Hexam Capital was formed mid 2006 by a team of like minded professionals who used to head up the emerging markets desk at Barings Asset Management. The Hexam boutique was made possible via a joint venture with Resolution Asset Management where Resolution provide the specialist managers with seed capital and back office infastructure enabling Hexam to purely focus on running money.
Q. The Emerging B.R.I.C.’s (Brazil, Russia, India and China) and EMEA (Eastern Europe, Middle East and Africa) are developing at a colossal rate causing a strong demand on hard commodities, can this strong demand continue amidst the current global slow-down?
A. One of the key differentiating factors between earlier investment cycles and this one is the much improved macro balances of emerging market economies and hence a greater ability to avoid protracted periods of slowdown. From current account surpluses and record FX reserves to fiscal surpluses and external creditor status the transformation is clear to see. We believe that the growth outlook for emerging markets continues to be positive as a combination of domestic demand, an increasing trend of emerging exports to other emerging markets and given an estimated $20trn in planned infrastructure projects over the next decade should provide support amongst a US led global slow down.
Q. What are your views on current Energy prices – namely crude oil and gas?
A. Currently WTI crude for September delivery sits close to $125/bl, some 15% off its highs seen in Mid July. As with many commodities we see positive demand and supply fundamentals as being the root cause for higher prices both in the short and longer term.
Whilst we are of the view that untapped oil resources are sufficiently high, note the huge potential discoveries offshore Brazil as an example, previous under-investment, increasing complexity of extraction, bottlenecks in refining and elsewhere are all reasons why oil and associated products will be underpinned going forward. Sure, geo-politics, changes in the fortunes of the US Dollar, speculation will all interact to cause volatility in the oil price but in terms of being a signaling mechanism for future extraction the price will have to remain elevated relative to history.
Hexam took an earlier decision to reduce some of our upstream exposure into strength as we believed that the benefit of higher oil would be offset by increased inflationary concern and a higher equity risk premium, something which has played out over the last couple of months.
Grant Shotter
Q. Are soft commodities a one way bet, on a long term perspective, with the population explosion, erratic weather conditions and development of bio-fuels?
A. To put into context some 40% of grain output is currently used as animal feed and when this is combined with growing populations and the impact of alternative fuels, the demand side of the equation has seen a radical shift. On the supply side the lack of available arable land in addition to increased climatic uncertainty has been amongst the major contributors to the spike in prices. For example Corn Futures are 53% higher year on year even following a 25% correction over the last month.
We believe that whilst the softs offer an attractive long term story, the volatility of the commodities themselves can be excessive as they can be influenced by factors that have a low degree of visibility. We prefer to play this long term theme via areas like Potash, as the demand for arable land and hence Potash and related fertilizers will continue apace and as the visibility is much greater given the limited number of suppliers and the sizeable deficit in Potash in places like China. We have holdings in the Russian Potash producer Uralkaliy and Potash Corp of Saskatchewan.
Q. We have already seen some emerging economies removing the price fixes on oil for domestic consumption but this has had little effect on the oil price – do you think political pressure can help to reduce oil prices or is it simply a case of supply and demand?
A. We have seen economies such as China and India amongst others increase domestic fuel prices to pass through the impact of high international prices. These effective subsidies were distorting demand in the eyes of many and proving a costly exercise for central coffers.
The hikes seen in product prices initially had a muted response on oil prices as concerns over long term supply, the standoff between Israel and Iran and an announced increase in OPEC quotas all provided short term support. Subsequently however, part of the retracement seen since mid July has been due to such talk of demand destruction in both Western and Emerging economies.
We would expect such subsidies to remain in place for some time yet but will gradually be phased out. This combined with the strong growth environment for emerging economies and greater policy flexibility should insure demand runs high.
Q. Tell me about what sectors you think are going to create good investment opportunities in the next 6 to 12 months and explain to me about Hexam’s internal strategies to maximize these opportunities.
A. We believe that the bulk commodities like thermal and coking coal, iron ore and fertilizers like potash will continue to show leadership over the next 6-12 months as they will continue to exhibit market tightness. Such tightness is conveyed by the current level of spot thermal coal prices, which currently trade at levels of around $170/t out of Newcastle, Australia, some $50 ahead of where contract levels were set earlier in Q2. Demand from the likes of China and India to feed coal fired power stations will continue to exert pressure on existing mined supply and will exacerbate the impact of any mine outages from weather or infrastructure related problems. There are of course plans to increase mined supply but long lead times, restricted availability of mining equipment and cost and time overruns mean that these areas should remain tight over the medium term.
At Hexam we analyse country, sector and stock on the basis of our 5 factor process, GLCMV, or growth, liquidity, currency, management and valuation. We believe these factors best capture the drivers and allow for a focused and consistent analysis. Taking account of the all the fundamental inputs and the application of GLCMV we produce the Hexam Idea Pool which is a list of some 130 stock names from which our 4 high conviction 30-40 stock portfolios are constructed. We believe that the only way of delivering consistent strong performance is by running high conviction concentrated portfolios whereby returns are not diversified away but risks are contained. This strategy has been central to the ongoing strong performance of our products through the recent periods of heightened volatility.
Q. Might the investment strategy change in the coming year if global growth slows overall, and possibly slows dramatically in key economies – if so, which other alternative strategy might come to the fore?
A. Our base case is that emerging markets demand will likely more than compensate for any slowdown seen in the US and Europe within the sectors we favour. In our view the emerging market economies have a superior ability to cope with any potential slowdown and hence why our base case is what it is. However any significant slowdown within somewhere like China would likely weigh on commodities and on the related equity so we would look to reduce our net positioning on any sign of this and put in place short positions to benefit from any correction. This remains a low chance event for us and we continue to remain exposed and positive within our chosen sectors.