Gaining exposure to a commodity with a strong outlook is only half the challenge
There can be a general misconception that buying a resources company is, in the main, buying direct exposure to the price of the resource it mines or produces.
This is sometimes true. Last year, almost every lithium company benefitted from skyrocketing lithium demand.
But if that was the whole game, we'd all just buy the commodity itself, or maybe some futures contracts, and call it a day.
In an ideal scenario, investors can gain exposure to a soaring commodity price and add some alpha on top of that by gaining said exposure through a well-run company.
It's here where the skill and experience of today's guest comes into play.
Daniel Sullivan is head of global natural resources and a portfolio manager at Janus Henderson Investors. He initially cut his teeth as a mining engineer, so has the know-how to understand the space - which can get pretty technical, to say the least.
"The great thing about investing for alpha is that it can be done all the way through a commodity cycle," says Sullivan.
"There are all these mechanisms through leverage, M&A, growth path, all those types of things that companies can and do outperform their underlying commodities."
0:30 - Understanding markets
1:15 - Company visits
2:30 - Filtering companies
3:50 - Local vs global
4:50 - Energy transition
7:00 - Legacy energy
9:40 - Generating alpha
11:30 - High conviction positions
13:30 - Lithium
21:30 - Importance of diversification
This transcript has been edited for length and clarity
How did you come to understand markets the way you do?
I've been at it for over 30 years now. I commenced training as a mining engineer and did a bit of fieldwork. And some of that was in Tasmania, and so I got my first taste of renewables and the tension between resource development and making money as well, out of the natural resources countries have. It was good grounding, but then I came back to the big city. I didn't know a lot about finance and I did the rounds all around here, up and down the streets, and knocked on 30 doors. My dad worked at the RBA, so I got his phone list of bankers in Sydney and I found myself a job at the AMP Society. So, that's how I got started in it, and that was as a mining analyst.
Those early years were very heavily focused on lots and lots of trips. I think I went to Asia, seven years in a row when China was first becoming topical. We started in Japan, but in the end, I saw so many steel mills in Asia, I never wanted to go again! But it's always interesting. There's always something new, so fieldwork is a good part of the job.
How important is it to actually go out and meet these companies and see these operations?
It's super critical. You'll know in corporate history in Australia, there's been a couple of cases where people literally didn't have the assets. So they've lied, and that's not just in mining, but other assets as well. There's that very simple due diligence level, like, "Does what they say they have actually exist?" And then beyond that it gets more nuanced, understanding the complexity of the geology of that deposit, "Is it likely to be able to grow much faster and be bigger?" "How expensive will it be to mine the material, to process the rock?" So there are probably at least 20 things that need to work to make a mineral deposit economic. And all of those questions need to be answered, as those deposits are being found and developed up.
How do you filter down new companies and identify opportunities?
I've got a strong quality bias, and that stems from being the markets for 30+ years and going through quite a few down cycles. We probably have a down cycle, every five to seven years, and they can be fairly brutal and it shakes a lot of investors out.
Over time, you can either leave the sector, which a lot of industrial-type fund managers do and just find it too hard, or you can work ways to diversify yourself in-sector. What we did 10 years ago in setting up our Janus Henderson Global Natural Resources Fund was add agriculture. It is one of the major things that makes this a different type of offering. And also, it's global. We get access to probably well over 10 times the number of companies, and the types of companies are much more diverse. Agriculture's been a really good choice in the last decade - it's been the best performer and the lowest volatility of the mining, energy, and agriculture sectors.
Resources are such a staple in the Australian market. What's your mix between local assets and global assets, and why?
We have a team of five. Three of us live here in Australia. We've got another PM in London, and another analyst in Singapore. Living here and having access to so many assets and people, you naturally have an Australian bias. It's probably only a modest part of the global benchmark, somewhere between 5 and 10%, and we probably tend to run at double that because we've got so much good access to information. The other thing is, whilst the global scene is much bigger, in the mining segment Australia is very significant. There are two big engine rooms of global mining entrepreneurial activity, and that's Australia and Canada. Or to be more specific Vancouver and Perth. We're lucky as not only do we have a big country with lots of rocks, but we've got a bunch of guys and girls in Perth who put their minds to it and are constantly creating new types of companies and new opportunities. That's been a really good thing for us.
What's your view on the energy transition and how to gain exposure to it?
