With equity markets gyrating wildly and bond prices at record lows, many investors are looking for alternatives. Resources offer returns that are uncorrelated with equities and bonds, and the choice on offer is incredibly broad.
The team at the Tribeca Global Natural Resources Fund cover everything from bulk commodity producers like BHP and RIO, to shipping, energy, and even cannabis companies.
I recently spoke with the fund's founder and Portfolio Manager, Ben Cleary, to hear what ideas he's excited about at the moment. He told us about a completely different way to play the oil market and discussed one commodity that he gives a glowing review.
Image: Ben Cleary, Portfolio Manager, Tribeca Global Natural Resources
Is the recent investor enthusiasm for gold justified?
Yes, we think it's justified and will continue. The Fed cannot print gold and it's going to benefit from the extreme stimulus measures the world over is implementing with borrowed money. Negative real rates will support gold for the foreseeable future.
What's the best way to get exposure to gold?
We think the Australian producers, in general, look good and are producing very strong cash margins. We are invested in most major and mid tier producers and think generally owning gold producers is far more attractive than owning the commodity as you will also get paid good dividends and should get more capital growth owning companies than the commodity itself.
One of the most popular ways to invest in oil is through synthetic oil ETFs. Can you explain some of the dangers in investing in these vehicles?
Oil ETFs effectively try to replicate the oil price but do so by buying futures contracts. In addition, they are unable to hold physical oil. The ETF needs to continue to sell the nearest month to maturity futures contract to buy the next month. The ETF itself wants to hold the most current contract as long as possible as this is most representative of the current oil price.
This is important to know because it helps explain what happened during April with the May futures contract that went negative. Heading into the expiry last week, it is understood some oil ETFs were holding onto their May contract until two days prior to expiry. When it became apparent there was no demand, and given they can’t hold physical oil, they had to take any price to roll the contract to June. They held on too long and forced the price to unbelievable lows. This is unlikely to happen in the future as you’d assume those running the contract have learnt but it highlights how the oil price and ETF performance may diverge.
In addition, there have been record inflows into the ETF since the oil price collapsed. Investors are taking advantage of the low prices and the asymmetry of the price where the downside is somewhat capped to zero (negative prices are unsustainable for more than a few days before production ceases) but the upside could be over $100. The massive inflow has meant the ETF is no longer able to just buy the current month futures contract but then starts moving along the maturity curve going out two to three months or more. The issue is that the price of oil in three months’ time is almost $10 per barrel higher.
Instead of a consumer thinking they are buying at around $15 per barrel, they are in fact partly buying at $25 per barrel meaning their return will be less than what they anticipated.
On top of this, it is important to remember that ETFs are also exposed to transaction costs. The ETF needs to constantly buy and sell the futures contracts. Given volatility in oil price at the moment, the cost of trading in the futures market is high, particularly close to the futures expiry where no one wants to take the physical oil. These costs can be in excess of $3 per barrel for each contract. In addition, the funds themselves charge a management fee on top of the cost of transaction. At the moment, the fund expense ratio is 0.8% which should also be factored into investor thinking. These all reduce the potential returns from investing in the ETF on top of the abovementioned risks around contract rolls.
What's one implication of the oil price crash that you don't think has been discussed enough?
We think the value of storage is being underappreciated from our views. We see this in the heavily discounted oil tanker equities. At the moment a trader can charter a vessel for six months and so long as the time charter rate is less than $100,000 per day, they will make an arbitrage profit by trading the current oil curve.
What this means for the vessel owners, is that each of their Very Large Crude Carriers (VLCCs), which carry two million barrels of oil, can earn over $18m per vessel in 6 months. A new VLCC is less than $90m new from the yard in Asia. In six months, vessel owners are generating 20% of the value of the boat. Given the typical leverage in these businesses of greater than 50%, the return to equity is significant. It should also be considered in light of the useful life of a ship of 20 years.
As a result, looking at spot charter rates for the boats, the companies are sitting on PEs of less than 2x and dividend yields greater than 60%. These earnings, due to the size of the oil price contango (i.e. the price of oil in the future less the price today) are largely locked into the end of 2020. While the inventory unwind will put pressure on rates through 2021, the underlying fundamentals for the oil tanker market was setting up strongly given the lack of new vessel orders and continued growth in underlying oil production. The oil glut has just supercharged the earnings in the near term.
We expect investor interest to grow once companies report their first quarter earnings in early May and give guidance for the second quarter, including average day rates secured. In addition, proof of their dividends will excite retail investors. Our top picks are Euronav, DHT, International Seaways on the NYSE and Hafnia in Oslo.
How long do you expect low oil prices to persist for?
