Valuations of natural resources stocks have never been cheaper, according to Neil Gregson (pictured), manager of the JPM Natural Resources fund, who believes the worst is over for the out-of favour sector. The £970m fund has fallen more than 50 per cent since the beginning of 2011, even more than the HSBC Global Gold, Mining & Energy index, which is down around 35 per cent.
Waning Chinese growth and demand is regarded as one of the principal reasons for this underperformance, but Gregson believes the tide could change for natural resources, which makes a compelling case for the sector given how low valuations have gone.
"History doesn’t always repeat itself but looking back at the sector over the last 20-odd years since I started investing, this is the longest period of underperformance I’ve seen," he explained.
"We’ve had a couple of instances when natural resources underperformed for two years including back in 1997 and 1998, but not this long."
Performance of fund vs indices over 3yrs
Source: FE Analytics
"It’s the cheapest I’ve seen the sector as well. Back in the 1990s we saw Rio Tinto trading between 12 and 23x and it has a historical average now of 15 or 16. When you see it is now trading on 7 or 8x, you can see things have got very cheap."
"Only in 2010 [exploration and production] stocks were on a premium to probable reserves. Now they’re on a decent discount."
"A combination of better global news – particularly in China – a significant period of underperformance, cheap valuations and extremely low sentiment makes for a compelling case."
"There are a lot of reasons to be more positive here, and not as many for being negative. In the ‘why not?’ camp, if you’re very bearish on China then there’s little to see why you’d be buying commodities," he added.
Gregson admits China is unlikely to see the kind of growth it experienced in the early 2000s, but thinks even slower expansion will provide significant support to the natural resources sector.
"If you look at somewhere like Korea and Japan, if China gets halfway to where they are now then you’re talking about a huge amount of consumption taking place," he explained.
Gregson points out that natural resources have experienced a significant uptick in performance in the last month or so, which could be a precursor to a longer term recovery.
"I believe we’re past the worse and have seen the bottom," he added.
Performance of fund and indices over 3 months
Source: FE Analytics
Like Gregson, ETF Securities’ Martin Arnold believes the negative sentiment towards China has gone too far, which bodes well for the commodities sector in general.
"Industrial metals are heavily dependent on the outlook for Chinese growth," he explained. "China accounts for around 40 per cent of global demand across the industrial metal complex, but concerns over a China slowdown are exaggerated in our opinion."
"The industrialisation process of China is still at an early stage, and as such, when a massive population is combined with increasing incomes, demand for raw materials, and industrial metals in particular, is likely to continue at a robust rate."
"On the supply side, concerns over labour stoppages and declining ore grades are prevalent and raise the cost of metal mining production."
Arnold believes the outlook for copper is particularly attractive, as it has a wide range of industrial applications, from construction to the auto sector. He is also optimistic about lead's prospects, but less so about nickel's.
Gregson says that the outlook for gold equities is less clear-cut however, as structural challenges have led to a general de-rating of the sector. This is reflected by the fund’s 14.9 per cent weighting to gold mining shares – the lowest level it has been for more than a decade.
He explains that gold equities have historically traded on a premium to the wider equity market because they represented the natural way for investors to get exposure to bullion. However, as a result of the rise of gold ETFs, he says they have experienced a natural de-rating.
"They’re now priced like any other equity," he explained. "I don’t think we will see a return to premium status again, unless something extreme happened like the gold ETF industry taking a turn."
The manager believes there is still value in some gold miners and that the de-rating sequence could soon come to an end.
In the shorter term he thinks the gold price will remain under pressure as a result of a stronger dollar and question marks over the future of quantitative easing. As a result, he says he is targeting gold miners that have a low cost of production.
In general, JPM Natural Resources is equally split between gold miners, base metal stocks, and oil and gas stocks. Gregson currently has exactly a third of the portfolio in oil stocks but nothing at all in the gas sector.
He tends to target small and mid cap stocks, where he sees more potential for long-term growth.
The fund has a stellar absolute and relative long-term track record, with returns exceeding 550 per cent over a 15-year period. For much of this time Ian Henderson headed up the fund – Gregson took over as lead manager in January 2012, following a short stint as a deputy.
Performance of fund and index over 15yrs
Source: FE Analytics
However, the poor performance of JPM Natural Resources and the sector in general has led many investors to question its place in their portfolio.
Our data shows that the fund has shrunk from a high of £2.9bn in early 2011 to just under £1bn today. Much of the shrinkage has been because of the losses sustained by the fund, but there has also been a lot in the way of outflows: FE data shows that a little under £300m of investors’ money has been pulled out in the last year alone.
Neil Shillito, director of SG Wealth Management, believes now could be a good time for investors to put money back in the fund – as long as they have a long-term time horizon.
"The manager has been around for a long time and has been there and done it," said Shillito. "I don’t think you can really blame him for the performance, given what’s happened to the mining sector."
"After speaking to another manager recently – First State’s Joanna Warner – who also has immense knowledge and experience in the field, it’s important to remember that the mining sector is extremely cyclical and can go through long bouts of underperformance."
"If you’re in it for the long game then now could be as good a time as any to invest, given where valuations are. It could take a while for the market to come back, but long-term it looks like a decent bet."
Shillito says a regular savings plan may be of interest to investors, as it allows them to capture even cheaper valuations if the market continues to tumble.
Mark Dampier, head of research at Hargreaves Lansdown, agrees that there is a strong case for picking a fund like JPM Natural Resources at this point, and welcomes the conviction with which Gregson talks about valuations.
However, in general he thinks specialist managers do not speak out enough about their sectors.
"People tend to buy these kinds of funds at the wrong time, so it makes sense to buy at this kind of time. It’s far better than buying after it’s gone up by however many per cent," he said.
"These kinds of funds either tend to be at the bottom or top of the performance tables, which is why you can’t hold them for the short-term. Just because it’s cheap doesn’t mean it will keep going down though – momentum is a very powerful thing when the market is both going up and down, and often it takes a lot longer than people think to turn."
"What does annoy me is that the fund managers don’t come out and say more about it. If I was being called up about these valuations then I’d be more interested in these funds, but I’m not hearing it at the moment."
"It’s also frustrating you don’t hear from these managers when they think valuations are expensive. It’s quite typical of specialist fund managers," he added.
JPM Natural Resources requires a minimum investment of £1,000 and has ongoing charges of 1.68 per cent. It is available across all major platforms.
