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Take a more diverse approach to playing the commodities game

Mining was the second best performing FTSE 350 sector in 2016 and is still in the top 10 so far this year. Improving commodity prices, stronger balance sheets and more lean mining operations have all contributed to share price success.

Anyone who wants exposure to the sector without the individual country risk should look at the wide range of investment trusts that invest in miners. You should be able to get diversified exposure to numerous companies via a single product.

Some natural resources-themed investment trusts even have stakes in oil and gas firms, particularly if they have a broad commodities remit. One example is BlackRock Commodities Income Investment Trust (BRCI) whose portfolio includes Royal Dutch Shell (RDSB).

BRCI - Comparison Line Chart (Rebased to first)

The product’s co-fund manager Tom Holl says many commodities are seeing an improvement in the balance between supply and demand. Some commodities, such as zinc, are even forecast to move into meaningful deficit.

‘This should be supportive for prices and the lack of capital investment in new projects means that the supply side should remain tight, at least in the next year or two,’ says Holl, who runs the investment trust alongside Olivia Markham.

‘Some of the bulk commodities performed exceptionally well in 2016 and could fall from their highs if speculative activity in China does reverse strongly but we think they would still settle at prices above those forecast at the start of 2016 as the underlying fundamentals
have improved.

‘There is the risk that an economic shock in China could derail the mining recovery but, as we have seen early in 2016, the authorities in China have levers which they are not afraid to pull to avoid a hard-landing scenario.’

Valuation opportunity

Holl says natural resource companies are in a stronger financial position than a year ago, particularly on the mining side, and are still valued at a discount to the wider equity market.

‘If management teams remain disciplined in their capital allocation and do not make the same mistakes they made in the post financial crisis upcycle then the sector is well positioned to deliver for investors.’

Holl’s associate Markham also co-manages BlackRock World Mining (BRWM) alongside Evy Hambro. The trust reported a 92.9% surge in net asset value per share to 383.98p for calendar year 2016, during which its shares doubled in price.

Hambro and Markham focus on quality companies with strong balance sheets, while eschewing miners with higher debt levels and lower quality reserves.

During 2016, shares in key copper holding First Quantum raced ahead, while the improving nickel price buoyed Norilsk Nickel in the second half of the year.

Also boosting performance was silver miner Fresnillo (FRES) and an exposure to the rallying iron ore price through Vale, BHP Billiton (BLT) and Rio Tinto.

Inv trusts table

Dividend rollercoaster

One significant disappointment was the cut in the total dividend from 21p to 13p, reflecting previous commodity price falls which forced a number of portfolio holdings to cut or cancel dividends.

‘Dividends are expected to grow in 2017 as companies either increase the amounts paid out or return to paying them after having been forced to cancel them in the downturn,’ explain Hambro and Markham. ‘In addition, we see room for other companies to return surplus cash by either paying special dividends or starting share buyback programmes.’

The gold nuggets isolated on white

Further options

Other ways to ride the resources rally include Riverstone Energy (RSE) which invests exclusively in the global energy industry. It has a focus on the exploration, production and midstream sectors.

Languishing on a discount of 21.7% is Baker Steel Resources Trust (BSRT), which predominantly invests in attractively valued pre-IPO opportunities, but also backs listed companies where it spots pricing anomalies.

Run by New City Investment Managers is the City Natural Resources High Yield Trust (CYN), trading at a 17% discount and offering a 4.1% dividend yield. It has exposure to gold, oil and gas, nickel and uranium, as well as recent strong base metal performers zinc and lead.

Portfolio holdings ranging from Trevali Mining and First Quantum Minerals to Central Asia Metals (CAML:AIM) and Americas Silver.

Brighter outlook

New City also manages Golden Prospect Precious Metals (GPM), currently on a material 15.5% discount to net asset value; as well as running Geiger Counter (GCL) which invests in uranium explorers and producers.

Interestingly, in the latest Geiger Counter fund commentary, the fund managers flag a fundamental turn in the fortunes of the uranium sector in January 2017, following the announcement that one of the world’s biggest uranium producers would cut output by 10% this year.

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