BlackRock World Mining Trust plc
LEI – LNFFPBEUZJBOSR6PW155
Condensed Half Yearly Financial Report 30 June 2023
PERFORMANCE RECORD
| As at 30 June 2023 | As at 31 December 2022 | ||
| Net assets (£’000)1 | 1,171,418 | 1,299,285 | |
| Net asset value per ordinary share (NAV) (pence) | 612.72 | 688.35 | |
| Ordinary share price (mid-market) (pence) | 599.00 | 697.00 | |
| Reference index2 – net total return | 5,546.55 | 5,863.32 | |
| (Discount)/premium to net asset value3 | (2.2%) | 1.3% | |
| ======== | ======== |
| For the six months ended 30 June 2023 | For the year ended 31 December 2022 | ||
| Performance (with dividends reinvested) | |||
| Net asset value per ordinary share3 | -7.1% | +17.7% | |
| Ordinary share price3 | -10.3% | +26.0% | |
| Reference index2 | -5.4% | +11.5% | |
| ======== | ======== |
| For the six months ended 30 June 2023 | For the six months ended 30 June 2022 | Change % | |
| Revenue | |||
| Net revenue profit on ordinary activities after taxation (£’000) | 31,767 | 37,148 | -14.5 |
| Revenue earnings per ordinary share (pence)3 | 16.73 | 20.07 | -16.6 |
| Dividend per ordinary share (pence) | |||
| – 1st interim | 5.50 | 5.50 | – |
| – 2nd interim | 5.50 | 5.50 | – |
| ————— | ————— | ————— | |
| Total dividends paid and payable | 11.00 | 11.00 | – |
| ======== | ======== | ======== |
1 The change in net assets reflects portfolio movements, dividends paid and the reissue of ordinary shares from treasury during the period.
2 With effect from 31 December 2019, the reference index changed to the MSCI ACWI Metals & Mining 30% Buffer 10/40 Index (net total return). Prior to 31 December 2019, the reference index was the EMIX Global Mining Index (net total return). The performance returns of the reference index since inception have been blended to reflect this change.
3 Alternative Performance Measures; further details are given in the Glossary contained within the Half Yearly Financial Report.
CHAIRMAN’S STATEMENT
Overview
The global economy performed well at the start of the year, supported by factors such as falling energy prices, strong consumer balance sheets and the reopening of the Chinese economy. There was positive sentiment in the mining sector too following China’s reversal of its zero COVID-19 policies which initially led to strong commodity demand and the majority of mined commodity prices performing well. However, relatively quickly, positive momentum stalled as global manufacturing activity receded and China’s economy, historically a major demand engine, delivered a disappointing rebound. By the end of the first half of the year, most mined commodity prices had fallen below the levels where they started.
Performance
Against this backdrop, over the six months ended 30 June 2023, the Company’s net asset value per share (NAV) returned -7.1% and the share price -10.3%. The Company’s reference index, the MSCI ACWI Metals & Mining 30% Buffer 10/40 Index, returned -5.4% (all percentages calculated in Sterling terms with dividends reinvested).
Since the period end and up to the close of business on 22 August 2023, the Company’s NAV has decreased by 5.2% compared to a fall of 3.2% (on a net return basis) in the reference index (in Sterling terms with dividends reinvested). Further information on the Company’s performance and the factors that contributed to, or detracted from, performance during the six months are set out in the Investment Manager’s Report below.
Revenue return and dividends
The Company’s revenue return per share for the six-month period ended 30 June 2023 amounted to 16.73p per share, compared to 20.07p per share during the same six-month period last year. This represents a decrease of 16.6% and reflects reductions in dividends from many mining companies.
The first quarterly dividend of 5.50p per share was paid on 31 May 2023 and, today, the Board has announced a second quarterly dividend of 5.50p per share which will be paid on 6 October 2023 to shareholders on the register on 8 September 2023, the ex-dividend date being 7 September 2023. It remains the Board’s intention to distribute substantially all of the Company’s available income in the future.