In the short term, low oil prices will continue so long as demand is depressed given the lag for production cuts, particularly in the US. Currently oil demand is down 30% from normal, pre-COVID-19 levels. Producer cuts announced to date, even on the most optimistic view of 20 million barrels per day, still see a 10 million barrel per day surplus. In our view, cuts are only eight million barrels per day from where we were in January and February. That essentially means there are around 20 million barrels per day entering storage. At that rate, and depending on your assumption of storage capacity, it means that storage theoretically fills in under two months.
The question becomes what sort of demand recovery we see and via what products. It is likely gasoline and diesel will be the quickest products to recover but the key is when will we see jet fuel pick up?
Jet fuel is over 7% of the total crude barrel and it is likely to be depressed through to the end of the year.
However, lower prices will ultimately impact production, particularly for Non-OPEC producers. Once capacity curtailments are seen in the market, then the surplus production will disappear and prices can recover. At this stage, and looking at the oil forward curve, it suggests we could end the year with WTI prices back towards $40 per barrel which would help to relieve the market.
The supply cuts we expect to see are across OPEC+ including Russia which were agreed in April but also other large non-OPEC producers such as the US, Canada and Europe. For the US shale producers we see production for 2020 will be down over 10% and 20% by the end of 2021. Essential signalling the maturity of the US shale boom.
Looking into 2021, it feels that we could be at the start of a multi-year bull market for crude with recovering global demand and supply growth struggling to keep up given the financial challenges of investing in growth within the oil patch. It is not unreasonable to see +$100 per barrel at some time in the next two to three years. The cure for low oil prices is lower oil prices.
What's your top commodity to be exposed to for the rest of 2020? What's your preferred exposure to this commodity?
COVID-19 precautions have prompted two of the largest and lowest cost uranium producers to further cut production. Add this to previous supply cuts caused by a decade of unsustainably low prices and currently ~50% of total monthly global mine supply is idled.
Cameco has since announced that Cigar Lake will stay offline indefinitely. The largest Western uranium miner is not mining any uranium and is being forced into the physical spot market to meet sales contract obligations. We cannot think of another market where this is the case.
Uranium is one of the only commodities where demand does not fall more than supply in a period of global financial upheaval. The market deficit has been previously filled by secondary supply and inventory draw, but secondary supply has been decreasing as demand for conversion and enrichment rises (the next steps in the uranium fuel cycle).
Estimated primary mine supply for 2020 could be as low as 115 million pounds versus an already low 135 million pounds in 2019. Annual demand expected to be around 195 million pounds. With 53 reactors under construction this will continue to increase as completed reactors connect to their respective grids.
Inventories are being drawn at the wrong point of the cycle - they should be accumulated at low prices. US utilities have less than two years of inventory, which has historically been their minimum preferred exposure.
Contract coverage - the percentage of demand that's covered by short, medium, or long-term contracts, and therefore doesn't need to be purchased in the spot market - is at low levels and still falling.
The uranium spot price continues to make highs not seen in over five years. Previous bull markets in 2007 and 2011 saw prices as high as $150 USD/lb and $70 USD/lb respectively. Even at five years highs of $33.50 USD/lb, prices are not enough to incentivise care and maintenance assets to come back online. The medium term incentive price is $45-50 USD/lb, even for Cameco’s McArthur River mine.
Mines not only require a higher price but will also require committed long term contracts form utilities in order to be able to attract the capital required to enter into production.
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There are two separate tanker markets. You have the dirty and the clean which is the crude and the product. Rates have reached all time highs for both, the dirty tanker rates are now dropping to still high but more sustainable rates while the product tanker market remains elevated. Im on the product tanker side of the bet through STNG, Scorpio tankers. Refineries are trying their best to continue to operate at high utilisation rates so product tankers are being used for storage too. The space is totally divided between bulls and bears, shorts have increased over the last week or two in many of the companies at a time when rates are at all time highs. The general thesis that I see from bears is that demand has plummeted, will remain subdued while production is being stopped, so less tankers needed to transport oil than usual. The bull side has a few aspects; 1. New tanker order book (tankers have a certain life after which they get scrapped, some companies wont use old tankers to transport oil due to contamination potential) is at all time lows due to tanker rates being low over the last few years and what is being built has been delayed due to virus restrictions leading to a tighter market. 2. Tankers normally being used for transport are being used for storage and so are taken out of the normal pool available due to over production and land storage likely to be full (to the extent that it can be) by next month. 3. That the proposed production cuts wont be enough to stem the overproduction any time soon meaning further tankers will be taken out of the transport pool. 4. There are examples of long term contracts (12-18 months) being locked in at high rates today by oil industry players, why do that if you expect tanker rates to drop in the coming months? The share prices of some of the product tankers are 50% off 52 week highs like STNG at circa $20. It hit a low of circa $13 during the big sell down in March. Many names releasing Q1 and showing Q2 guidance this coming week. The risk is skewed to the upside based on the above and other factors in what could be a sustained high rate environment.