James Govan, co-investment manager of Baring Global Resources Fund and Baring Global Agriculture Fund, says the investment case for global resources remains intact as demand will continue to be driven by industrialisation and urbanisation in fast-growing emerging markets.
Sustainable worldwide demand and inadequacy of supply, as well as increasing economic wealth, will support agricultural markets over the long term, Govan told a media briefing during a visit to Hong Kong earlier this week.
“A number of commodities have constraints to bringing on more production as resources companies are increasingly having to exploit technically and geologically challenging deposits in more politically challenging geographies,” Govan said. The supply-side is under pressure to meet the demand from emerging markets.
Baring Global Resources Fund and Baring Global Agriculture Fund were launched in December 1994 and January 2009, respectively. At the end of July 2011, the resources fund had $968 million in assets under management and the agriculture fund had just over $265 million.
“Valuations have become attractive amid the recent market sell-off,” said Govan.
Barings favours commodities with supply constraints and where China, in particular, is structurally in deficit.
“Demand for base metals in China is also likely to see a marked increase as a result of its central government targets to construct eight million units of affordable housing in 2012. Our current exposure is therefore focused on copper, iron ore and coking coal, which are areas of the market where we deem fundamentals are the strongest,” he added.
However, the Barings Global Resources Fund is underweight base metal companies in general because of a current glut of steel. Govan also warned that there is downside risk to the oil price, with production likely to pick up in the second half. Barings recently reduced its oil exposure.
On the other hand, “uncertainty in the current economic environment, negative real interest rates, as well as a structurally weaker US dollar provides strong support for precious metals such as gold, which are seen as safe haven investments”, he said. Barings’ Global Resources Fund is overweight companies mining precious metals.
The outlook for soft commodities is highly positive, too. Structural long-term demand for agriculture is being driven by “food, feed and fuel”, particularly in emerging markets, and represents a secular shift, added Govan.
In terms of sector allocation, Barings is positioned towards the upstream sectors such as agrochemicals and agricultural machinery companies, as it believes crop prices are likely to remain high, providing a strong environment for these enterprises.
“The rising price environment for grains has improved farmers’ profitability, which benefits upstream sectors with farmers incentivised to maximise production through applying optimum levels of fertiliser and using the best seeds,” said Govan. ”Farmers have also been using their strong financial position in terms of profitability and balance sheets to purchase agricultural machinery.
“Soft commodity prices should be well supported as global grain inventories relative to consumption remain low from a historical perspective. Moreover, elevated food prices are needed to encourage investment to boost supply, and this should also lead to a strong environment for agricultural products and services over the long term.”
Of course, the immediate outlook for commodity-based stocks depends more on the direction of equity markets, rather than the prices of commodities themselves. As Govan reminded his audience, companies’ stocks have “de-linked” from the crops and resources they produce or excavate. But Barings is sanguine.
Although Govan conceded that the risk of a “double dip” has increased, Barings maintains that the world is entering a period of weaker global growth rather than an outright recession. If the economic outlook in the US deteriorates significantly, the likelihood of a third round of quantitative easing will rise, especially with few fiscal levers available to policymakers.
“A resumption of the US Federal Reserve’s asset purchase scheme would be very positive for real assets such as commodities, with resources-related equities benefitting as a result,” said Govan.
Other positive indicators, including the economic rebound in Japan after the earthquake in March, are also starting to arise, apparently, and inflationary pressures in China are beginning to ease following a series of rate rises by the central bank.
“This development should give support to the asset class as the Chinese demand for commodities picks up, subsequent to a temporary policy-induced lull,” he concluded.