Management of share rating
The Directors recognise the importance to investors that the Company’s share price should not trade at a significant premium or discount to NAV, and therefore, in normal market conditions, may use the Company’s share buyback and share issuance powers to ensure that the share price is broadly in line with the underlying NAV.
The discount of the Company’s share price to the underlying NAV per share finished the six months under review at 2.2% on a cum income basis, having stood at a premium of 1.3% at the beginning of the period. At the close of business on 22 August 2023, the Company’s shares were trading at a discount of 1.9% on a cum income basis.
Over the six months to 30 June 2023, the Company’s shares have traded at an average premium of 0.2%, and within a range of a 4.2% discount to a 3.1% premium. I am pleased to report that, during the first half of the year, the Company reissued 2,430,000 ordinary shares from treasury at an average price of 644.44p per share for a total consideration of £15,691,000. All shares were reissued at a premium to the prevailing NAV and were therefore accretive to existing shareholders. The Company did not buy back any shares during the six month period ended 30 June 2023. Since the period end and up to the date of this report, no ordinary shares have been reissued or bought back.
Gearing
The Company operates a flexible gearing policy which depends on prevailing market conditions. It is not intended that gearing will exceed 25% of the net assets of the Company and its subsidiary. Gearing as at 30 June 2023 was 9.6% and maximum gearing during the period was 14.6%.
Board composition
I am delighted to welcome Charles (Chip) Goodyear to the Board. Chip was appointed today and brings a wealth of relevant industry knowledge and experience and, subject to his re-election by shareholders, he is intended to succeed me as Chairman immediately following the next Annual General Meeting. He began his career at Kidder, Peabody & Co. where he participated in merger and acquisition and financing activities for natural resources companies. Chip then joined Freeport-McMoRan, one of the world’s largest producers of copper and gold, where he was promoted to executive vice president and chief financial officer. In 1999 he joined BHP Billiton (now BHP), the world’s largest diversified resources company as chief financial officer and served in that role until 2001 when he became chief development officer, a post he held until 2003 when he then became chief executive officer.
In October 2007 Chip retired from BHP and in 2009 served as CEO-designate of Temasek Holdings, an investment company wholly owned by the Singapore Minister for Finance. He also served on Temasek’s board. He is currently the president of Goodyear Capital Corporation and Goodyear Investment Company and a director of several private companies. Chip has also been a member of the International Council on Mining and Metals and the National Petroleum Council.
Market outlook
Central banks in most parts of the world have aggressively tightened monetary policy to restrictive levels and the way forward remains uncertain as they try to strike a delicate balance between fighting inflation and maintaining financial stability. Headline inflation rates are currently falling in the developed world, driven by lower energy prices and normalising supply chains. However, core inflation, which excludes items frequently subject to volatile prices like food and energy, does not appear likely to fall to many central banks’ 2.0% inflation target due to ongoing strength in wage growth.
Uncertainty on the interest rate path, reflecting inflation concerns, weighs on the outlook for economic growth. However, there has never been greater demand for metals and minerals and the mining sector must increase production to supply businesses with the materials, such as lithium and copper, they need in enabling the global economy to shift to a carbon-free future. The mining and metals industry as a whole is also confident that it can reconcile rapid output growth with sustainability goals.
Whilst near-term caution is warranted, the Board remains fully supportive of our portfolio managers, the strength of the holdings in the portfolio and their belief in the ability of our companies to navigate the upcoming environment.
David Cheyne
Chairman
24 August 2023
INVESTMENT MANAGERS’ REPORT
The first half of 2023 finished worse than expected, despite a strong start to the year. Commodity prices initially moved higher but by March started to fall, finishing the period in negative territory on the back of fears of further interest rate hikes and uncertainty on Chinese economic activity. The combination of these two factors was able to overwhelm supportive supply side constraints and growth from the energy transition related demand. Mining company share prices fell in tandem with the aforementioned moves but were also pressured by cost inflation that compressed margins.
