The third quarter was dominated by uncertainty surrounding U.S. trade policy and the potential impact trade restrictions might have on any type of sustained future growth. While some fears were allayed following the resolution of the NAFTA dispute by quarter end, escalating tensions between the U.S. and China remained at the core of the seemingly generalized bearish market sentiment for commodities. China consumes nearly half of the world's base metals, and any perceived economic slowdown there due to trade tariffs could project a negative short-term outlook for commodities.
Base and industrial metals and, consequently, related mining companies, suffered the most from trade concerns. Many metals ended the second quarter with their prices close to near-term highs, yet spent the next three months in a slow, steady decline following the announcement of further U.S./China trade restrictions. By end September, aluminum, copper, zinc, and nickel had lost approximately 3%, 5%, 8.5%, and 15%, respectively, on the quarter, despite tightening fundamentals.
While not hampered directly by trade issues, gold and gold equities suffered from weakness during the quarter due to both a strong U.S. dollar and thin trading in the gold commodity and gold equity markets. By midway through August, market action in gold was dominated by short-sellers, resulting in a net speculative short position in physical gold for the first time since 2001. Combined with a U.S. dollar rally, this helped drive the price of the metal below its established near-term base of $1,200/oz and placed further pressure on gold mining shares already squeezed by plateauing margins.
Within the energy sector, concerns around pipeline takeaway capacity in the Permian Basin of West Texas abated somewhat following the approved conversion of an existing major pipeline construction project from natural gas liquids to Permian-based crude oil transport to the Gulf of Mexico. In anticipation of this approval, U.S. shale operators and servicers in the region experienced modest recoveries in their share prices beginning in September. However, most investors still appear to be in somewhat of a "wait-and-see" mode, expressing at least some skepticism around the ability of these U.S. shale operators to grow near-term production at current expected rates, while also generating highly touted earnings and cash flow growth.
Grains (soybeans and corn, in particular), too, continued to be hit hard by trade fears. However, as in the second quarter, better pricing in potash and urea helped agriculture equities relative to their corresponding commodities.
In our opinion, this quarter was the peak of the proverbial "perfect storm" when it comes to underperformance in the hard assets space, and, in particular, with respects to several of our core holdings. Whether it be the concerns around a meaningful, trade war-induced slowdown in global growth and associated metals weakness, lingering concerns about the impact of Permian takeaway capacity, or issues specifically related to resource nationalism or presumed dilutive acquisitions, the asset class and some of our holdings suffered. However, we believe the natural resource equity complex has transformed dramatically over the last several years and see the investment opportunity as historically attractive.
In our view, the compelling investment thesis is bolstered by the three key points we have reiterated over the last several years:
- Dramatic under-representation and related undervaluation of resource equities relative to the broader market.
- Strong evidence that the multi-year plunge of capital investment in new natural resources is impacting supply.
- Broad and substantial improvements at the individual corporate level in terms of operating performance (growth and costs), capital efficiency (margins and returns), balance sheet (debt metrics), and returns of capital to shareholders (dividends and share repurchases).
The harmonic convergence of all these factors appeared to have a nascent impact on equity market returns since the beginning of September, and we believe this may continue into 2019 as the natural resources industry continues on its path of delivering historically strong operational and financial performance.
See below Commentary PDF with Fund-specific information and performance:
Important Definitions And Disclosures
All indices listed are unmanaged indices and include the reinvestment of dividends, but do not reflect the payment of transaction costs, advisory fees or expenses that are associated with an investment in the Fund. Certain indices may take into account withholding taxes. An index's performance is not illustrative of the Fund's performance. Indices are not securities in which investments can be made.
1The S&P North American Natural Resources Sector Index (SPGINRTR) includes mining, energy, paper and forest products, and plantation-owning companies. 2The MSCI ACWI Commodity Producers Index (M2WDCOMP) is a free float-adjusted market capitalization index designed to reflect the performance of listed commodity producers across three industry (or sub-industry) categories as defined by the Global Industry Classification Standard: energy, metals, and agriculture.
Please note that the information herein represents the opinion of the author, but not necessarily those of VanEck, and this opinion may change at any time and from time to time. Non-VanEck proprietary information contained herein has been obtained from sources believed to be reliable, but not guaranteed. Not intended to be a forecast of future events, a guarantee of future results or investment advice. Historical performance is not indicative of future results. Current data may differ from data quoted. Any graphs shown herein are for illustrative purposes only. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission of VanEck.
You can lose money by investing in the Fund. Any investment in the Fund should be part of an overall investment program, not a complete program. The Fund is subject to risks associated with concentrating its investments in Canadian issuers, commodities and commodity-linked derivatives, commodities and commodity-linked derivatives tax, derivatives, direct investments, emerging market securities, foreign currency transactions, foreign securities, other investment companies, management, market, operational, small- and medium-capitalization companies and hard assets sectors risks, including, precious metals and natural resources, that can be significantly affected by events relating to these industries, including international political and economic developments, inflation, and other factors. The Fund's portfolio securities may experience substantial price fluctuations as a result of these factors, and may move independently of the trends of industrialized companies. The Fund's investments in foreign securities involve risks related to adverse political and economic developments unique to a country or a region, currency fluctuations or controls, and the possibility of arbitrary action by foreign governments, including the takeover of property without adequate compensation or imposition of prohibitive taxation.
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