Resources Should be Resilient in a Recession: Manager

Resources Still Limited in Recessions

“Market sentiment has been dominated recently by recession fears, but my philosophy is that things like copper, oil, and nickel can’t be replicated,” says Curtis. “There are only so many parts of the world endowed by Mother Nature, and supply is tighter and inventories lower than in the past.”

For example, copper is increasingly being used in the replacement of products to replace traditional combustion engines as part of the electrification of cars. But new supply of copper, as well as other resource commodities, can’t be brought on stream quickly, he says. A greater emphasis on environmental factors has also lengthened the time it takes to build mines and production facilities, and the construction of new facilities can be costly.  

“As demand begins to outstrip supply, mining companies with resources in place will capture the best return,” he says. “We’re in a soft patch now with concerns about rising interest rates, the dampening effects of Covid lockdowns in China and recession fears.  I’m in the camp that these conditions are short-term and that in 2023, 2024 and 2025 we’ll run into deficits in supply of many commodities relative to demand.”

Follow the Capital Allocation

On the energy side, the big producers are maintaining greater capital discipline than in the past, returning a more free cash flow to shareholders in the form of dividends and share buybacks rather than spending extravagantly on drilling and exploration.  

Resource supplies are therefore tighter and inventories are lower than they were heading into past economic downturns, Gillis says. Even if there is a recession the effect on commodity prices will be more muted than during past cycles.

“Rather than spending 125% of cash flow, companies are being more rigorous in capital management and they might now be spending 30%.  They’re not growing solely for the sake of growth, and that is resulting in a tighter supply/demand balance.”

CI Global Resources F, ranked bronze by Morningstar, showed a 9.6% decline in the three months ended June 30 after a strong start to the year as commodity prices and resource-related stocks pulled back. Nevertheless, the fund finished with a positive return of 10.1% for the first six months of 2022 and an impressive one-year gain of 22.4%.  For the five years ended June 30, the fund had an average annual compounded return of 5.4%.

Gillis achieves healthy diversification within a confined mandate by investing globally and holding stakes in a variety of resource-related industries including energy, base metals, precious metals, forestry, utilities, packaging, chemicals, construction materials, renewable energy and fertilizer.

Rising Rates and Russia

By sector, the fund’s biggest weight is in energy, at about half the portfolio. Gold is currently a much smaller 5% weight, although it was higher earlier in the year. Gillis lowered exposure after the February invasion of Ukraine by Russia. He also reduced lumber due to the dampening effect of rising interest rates on housing starts.

“The safety trade was reflected in the bullion market, and there was a move to rising interest rates around the globe, which is a headwind for the bullion price,” Curtis says.

Geographically, about a third of fund assets are invested in Canadian-headquartered companies, with a similar percentage in both Europe and the U.S.  The rest is in other parts of the world such as Latin America. However, wherever a company is headquartered, its assets could be in a mix of locations.

The focus is on large and mid-capitalization companies. Gillis would rather not go further out on the risk curve by investing in smaller, less liquid companies or those with a focus on exploration, where results are less predictable.

“We like resource companies at the low end of the cost curve that have good geology,” he says. “With a lower break-even point, they are better able to cover costs and earn a positive return.”

Top Resource Stock Picks

Among the top holdings, a longtime favourite is British-based Shell PLC (SHEL), one of the largest companies in the world. It is an integrated energy multinational that has an attractive Liquified Natural Gas (LNG) portfolio and is benefitting from growing demand and rising prices in that sector, Gillis says. Shell is also making investments in renewable energy such as solar and wind.

 “Shell isn’t standing still, it’s positioning itself for the future while generating healthy free cash flow,” he says.

Gillis has been adding to some less cyclical, defensive names such as Linde PLC (LIN), an Ireland-based producer of industrial gases such as oxygen, hydrogen and nitrogen. The company, which merged with U.S.-based Praxair Inc. in 2018, has a dominant market share and benefits from some long-term contracts such as supplying oxygen to hospitals and hydrogen to refineries.  Through its engineering and construction arm, it also builds large-scale chemical plants.

Gillis has been adding to Olin Corp. (OLN), a U.S.-based firm that makes chemical products such as caustic soda, chlorine and vinyl epoxy.  Its products are used in a variety of applications, including the production of soap, aluminum and pulp and paper, and its vinyl epoxy is used to make windmill blades.  The company also makes ammunition under the Winchester brand.

Also in the specialty chemicals business, the fund holds Royal DSM, a Dutch maker of health and nutrition products that supply ingredients used in health products such as vitamins and infant formula as well as in animal nutrition. For example, it makes Bovaer, an additive to cattle feed that reduces the production of methane gas.

“There are lots of companies in related sectors with unique characteristics, and that broadens the scope of our portfolio,” Gillis says.