Given the negative backdrop of the period, returns would historically have been worse than what transpired due to weak balance sheets, overspending on growth and falling margins. These factors have nearly always resulted in enlarging the negative returns and driving the steep cyclicality most investors associate with the sector, but once again the sector proved to be more resilient than in the past. Mining companies have largely paid down debt, leaving balance sheets supportive rather than the opposite. Disciplined capital spending has reduced commitments to growth related capital expenditure and thus freed up cash to spend on buybacks and dividends. If companies can hold to the capital allocation frameworks outlined at last cycle’s low point, 2016, then there is a strong probability that once the near-term economic noise dissipates, the underlying fundamentals should drive returns.
Over the period, the NAV of the Company was down by 7.1% with dividends reinvested and the share price total return was down by 10.3%. This compares to the FTSE 100 Index which was up by 3.2%, the Consumer Price Index (during the 12 months to 30 June 2023) which was up by 7.9% and the reference index (MSCI ACWI Metals & Mining Index 30% Buffer 10/40 Index net total return) which was down by 5.4% (all total return numbers based in Sterling terms).
The old enemy – inflation
Central banks from the Federal Reserve, the Bank of England, the European Central Bank and nearly all other regions sought to raise rates in a battle against inflation. A near perfect storm of supply chain issues, strong consumer balance sheets and tight labour markets drove inflation to levels not seen for years. In addition, the stickiness of the data continually defied market expectations that rates would peak in the near term.
Given the focus of governments, society and central banks on bringing inflation under control, we consider that it is likely that rates will remain higher than expected and for longer, especially if the consumer continues to spend down the “personal balance sheet” built up during the COVID-19 pandemic. However, recent data points are starting to show a reprieve in areas such as energy costs, raw materials and food prices. Time will tell if these will result in a steep enough fall in overall inflation data allowing central banks to pause rather than raise interest rates again.
As shown in the chart on page 8 of the Half yearly Financial Report, rates are now at a level where investors seem to be satisfied with the return available on short-term deposit rates of 5% or more. The attractiveness of this creates a significant burden for general equities given the higher volatility and lower yields versus the simple return on cash. In addition, ongoing economic uncertainty in certain parts of the world means that equity returns are likely to remain divergent. The year to date moves in large cap technology companies versus companies aligned to the broader economy is a case in point (as seen in the chart on page 7 of the Half Yearly Financial Report).
ESG issues and the social licence to operate
ESG (Environmental, Social and Governance) issues are highly relevant to the mining sector and we seek to understand the ESG risks and possible related opportunities facing companies and industries in the portfolio. As an extractive industry, the mining sector naturally faces a number of ESG challenges given its dependence on water, carbon emissions and geographical location of assets. However, we consider that the sector can provide critical infrastructure, taxes and employment to local communities, as well as materials essential to technological development, enabling the carbon transition through the production of the metals required for the technology underpinning that transition.
We consider ESG insights and data, including sustainability risks, within the total set of information in our research process and makes a determination as to the materiality of such information as part of the investment process used to build and manage the portfolio. ESG insights are not the sole consideration when making investment decisions but, in most cases, the Company will not invest in companies which have high ESG risks (risks that affect a company’s financial position or operating performance) and which have no plans to address existing deficiencies.
– We take a long-term approach, focused on engaging with portfolio company boards and executive leadership to understand the drivers of risk and financial value creation in companies’ business models, including material sustainability-related risks and opportunities, as appropriate.
– There will be cases where a serious event has occurred and, in that case, we will assess whether the relevant portfolio company is taking appropriate action to resolve matters before deciding what to do.
– There will be companies which have derated (the downward adjustment of multiples) as a result of an adverse ESG event or generally due to poor ESG practices where there may be opportunities to invest at a discounted price. However, the Company will only invest in these value-based opportunities if we are satisfied that there is real evidence that the relevant company’s culture has changed and that better operating practices have been put in place.