We got to this actually through climate change. I mentioned renewables way back in the dark ages of my career, and there's always been a tension between ownership and outcomes. And another huge one in my career was the Mabo Case and land rights for Indigenous people across assets. And these things used to happen, I'm going to say, once every 5 or 10 years, you get this landmark decision and it was important. And now, what we've seen in the last five years is we're probably getting these landmark-type outcomes at least every month. It's becoming a very, very exciting and interesting space. And when we first contemplated, "How does climate change impact this offering with these types of companies?" I guess we thought about it as a negative initially, like, "This is all trouble. It's going to be bad."
The more we delved into it, we realised that actually, this is going to become a positive. The massive thing is to get rid of petroleum from the global economy or reduce it, and coal, to get rid of CO2 emissions, and replace it with something else that works. And so electrifying the economy through renewable energy and getting transport mostly electric, are very related things and they'll talk to each other. And they're very resource-intensive, away from energy and into metal. And so that's a big part of the Fund where we see growth. Copper, lithium, of course, nickel, cobalt, graphite - there are all these different materials that are in the current generation of batteries that are dominating world production, and that's a very exciting space for us. We're pretty happy that the world's changed, and it's actually changed in a very, very favourable way for our space.
Legacy energy will be needed to facilitate the energy transition. And presumably, before the curtain falls prices will really skyrocket. How do you keep a foot in that camp whilst also being invested for the future?
It's really interesting and it is very complex. And you're one of the few people who talk about energy prices skyrocketing, because most people think, "Oh, we just get rid of it and it goes away, and this has no consequence." But I agree with you. As we shrink this market size, if we choose to have less and less of it, we can probably expect prices to be more volatile. It's an absolutely enormous market and it's already reasonably volatile, the oil price globally. If we keep putting pressure on it and shrinking it and withdrawing capital from it, I think we will see higher volatility and that's good for an investor. We had a really good period of investing three years ago when the oil price was $20 or less. And oil shares were being sold very, very cheaply, so that was very good for the Fund.
This much higher elevated price is more difficult. We tend to be moderately neutral on commodities. We think they've got long-range prices that are related to their cost of production, plus a margin. And so when oil's at $20, you can be convinced it's got to get to $50. And when it's $150, you're pretty sure it's not going to stay there for very long. So that's how we think about it. Oil and gas are in the Fund, and they have their role to play. And within the individual companies, we're seeing that they are all participating in these thoughts towards net zero. Their main problem is that's their only product. So it's a big, big amount of work to be done, and we're seeing all different ways of achieving that outcome.
So BHP (ASX: BHP) gave theirs to their shareholders via Woodside disbursement. We're seeing a company like Repsol which sold a quarter of their EMP off to another party. So, some are leaving and some are adjusting. I guess at the progressive end for me, there's a company called Hess that's made fantastic world-beating discoveries offshore Guyana in South America, and they've just done a voluntary programme to give the government of Guyana three-quarters of a billion dollars to help the country maintain or achieve their carbon-neutral status as all this oil production comes on. So it's a little bit convoluted, but you can see they believe in it and they're keen to do their part, even though they're an oil company.
Much of the conversation around investing in resources is around the beta. How do you think about achieving alpha from your investments?
To cover the beta side, we manage our risk by thinking about the ranges that commodities trade in and then diversifying. So we'll try to have the Fund in at least those three big mining, energy, and agriculture areas. But across the Fund, we might be looking for upwards of 20 different commodities to have good diversification. And we know some of them can move very fast, and we want to participate in that if that happens, like silver or uranium or some of these smaller materials. In terms of day-to-day, what can a company do that a commodity can't? At its very simplest, a commodity's a static piece of stuff and a company's run by intelligent individuals, right? So that's your first thing. You got smart people who can do something. They can have a bit of leverage. And most companies have a little bit of leverage, so there's a win there.
They can think strategically about whether they want to grow or shrink, and do they want to take over a competitor. They can be smart enough to know that when oil's $20, hey, they should buy people because it's going to go to $100. And so there's all these mechanisms through leverage, M&A, growth path, all those types of things that companies can and do outperform their underlying commodities. And you see it, when you have a bad down cycle, and particularly the North Americans, they really talk about, "Let's use this. We're going to use this down cycle to transform our company." And that's not what you usually hear people saying when things are going poorly, but that's when they go and buy their competitors.
Describe some high-conviction positions in the Fund, and why do they deserve a place in the Fund in 2023?
