Diversification and the early bird that catches the worm

Tuesday, 11th April 2017 08:42 - by David Harbage

The apparent escalation of geo-political hostility in the Middle East, and in Syria, Iraq and Egypt in particular, over the past few days has inevitably dominated the media headlines. Leaving aside the shocking images of the human suffering, prospective investors in real and risk assets will be wondering how the increase in US-Russian tensions – post the Americans’ air strike on a Syrian air base – will impact sentiment and valuations.

The price of gold, a non-paper currency perceived as a ‘safe haven’ in times of such conflict, and oil – in anticipation of a potential disruption to supply – rose on Friday, to US$1252 per ounce and $55 per barrel of Brent crude respectively, and are a little higher at the time of writing. Perhaps more surprisingly, the UK equity market shrugged off fears of a wider conflict involving the superpowers as the FTSE100 advanced 0.6% to close at 7,349.4. Dull domestic economic data (UK trade balance in March, along with the industrial & manufacturing production numbers for February) had kept sterling on the back foot – the most frequent prompt to the UK’s lead indicator of listed company worth these days. On the Middle East situation, or indeed terrorist atrocity closer to home, much is already ‘priced into the market’ and investors’ appetite for risk barely seemed to suffer. The US attack on the specific Syrian airbase - believed to have despatched chemical weapons used against its own people – will hopefully be seen as a one-off warning to stop such practice, rather than produce anything more.   

Investors looking to broaden their spread of assets by incorporating the likes of gold, oil or other commodities can do so by investing in a number of different ways. The actual product, an exchange traded fund (ETF) reflecting the commodity or in listed company shares which own the mineral. Typically the latter would be upstream resource firms, which are at the extracting & production – rather than refining or distribution – end of the business process.

One example of an ETF relevant to gold would be i shares Physical Gold ETF which is a direct investment into gold and whose performance would track the return of gold’s spot price. A US$ denominated 2.8bn fund, this ETF produces no income, has an annual cost (TER) of 0.25% and recent calendar year returns reflect investors preference for other assets: 2012 +5.4%, 2013 -27.8%, 2014 -0.4%, 2015 -11.6% and 2016 +8.9%. i shares’ commodity stable also features a US$73m Physical Silver ETF (TER 0.4%) with equivalent 2012-2016 period returns of +5.8%, -35.1%, -18.4%, -13.8% and +17.1% - alongside a US$12m Physical Platinum ETF and a $5m Physical Palladium ETF.

Without wishing to overly publicise Blackrock’s stable (the owner of i shares product range), they also offer an interesting Gold Producers ETF which has US$432m invested into gold producing companies. The TER rises to 0.55% per annum, reflecting the expense of monitoring and dealing in the current portfolio of 51 companies listed, (but not necessarily reflecting the place of primary operation) in: Canada 57%, USA 14%, Australia 13%, UK 7% and South Africa 6%. The underlying performance of these companies is considerably more volatile than the gold price itself – reflecting their gearing (both operational, as some become marginal producers, & financial): comparable 2012-2016 calendar returns: -14.1%, -52.2%, -12.9%, -21.7% and +53.6%.

Taking a look at the largest UK listed gold miner, the £6.8bn market capitalised, FTSE100 constituent Randgold Resources, whose operations are domiciled in several African countries, its shares have ranged between 5470p and 9715p over the past twelve months. The stock is undoubtedly highly priced by reference to its profits and that which it distributes to shareholders; although earning growth is likely to be circa 20% in 2017 and 2018, consensus forecast from brokers is EPS of 309p next year which equates to a PE of 24x, double the wider market’s average multiple, and a 2% dividend yield. With few liquid alternatives for such investment, the Sell side community are natural backers: currently 16 brokers say Buy, 6 suggest Hold and only 1 recommends a Sale.     

Based on the feedback received and Bulletin Board activity, many of our readers take a keen interest in the potential commodity producers of the future. Oil drillers and mineral explorers have long been viewed as the most speculative business segment in which to invest – prompting some to regard the overall stock market as a gamble – as some of these businesses have yet to progress to the point of production and revenue generation.

Two such companies in different stages of operational development made significant announcements today: one was Centamin a gold miner, whose prime asset is in Sukari, Egypt, announced production results for the first quarter of 2017. The FTSE250 index constituent reported a 20% downturn in production of 109k ounces, compared to the final three months of 2016, something which management had previously flagged as a temporal factor. Despite full year guidance of producing 540k ounces - at an ‘all-in’ cost of US$790 per ounce - being reiterated, this didn’t stop the shares slipping back 3% on the day to 179.5p. Nevertheless, at this price the miner remains very fully valued compared to the wider UK market, on a price-to-earnings multiple of 17 times the 10.3p forecast EPS for both 2017 & 2018. Paying out half of profits via a 5p dividend provides some comfort.

