“The risk/reward status of these companies is simply too good to ignore. This is when you should be buying these equities, when there is blood on the streets.”
You can hear the frustration in WS Amati Strategic Metals co-manager Georges Lequime’s voice when he gives his assessment of the commodities market in recent times. Barring a few of the big players – think of the likes of Rio Tinto and BHP – 2023 was something of an annus horribilis across the sector, particularly precious metals and battery metals – although it should be noted that gold and silver have held up relatively well.
Last year saw a confluence of factors hit the sector. Weakness in China’s key commodity-consuming sectors – such as property and infrastructure – has seen a drag on demand for commodities; the US infrastructure bill was effectively kicked down the road; while Europe also struggled. Lequime says all these regions de-stocked on commodities with them all arguably “sleepwalking through a recession without it effectively being called such”.
The impact on the fund has been marked – it does not invest in those handful of big players who have managed to hold up well (see chart below). Lequime says the disparity in valuations between the developers, the juniors and mid-tiers with the very large/liquid companies is so wide now. He says: “The big guys look expensive and are focused on the defensive. We have nothing to do with them in the portfolio – there is nothing we can add, it is all to do with development risk.”
This fund is all about long-term risk/reward. It is a high conviction portfolio with an investment process driven both by bottom-up analysis and the prevailing macroeconomic environment. The skill of Lequime, and co-manager Mark Smith, is to tap into medium to smaller-sized mining firms that can meaningfully grow the value of their business through exploration success and the de-risking of the project build. To understand the long-term benefits you only have to remember that 190 countries agreed to a legally-binding international treaty to reduce their greenhouse gas emissions to ‘net zero’ by around 2050. You will need a huge increase in precious metals to meet the growing need for solar and wind power.
Today’s challenges could soon be opportunities
The team have made some punchy bets which have also hit performance. This includes holding 26 per cent in lithium (vs. 1.7 per cent for the benchmark)*. Following a strong run, the team expected lithium prices to fall back to a more sustainable level in 2023 but what surprised them was the scale of de-stocking in China, where they believe inventory levels have dropped from 85 per cent to around 10-12 per cent**. A move which has pushed lithium prices well below the prices they believe are necessary to ensure adequate supply into the future.
Lequime points to positions in Sigma Lithium, Atlantic Lithium and Latin Resources as examples of firms which he believes are low cost, best in class in their field and will survive any downturn. He expects positive newsflow for all of these companies in the coming months.
Atlantic Lithium for example, was bid for at 33p in October/November 2023 by Assore Holdings – which already holds 28 per cent of the business. This was rejected, by the board and the management duo (they feel it is worth closer to 70-80p)***.
Lequime says the plans for the development project work, adding that spodumene (a commercially important source of lithium) has an all in production cost of about $417 per tonne***. Spodumene prices have come down but are still significantly above these levels.
He says: “The challenge in general is any company with a development project, which needs funding, has been priced right out of the market. Investors don’t want to know any company – no matter how good it is – if it needs funding.”
“We’ve probably hit a basement price on lithium. Talking to US companies they still believe the incentive price for lithium projects is still 25 per cent higher than what they see at the moment.”
But it’s not only lithium, graphite and nickel are in the same boat – with the latter falling 40 per cent in 2023**. It should be noted that Indonesia and the Philippines have supplied the market with pollutive nickel, with consumers not willing to pay a premium for responsibly-sourced metal at this point**.
Lequime says the fund has three positions in high class nickel companies, including Talon Metals, which been given a grant (not a loan) by the US Department of Energy for US$114m and the US Department of Defense for US$20.6 million to support and accelerate Talon’s exploration efforts***.
He says: “This was after five years of reviewing the business plan. The plan is completely on track, but the stock has come back so much that it is trading below the value of the grants. They even have an agreement with Tesla for their nickel from 2028 onwards. The value of the project is close to $1bn, the market cap is around $130m – these are stupid values.”
Gold and silver are particularly rate cut reliant
In addition to the aforementioned battery metals, precious metals like gold and silver have also had their challenges. Gold and silver equities rallied at the end of 2023, before falling back this year, courtesy of a change in sentiment towards the first rate cut. Lequime says recent results for the precious metals sector have been mixed but not disappointing, however he adds that shares are currently discounting the gold price some $500-600/oz below spot**.
He says: “Companies are trading at attractive yields with rock bottom valuations. We’re also encouraged and confused because we’ve seen the gold price above $2,000 an ounce for the past couple of months, yet brokers and institutions are still seeing sales of gold ETFs.
“With the Magnificent Seven doing so well no one sees the need to get their head around this, until we start seeing interest rate cuts. This is why the market has gone risk off on precious metals in the past couple of months.”
Lequime believes opportunities are not far away with precious metals waiting on interest rates, while many battery metals are at the point where many operations are being shut because these metals are below their incentive prices. It was the same case with uranium, where demand was rising and supply was flat. The team eventually built a 6-7 per cent position in uranium through names like Cameco and UEC, making a 65 per cent return on both names before selling off ahead of an anticipated pullback in prices in 2024***.
Lequime says there is optimism of some kind of stimulus package coming through in China, while we are in a US election year where he believes some type of stimulus package will come through, and there is also hope Europe will pick up.
He says: “We feel the destocking of commodities has come to an end now. Demand is creeping up and supply has been curtailed. We have great companies with strong balance sheets and low valuations. When the market comes back it comes back hard – we could see 20-30 per cent in a single day.”
It has been a difficult period for this fund, but this should not come as any surprise for those who understand the segment of the market it invests in. It has a significant mega-trend behind it, which will not go away – precious metals are integral to future global growth. It remains a strong diversifier for any long-term investor.
*Source: fund factsheet, 31 December 2023
**Source: Amati Global Investors, 9 February 2024
***Source: Amati Global Investors, February 2024
Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. Juliet’s views are her own and do not constitute financial advice.