Let's lead with the metals. As you said, a really exciting area. We all invested through the China supercycle, which was a fantastic time. China moved around a quarter of a billion people from rural to city and built a lot of cities at a phenomenal rate, and that really pushed hard on all resources. And amongst that, they've become the world's manufacturer. And so China ended up consuming 40% to 50% of nearly all commodities on the earth, which used to be the role of America. When I started in the '90s, they were mostly manufacturing, and they were probably consuming 40% of everything. So China took that role on, and that was an amazing boom. And the natural resource space outperformed world equities for about eight years in a row. And some of those very significantly, by 20%.
So in this period right now, we've just had that type of magnitude out-performance of resources over general equities, around 20%. And whereas China’s supercycle was driven by a quarter of a billion or half a billion people, the growth engine that we see now is a global population of 8 billion people, with 2 to 3 billion coming in the next decade, who have collectively decided that we're going to get rid of oil and coal out of the fuel system.
So you saw what happened to commodities when China moved half a billion people. We're now saying, "Oh, we're going to move 10 billion+ off coal and oil and into electric vehicles and onto electricity generated by renewable energy." It's staggeringly large, right? And we've never seen anything like this in our careers. Usually, a miner finds something and has to scratch around for five years, trying to get people to fund them and get help. Now, if you find anything that's viable, you're getting funding reaching right down from governmental or a major corporation-level customer, straight to your project. It's a very exciting time. We have had five years where a lot of capital that should have been deployed wasn't, as companies got very cautious from the last downturn - it's actually quite tight conditions. So, the outcomes are that we've seen lithium quadruple and it's very exciting. And it's proliferating a massive number of new companies, so that's fantastic for us.
Is lithium a crowded trade?
It's very, very popular because it's been such a winner. So whenever underlying commodities are driven so high, I guess we start to think about, "Well, how do we approach the prospect that maybe that commodity may now halve?" And they're big numbers. So lithium might have been 7,000 a tonne to 70,000. So no one really thinks it should be 70 for very long, but does it go to 50 or 30, or back to 70, right? So it's a big, big problem to think about. So again, we resolve that through diversification across the whole fund and diversification across the names. And some of the best ways of making money is through new project discovery, execution, and genuine growth of something new, rather than just buying the more beta name of the sector. So we do a bit of that as well, to try and moderate that risk.
But yeah, so lithium's very good. Possibly a bit hot at the moment. Nickel's very good. It is actually at quite a high price, but the market doesn't think about it much because the access to nickel equities is quite limited. So nickel's held by all sorts of different governmental and ex-government bodies and in large cap companies, and you don't really sense that the nickel means anything. But we do feel we need a lot more of it. Indonesia's ramping up to generate a lot more of it, but I think it'll all get absorbed and it's a powerful place to be invested in. Cobalt's had its heydays on and off. A lot of it comes from the Congo. And again, a lot of it's embedded in copper companies and other companies. So it's hard to find pure plays in that way, so we talk about it a bit less. And copper's the big one. In electrifying everything, we need a lot more copper, and that's on both sides of the renewable energy and the EVs for the copper wiring. And so copper's interesting. It's a very big metal market and it's the bellwether of the global economy. It's telling us now we're all excited and happy again. So it sat at $4.50 for a fair while, and then fell away last year with all the interest rate rises and disruptions. And dropped to about $3.50, and now it's rallied back very, very quickly, giving us a powerful signal. And so that's very, very positive. Our feeling is copper does have to have one of these step changes and this isn't it. This is a starter, but we do think the way the demand growth rates, and some of these rates are 10 times for certain items, offshore wind power, had been a small thing, but it's going to be an enormous thing globally. And copper and steel are the mainstays of that type of activity. Another great area in the Fund is gold, and we own gold for a variety of reasons. It's quite diversifying in the Fund. There's plenty of gold on-ground, in central bank and vaults. Except for Australia, because we sold ours. But it's a very favourable commodity in terms of protecting yourself from a severe downside. So lots of very populous and important countries in the world have had currency downside events of 65 to 95% in the last 10 years.
And for them to have had gold in a portfolio would've been really very significant and positive. So that's important, but the thing that we really like about the gold is these companies can have the best cycle time for generating real wealth. So with the smallest amount of upfront exploration capital and modest developmental costs, they can bring a brand new asset to the market and make really high returns. So payback periods in a gold mine, a good one might only be two to three years, versus a, say, big energy project payback might be 15 or even 20 years. And these gold miners, yeah, they can generate very high net present values or return on capital numbers from scratch. So a good example of that's De Grey up in the northwest of Western Australia. So, something that basically didn't exist a few years ago. They've been drilling and found 10 million ounces of gold, and it's under planning and preparation to become a major low-cost gold mine. So that's a really good way for the Fund to make money. So we tend to run gold between 5 and 15% of the Fund, sometimes 20, and it's a very important part for us.
