Trading the ‘perfect storm’ for resources
Growing up on the family property in country Victoria, James Stewart’s favourite pastime involved dismantling toys to understand the mechanics of how they worked (reports The Australian Financial Review).
2nd July 2021
Resources Rising Stars
“When I was five, I was pulling an alarm clock apart and my aunt tried to stop me,” Stewart recalls. “My mum just told her to let me figure out how it works – she knew I wouldn’t stop until I worked it out.”
This innate curiosity saw Stewart build his first car at 15 years of age and then his first engine a year later before undertaking a degree in mechanical engineering at Monash University.
Fast-forward a number of decades, and the co-portfolio manager of Ausbil’s global resources fund applies the exact same thinking to picking stocks.
“If I can’t get my head around how a process works or something doesn’t make sense to me, it’s hard for me to invest in it,” Stewart says.
This rationale is paying dividends: the global resources fund, which Stewart co-manages with close friend Luke Smith, has returned 88.3 per cent in the past year.
While conceding the fund’s outperformance of its Bloomberg AusBond Bank Bill Index benchmark is impressive, Stewart points to the consistent returns of 24.3 per cent a year since inception as the superior feat. This is because the global resources fund has seen its fair share of turbulence in commodity markets since launching in May 2018.
“The trade wars period between the US and China was incredibly unpredictable – a simple Trump tweet could move the market by 5 per cent,” Stewart says. “And then you had COVID-19, which was an interesting one.”
Most investors are aware that China is a key driver of commodity markets, but a fixation on the country’s activity leading into COVID-19 gave Stewart a heads up to move the fund net short prior to the market crash early last year.
“During January , we were seeing a lot of data coming out of China which revealed shutdowns and constraints on the movement of people. It was phenomenal,” Stewart recalls.
“We were looking at massive drops in coal consumption, transit times halved which we found from traffic data from GPS providers, people weren’t driving or going out to eat. It’s amazing how much data is out there if you look hard enough.”
Indeed, Stewart and Smith looked hard.
The pair skimmed through 3000 articles a day coming out of China while working around the clock – a necessary evil in global equities.
Their decision to move the fund to a short position in January was against the grain, with the commodity market buoyant as the Chinese economy emerged from the trade war period.
But the trade played out beautifully. Resources stocks were caught in a global sell-off that started in February 2020 and ran until late March.
It wasn’t long before Stewart and Smith looked to go long again, as China’s stimulus efforts sent commodity prices and mining stocks surging.
The move to go short typified why the global resources fund chose a long-short approach.
“The way we run our portfolio is we use some shorts to adjust our market exposure, but we also use options strategies to protect capital as it helps provide a shock absorber,” Stewart explains.
“With a fund like this, you have to remain really agile which means staying on top of the news but importantly, not always reacting to it.”
The fund manager is usually awake for both the open and close of US markets. Happily, this schedule allows him to spend time with his two young kids in the morning and read to them before they go to sleep.
“The benefit of working global is there’s some flexibility. But the fallback is, you are always on,” Stewart admits.
Having been in commodities for over two decades, he says the current market is the most challenging he’s seen, and believe it or not, he views that as a good thing.
“The way the market moves aggressively makes it the most difficult market I can remember,” he says. “That means two things: you have to be prepared for those swings and the other is, it can produce buying opportunities.”
This volatility was seen in the days following the June meeting of the Federal Open Market Committee in the US.
“If we see a broad sell-off in the market and materials go down the same or more than other areas of the market, that doesn’t make sense to us from an inflation perspective,” he says.
“It means you have broad equity investors just pressing a button saying, ‘sell me millions of dollars worth of equities’, and we get caught up in that. That, to us, is a buying opportunity.”
These blips are part of an elongated commodity bull market where COVID-19 has created “the perfect storm for resources”. And while China used to be the key driver of commodity demand, this has switched to other parts of the globe, Stewart believes.
“Now the rest of the world is really driving commodity demand which will only increase as the US, Europe, Asia and South America open up,” he says.
“So there’s this huge restock that’s going through global economies.”
A severe lack of supply makes for a unique dynamic. “Over the last seven years, we’ve had almost no investment in new projects and particularly over the last 12 to 18 months with COVID-19, there’s been no investment at all,” Stewart says.
“It means we’ve got a situation where the supply-demand dynamics look very strong and we see it as a Goldilocks scenario.”
There’s perhaps no better example than the battery minerals sector, which Stewart and Smith have weighted the fund towards in anticipation of the elusive lithium boom finally coming to fruition.
The fund’s tilt towards the sector occurred in August last year having steered clear of it before given the oversupply and pricing of battery materials.
But conditions are now ideal, meaning that’s where the global resources fund will be focused over the next year.
“The volume of electric vehicles sales going through Europe and the US is phenomenal,” Stewart says.
“Because of the terrible environment over the last few years with weak pricing, driven by supply, but also weak demand from COVID, it means there’s been no investment in lithium.”
Over the next six to 12 months, there won’t be enough volume coming online in lithium production to meet demand.
Ausbil has positioned in two lithium companies – Orocobre at 6.2 per cent and Pilbara Minerals at 5.7 per cent – being among the top five long positions held by the fund.
The electrification theme occurring across the globe also leaves it bullish on rare earths, with the fund holding a significant position in Lynas. Rare earths are used in high strength magnets for wind turbines, electric vehicles and energy efficiency applications.
Graphite rounds out the third commodity Stewart sees as being central to an electrified world, with a 5.4 per cent long position in Syrah Resources.
On the short side of its book, iron ore is the main focus because of the perceived sustainability of prices, alongside global diversified miners, with Stewart seeing better leverage in pure-play names.
Given the positive outlook, the resources duo’s net market exposure remains towards the upper end of its normal levels.
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