Centamin shares have rallied from the £1 level of a year ago, but any further progress for this very profitable producer will require a marked pick-up in the gold price. The latter would almost certainly be predicated in part on rising geo-political tensions in the Middle East which, ionically, could leave investors anxious about owning an asset which could be at risk of being sequestrated. Only for the brave perhaps, but the broking community are ‘holding their nerve’, remaining positive (10 Buyers, 2 Holders and 1 Seller) and ten major institutional investors own 3%+ stakes (ranging from Blackrock, with 15%, to Aberforth with 3%).

The other prospective natural resource miner to catch the writer’s attention today was the Alternative Investment Market (AIM) listed junior Bluejay Mining. This little-known (and not just because it changed its name last month from Finnaust Mining – to reflect its changing geographic emphasis), £100m market capitalised business provided a resource estimates for its prime titanium dioxide asset found on the beach and shallow waters of Pituffik in Greenland. The maiden estimate is highly encouraging - “exceeding expectations” in the words of CEO Roderick McIllree and “the highest grade mineral sand ilmenite project globally” - in terms of its assessment of the quantity and quality of the likely mineralisation from the black sand, itself increasingly exposed by global warming.

Testing one sixth of the 50 miles of beach which the company acquired in 2015, delivered an inferred resource of 23.6m tonnes at 8.8% ilmenite (which is the principle ore of titanium, whose use encompasses high performance alloys through to the dioxide use in white paint). Much purer than typical current extraction in China, and at relatively low cost (easily dredged), this project could progress to production in the second half of 2018. Slowing supply and rising demand has seen the price of ilmenite double over the past year to aid the immediate corporate business case. While Greenland may be perceived as more business-friendly than Egypt, its weather remains a critical hurdle and investors will be mindful that a further cash raising exercise could be required to make the project a reality. Today’s announcement pushed the shares on another 7% to 14.5p, double the level they began 2017.

Investors in equity would be sensible to diversify their assets in as many ways as can be deemed logical and beneficial. For the most part, this would feature a focus on industry leading companies - across a wide range of different business activities - with a proven track record of profit and dividend growth. In addition to considering whether to adopt a bias towards domestic or international stocks, economically-sensitive cyclicals or defensives, through to larger or smaller companies, some will want to diversify via exposure to investments which are asset-rich (such as those based in property) or in embryonic form, which may represent alternatives to mature businesses in their later stage development.

Besides junior stock exchange listed companies like Bluejay, investors might wish to investigate other early stage opportunities such as new technologies (often university-developed and partly owned), private equity or venture capital. Certain fund managers – often those ‘fishing’ in the universe of smaller companies – have strong reputations for identifying the successful firms of the future, including (where allowed by the terms of their Fund) private, unlisted firms.

As an example, Neil Woodford - whose prime expertise was in managing larger UK companies within income-oriented funds at Invesco - also endeavoured to include a ‘tail’ of non-profitable, or non-dividend paying, smaller companies within his £9.9bn Woodford Equity Income fund. Such assets include Purplebricks the, as yet, unprofitable online estate agency previously mentioned in this blog. Two years ago, Woodford Patient Capital was launched to better capture (without having to consider income) such businesses, and currently 46% of the £748m fund’s total worth is invested in companies which are not quoted on the stock exchange – a quarter of which are based overseas. By contrast with the UK equity market’s strong returns over the past year or so, the performance of Woodford’s new vehicle has been disappointingly flat - but the need for patience has no doubt been emphasised for such early development and inevitably higher risk-reward businesses.                           

Finally, as we have looked at ‘early birds’ that might prove beneficial to long term investors, Electra Private Equity investment trust merits a mention. More often in the news as having sold one of its businesses (rather than being named as a buyer of, often distressed, ones), the company has been involved in taking stakes in private or unlisted companies for over 40 years. Last Friday, Electra announced the sale of its remaining stake in the UK’s largest ten-pin bowling operator, Hollywood Bowl Group, and a nationwide operator of pre-school childcare Treetop Nurseries for £40m and £94m respectively.

The performance of this £963m FTSE250 constituent has been consistently good over the past five years, with its share price trebling from 1670p to 5110p last week – before going ex-dividend last Thursday via a monster £1bn (2612p per share) pay-out, to leave the shares closing at 2515p today. Essentially, the well-known activist investor CEO Edward Bramson has facilitated a raft of disposals over the past 12 months (including Parkdean Resorts for £405m last December) and built up a £1.4bn cash pile as a consequence. The plan is to carry out its next major strategic review in June (probably relinquishing its investment trust status later this year) and become a corporate investment vehicle.

Markets and the investment opportunity set never remains the same for long. All the best in your efforts to ‘hit the moving target’!