2Q Hard Assets Strategy Review and Positioning
In the second quarter of 2016, the hard assets strategy's positions in Gold and Energy were, in particular, significant contributors to positive performance, with Gold leading Energy. Within the Energy sector, positive performance stemmed mainly from the Oil & Gas Exploration and Production (E&P) sub-industry; within this sector, the Oil & Gas Refining and Marketing sub-industry detracted from performance, but only minimally. Only three other sub-industries detracted from performance during the second quarter, and, likewise minimally: Precious Metals & Minerals, Electrical Components & Equipment, and Fertilizers & Agricultural Chemicals.
2Q Performance Contributors
The top five contributing companies in 2Q came from the Gold and Energy sectors. The top two contributors were gold mining companies. The fact that gold miners continued to perform so well in 2Q provides, we believe, further confirmation that they came into 2016 considerably healthier than they had been for quite a while and truly deserved a valuation re-rating.
Agnico Eagle Mines1 (NYSE:AEM) benefited from strong operational performance, a continued focus on cost reduction, and engineering-related restructuring. Barrick Gold2 (NYSE:ABX) benefited from the restructuring it has been undertaking and its leverage to gold prices.
Within the Energy sector, Oil & Gas Exploration & Production company Newfield Exploration3 (NYSE:NFX) benefited from successful drilling results in central Oklahoma's STACK play, Oil & Gas Equipment & Services company Halliburton4 (NYSE:HAL) rose on the back of firmer oil prices and an uptick in drilling, and Oil & Gas Exploration & Production company Cimarex Energy5 (NYSE:XEC) benefited from successful drilling in the Delaware Basin.
2Q Performance Detractors
The hard assets strategy's five biggest individual performance detractors came from the Fertilizers & Agricultural Chemicals and Diversified Metals & Mining sub-industries, and the Energy sector. CF Industries Holdings6 (NYSE:CF) was hit by concerns around both Chinese production (which continued unabated) and the value of the renminbi, in addition to concerns around nitrogen prices. Glencore7 (OTCPK:GLCNF) suffered from profit-taking after a successful first quarter and a moderation in key commodity prices. Valero Energy (NYSE:VLO) (sold by the strategy during the quarter) suffered from the rebound in crude oil prices. Oil & Gas Storage & Transportation companies Scorpio Tankers8 (NYSE:STNG) and Golar LNG9 (NASDAQ:GLNG) suffered, respectively, due to lower tanker rates and a softening in the global liquefied natural gas (LNG) market.
Brexit Decision Seen as a Defining Moment of 2Q
Despite the market spending most of the three-month period under the twin shadows and uncertainties of Brexit and the U.S. presidential elections, sentiment remained positive. Overall, the environment was positive for commodities, particularly for gold. The most significant macroeconomic factor influencing commodities markets was the continued extraordinary accommodation extended by central banks around the world. In addition, supply and demand, particularly for oil and gas, continued to rebalance.
For many, the Brexit referendum on June 23, the result of which was the U.K. voting to reject continued membership of the European Union (EU), was seen as a defining moment. Perhaps somewhat surprisingly, Brexit's immediate effect was somewhat less than cataclysmic, and commodities have remained surprisingly resilient. It remains to be seen, however, just what the long-term effects of the vote will be.
Demand for Crude Oil Remains Strong
Despite lackluster prospects for economic growth in both Europe and the U.S., the demand for crude oil and, in particular, gasoline remained remarkably strong. The U.S. is now consuming almost 10 million barrels a day. The country's gasoline demand exceeds the unrefined crude oil demand of every country in the world except China.
Concerns that a flood of Iranian crude oil could swamp the market continued to prove unfounded. Albeit reasonably strong, supply from the country was in no way enough to offset supply disruptions in the market for exogenous reasons during the quarter. These included pipeline outages in Nigeria, wildfires in Canada that hit oil sands production particularly hard, reduced supply from Libya on the back of persistent political uncertainty, and supply from Venezuela reduced still further because of both the country's dire economic circumstances and continued drilling challenges.
Industrial Metals Companies Continued to Restructure
Base metal companies continued to restructure during the quarter, cleaning up balance sheets, streamlining operations, and focusing more on profitability. In addition, they continued to sell off assets and reduce debt levels. On the back of the finding by the U.S. Department of Commerce that government subsidies and dumping were occurring, tariffs were imposed on imports of steel into the U.S., particularly those from China. U.S. steel stocks benefited accordingly.
Hard Assets Strategy Prudently Positioned for Brexit Impact
The U.K.'s historic Brexit decision on June 23 was clearly one of the most important events during the quarter. Currently, our London-listed and GBP-denominated exposure represents around 4% of our strategy's exposure. We believe that we were prudently positioned going into the vote given a gold equities exposure of approximately 19%, one of the highest allocations since the inception of our hard assets strategy. Furthermore, the high-quality, companies (i.e., strong balance sheets and long-term structural growth stories) in our other sectors are likely to prove relatively resilient during the period of uncertainty that will follow the vote.
While global economic growth trends were put at risk by the result of the vote, we continue to believe demand for commodities will likely remain solid in the face of moderate GDP progression. Further output constraint in crude, base metals, and some bulk materials could possibly be exacerbated by this murky outlook, but this may in turn tighten commodity markets and support prices. Given that the U.S. Federal Reserve is now not likely to raise interest rates, this should continue to put pressure on the U.S. dollar, which may be stimulating to emerging markets and commodity demand.
Room for Tempered Optimism
While we still believe there is room for optimism, we also believe this should still remain tempered when it comes to supply and demand rebalancing in the oil & gas sector. It remains, perhaps, too easy to fall into the trap of thinking that a 10%, or even a 50%, increase in a U.S. onshore oil rig count of fewer than 350 can restore the balance, and to forget that, to plumb its current depths, the rig count has actually dropped from its highs by a total of some 1,300 rigs. It is going to take an increase of considerably more than 150-200 rigs to bring back any growth in production. Maybe not all 1,300 rigs, but perhaps at least half of them. And for crude to be anywhere from $50-60 a barrel.
One of the main pillars of our investment philosophy continues to be to look for long-term growth and the structural enhancement in intrinsic value in the companies in which we invest. Even in today's market conditions, this continues to be one of our guiding tenets. Since we remain convinced that positioning our strategy for the future, and not just reacting to current circumstance, is of paramount importance, our focus across the sectors in which we invest remains on companies that can navigate commodity price volatility and help grow sustainable net asset value.
For a complete listing of the holdings in VanEck Global Hard Assets Fund (the "Fund") as of 6/30/16, please click on this PDF. Please note that these are not recommendations to buy or sell any security.
1 Agnico Eagle Mines represented 4.95% of the Fund's net assets as of 6/30/16.
2 Barrick Gold represented 3.21% of the Fund's net assets as of 6/30/16.
3 Newfield Exploration represented 4.05% of the Fund's net assets as of 6/30/16.
4 Halliburton represented 4.07% of the Fund's net assets as of 6/30/16.
5 Cimarex Energy represented 4.13% of the Fund's net assets as of 6/30/16.
6 CF Industries Holdings represented 1.67% of the Fund's net assets as of 6/30/16.
7 Glencore represented 3.26% of the Fund's net assets as of 6/30/16.
8 Scorpio Tankers represented 0.22% of the Fund's net assets as of 6/30/16.
9 Golar LNG represented 0.50% of the Fund's net assets as of 6/30/16.
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