Agriculture's the other big area. It's a bit hard to get your head around it, because it's all sorts of different things. But at its heart for us, mining is still a major part. So potash in Canada, it's a mining activity. You saw BHP a few years ago try to buy PotashCorp in Saskatchewan. They failed. That went into an American company that's now called Nutrien, and they were a bit early. After the supercycle of China, potash was all the big rage and the big thing. And BHP spent all their money now to build a mine, which people thought was not going to make a profit. And lo and behold, after a very long bear market, potash has doubled or tripled and suddenly BHP looks smart. And they'll make some money on that, good money, but more importantly, Nutrien, who acquired PotashCorp at the low of the cycle, and again this is the strategic thinking of a mining company, they had one shot in 15 years to get that company and they got it. And it looked boring, right? It's taken six or seven years to get the payback. And now they're like, "Guess what? We've got 6 million tonnes of pre-built, ready-to-go potash capacity, and it's all coming to market." So they're in a multi-year now ramp-up phase to deliver, and that'll be massively profitable for them to get to full capacity. So that's one of the good Agriculture stories at the moment.
Take us through some of the positions that didn't work out in 2022.
Yeah, timing's always the tricky thing, and there's so much information flow. Not just at the macro level, but single companies as well. And companies are always transforming and changing. So we're growthy people, but we want to pay value prices. So there's that interaction and interplay. We don't want to just buy the highest, brightest shining light. That's generally not the right thing to do. But equally, if you're just buying a company that's just producing out a known asset to the end of its life, that's also pretty boring and unlikely to have significant upside for investors, right? So it's that mixture in-between. So one of the companies that was tough but has actually come good very recently is Sandfire (ASX: SFR). It was a smaller copper producer. Their asset in Australia was very good, but was nearing the end of its life. And so they wisely started their transformation and bought a copper developer in Botswana.
And again, the market thought, "Oh, Africa, is that you or not you? Do we like it or not like it?" So it traded very, very cheaply on a PE, cash-in-hand basis. And then that's a good thing they did, but then they've done the very large thing and bought a very large copper complex in Spain. And again, the market suffers. They take a while, "What is it? Why was it sold? Why did they buy it? Did they pay too much?" And so Sandfire traded very, very cheap. And so that was costing us over the last year, but with this subsequent rally with copper getting back on its feet, $3.50 into the fours now, Sandfire's had a great rerating and it's doubled in the last three months. The mining side's been very strong in the last three months, up around 35%. And single names, some of them up 100%. So, that's a good sort of picture of what can happen. And things move very, very quickly, and we'll be looking for, "What's the next unloved, good value, good catalyst to come? Where can we put the money and hope for that type of activity to happen again?"
What piece of advice would you give investors who are looking to gain some exposure?
Having done it for 30 years, I've talked about some of them. So we've diversified by bringing in the agriculture and not being fully reliant on just the mining side. And I'd certainly say for most people, it's not the right place to be, just to own just lithium or just copper or just timber. They're all good in their time, but they're all going to have tough periods as well. They're too narrow a space. So by trying to have at least these three big things working for investors, but within that, extra options as well, we think that's a good position to be in. We want people to be happy to be in this exposure for a long time and not think they have to keep tactically timing in and out. The history says that's a very hard thing to do, and most people don't get it right. We think the setup's so strong, the risk here is if you don't have any at all and we have either a supercycle or something that's better than that, you will feel you've missed out. And we think it's important for people to get that the world's changed a lot and that the whole funding into a resource company is changing and has changed, and it's a good place to be.
Learn more about the future of resources
Daniel and his team invest in high-quality mining, energy and agriculture companies with the flexibility to invest across the supply chain, taking advantage of price shifts between upstream and downstream sectors and across industries. For further information, please visit the fund profile below.
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David is a content editor at Livewire Markets. He currently hosts The Rules of Investing, a half hour podcast where he sits down with leading experts across equities, fixed income and macro.
David is a content editor at Livewire Markets. He currently hosts The Rules of Investing, a half hour podcast where he sits down with leading experts across equities, fixed income and macro.
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