Everything commodities-related has taken a hit of late, on the back of slowing growth in the emerging markets, such as China. This, combined with rising costs, has caused many experts to question the future profitability of miners.
According to FE Analytics, the FTSE 350 Mining index has lost close to 20 per cent over three years.
Performance of index over 3yrs
Source: FE Analytics
However Cheveley, co-manager of the Investec Enhanced Natural Resources fund, says that the majority of these mining companies have been through a period of cost-cutting and therefore have more free cash-flow on their balance sheets.
Although the manager does not expect sentiment to immediately turn in favour of miners, he says there are a number of reasons why the sector will become more popular in the near future.
"We have had a rebound recently, but unfortunately that rebound is only working off the fall in mining shares we saw earlier in the year," he said.
"One of the problems the sector has faced is that people can be bullish on copper prices one moment, then bearish on whether or not the commodity is moving into surplus. The sector as a whole has underperformed; however, there are more people dipping back into it."
"That is because a lot of these companies are yielding around 5 per cent or just generally more than the market. Clearly, some miners did have to cut their dividends in the past and a lot of people still remember that."
"But in fact, the higher-quality companies have been deleveraging so that they now have strong balance sheets and therefore a defendable dividend," he added.
Cheveley points to the FTSE 100-listed BHP Billiton, which is his second-largest holding in his Investec Enhanced Natural Resources fund.
"BHP has a yield of around 4 to 5 per cent at the moment and the company has had a progressive dividend policy over the last 100 years," he said.
"That is one of the reasons investors are looking at it again, because not only is it reasonable value but it pays a good and growing income."
"BHP has good growth volumes, which help dilute costs. But I also think that the fruits of their January cost-cutting means that the risks are only on the upside. Earlier in the year, they got rid of a lot of people, and obviously you have to pay them to leave, but now we should see the benefits."
"I think that is going to be one of the main catalysts for investors becoming more confident on miners. Companies such as BHP have great free cash-flow now and have successfully cut costs. We are also seeing capex falling, which helps the free cash-flow," he added.
Although he admits that miners have had a tough time of late, Cheveley takes issue with misinterpretation of China’s GDP growth – which has been the principal driver of poor sentiment towards the sector.
"This is where you have to be careful," he said.
"People are mistaking slower growth in the emerging markets for declining growth. I read so much about growth declining in the press, when actually growth rates are still there. I think the only way we would see growth declining is if China has a financial crisis."
"We don’t think that is going to happen, as China has the finances and they won’t allow it to happen," he added.
Cheveley has run the £180m Investec Enhanced Natural Resources fund with FE Alpha Manager Bradley George since it was launched in May 2008.
The fund has returned 10.2 per cent over this time while, the MSCI AC World Materials index has returned 1.67 per cent. It has also significantly outperformed JPM Natural Resources over that time.
Performance of funds vs index since May 2008
Source: FE Analytics
One of the major reason the fund has been able to outperform, as Cheveley points out, is because he and George are able to take short positions – effectively betting against the chances of a company or commodities price.
Short positions are currently worth 14.9 per cent of the fund’s net asset value, with the majority of these shorts in equities. The largest of these options are on gas exploration and production stocks.
Investec Enhanced Natural Resources' largest sector weighting is to diversified energy equities.
Cheveley is particularly optimistic about the sector, as he says the oil price will remain at its current levels for now, but adds that this should rise by the end of the year, as winter in the northern hemisphere kicks in, causing supply to tighten.
Investec Enhanced Natural Resources has an ongoing charges figure (OCF) of 1.68 per cent and requires a minimum investment of £1,000.
