does the election of a new Bahamian government mean it will be easier to get licenses to drill?
PR: We think so, yes. We believe the prime minister supports drilling as an opportunity for the nation. The company has some very big fold-belt structures, which it intends to drill and is looking for drilling partners right now.
TGR: Many of the companies in your portfolio operate in Canada. How much weight do you give geopolitical risk versus commodity fundamentals?
PR: Canada is well represented, but we've also talked about companies operating in the Falkland Islands and Bahamas.
Geopolitical risk is important. We prefer companies that are operating in a Western jurisdiction or a jurisdiction in Africa that has proven itself to be reliable. We have found it difficult to protect shareholders' interests in companies in the ex-Soviet Union countries.
TGR: You ended your last update by saying you were positive on the structural and long-term prospects of natural resources throughout 2014. How positive are you? When you get excited about a sector, how do you adjust your portfolio based on those predictions, given your long-term approach?
PR: We've said that structurally, we think oil, nickel, zinc and vanadium will be good. We're also pretty happy about gold and silver.
Iron ore, which we have liked in the past, has shocked us with excess supply. We were surprised by the relentless ramp-up of companies like Rio Tinto Plc (NYSE:RIO) and Fortescue Metals Group Ltd. (OTCQX:FSUMF). We are concerned that supply is a bit too strong in iron ore. As to copper, although there's no particular player to point at, supply seems to be coming on.
Overall, we think natural resources will be a better place to be than in recent years. But remember, the correlation between different natural resources is breaking down. One has to pick and choose the commodity more carefully than perhaps one did in the big boom of six years ago.
TGR: Philip, thank you for your time and your insights.
This interview was conducted by JT Long of The Gold Report.
Philip Richards is the executive director, founder and president of RAB Capital Limited, having co-founded the company with Michael Alen-Buckley in 1999. He is the investment manager for the RAB Special Situations Fund. Prior to joining RAB, Richards was at Smith New Court from 1987 to 1998 [later Merrill Lynch] where he was a founding member and executive director of the European equity division. At various times, he was responsible for Belgian, French and Italian equity research at Smith New Court and, after its acquisition by Merrill Lynch in 1995, he became a managing director of European research and later managing director of investment banking for Belgium and Luxembourg. Richards holds a Bachelor of Arts Honors from Oxford University [Corpus Christi College] in philosophy, politics and economics, was a captain in the Royal Green Jackets [British Army] and received the AIM Entrepreneur of the Year Award in 2006.
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