The main areas of focus during the period have been on decarbonisation plans. It is increasingly clear how essential it is for resource producers to move away from the carbon heavy processes that have been used for generations. New technologies will be required to facilitate this transition, as well as significant amounts of capital. It is also important that investors understand that the journey will not be a straight line, as companies contend with both the speed of decarbonisation and the importance of growing production to meet the needs of customers. In order to monitor progress, it is hoped that some new industry standards are implemented that will make assessing progress easier, as happened when the sector focused on safety many years ago.
Another area of focus during the period has been on governance. Given the battle to grow either by investing in new supply or via mergers and acquisitions, it is important that management teams respect their fiduciary duty when dealing with the latter. It is too easy for executives to shy away from opportunities by retreating into the safety of their own structure rather than engaging to see what might be possible. It is our hope that the positives delivered by increased focus on capital discipline are not wasted when it comes to evaluating value accretive opportunities.
Weaker prices
The first half of 2023 has seen markedly lower prices versus both the start of the year and versus the average prices seen in the same period last year. Double digit falls are commonplace across the industrial metals arena, with only precious metals showing upwards moves. Despite the scale of the falls, current prices continue to deliver strong margins for the producers and it is therefore important to highlight the ongoing cash generation the sector is likely to enjoy. In addition, inventory levels have fallen to record lows for a number of metals meaning that when demand strength returns the impact on prices from restocking could be dramatic.
Commodity price moves
Commodity | 30 June 2023 | % change YTD in 1H 23 | % change average price 1H23 vs 1H22 |
| Gold US$/oz | 1,916 | 5.5% | 3.1% |
| Silver US$/oz | 22.76 | -4.2% | 0.1% |
| Platinum US$/oz | 897 | -15.8% | 1.7% |
| Palladium US$/oz | 1,254 | -29.9% | -31.8% |
| Copper US$/lb | 3.77 | -0.5% | -10.9% |
| Nickel US$/lb | 9.23 | -31.9% | -15.4% |
| Aluminium US$/lb | 0.96 | -10.3% | -23.9% |
| Zinc US$/lb | 1.08 | -20.6% | -26.0% |
| Lead US$/lb | 0.97 | -8.5% | -5.9% |
| Tin US$/lb | 12.46 | 11.0% | -34.6% |
| Iron Ore (China 62% fines) US$/t | 114 | -3.4% | -15.3% |
| Thermal Coal (Newcastle) US$/t | 159 | -42.0% | 12.0% |
| Metallurgical Coal US$/t | 230 | -14.0% | -8.0% |
| Lithium (Battery Grade China) US$/kg | 106.2 | -44.5% | -21.2% |
| West Texas Intermediate Oil (Cushing) US$/barrel | 70.6 | -12.0% | -26.4% |
| ======== | ======== | ======== |
Sources: Datastream and Bloomberg, June 2023.
The key exposures for the Company are to producers of iron ore and copper. Average prices for these two commodities were lower in the first half of 2023 versus the first half of 2022 with iron ore down by 15% and copper down by 10%. What is interesting is that the actual year to date return for copper is flat, highlighting the volatility during the period. Inventories are now at levels rarely seen before, leaving consumers heavily exposed to price risk when they decide to rebuild stocks.
It is not just metals prices that have suffered during the period but also prices for other commodities such as oil and agricultural crops. During the period, OPEC (Organisation of Petroleum Exporting Countries) has had to step into the market to cut supply twice this year in order to protect prices in the face of lower economic activity. On the other side of the equation, sales of oil from the US Strategic Petroleum Reserve have moderated and the US Government has said they would look to restock at around US$70/bbl which is not far from current levels.
Capital allocation
It is now seven years since companies started to introduce changes to their capital allocation frameworks. The focus on value over volume, balance sheet risk, looking through the cycle, flexibility, improved payments to shareholders etc. have entrenched a culture of discipline which has steadied the ship during volatile times. It is great to see ongoing support for these plans and it is clear from the reduced share price volatility in periods like the first half of 2023 that they are working.
Many of the historic return plans continue to drive support for the sector. It is noteworthy the scale of delivery and ongoing ambition around share buyback plans that continue to erode the number of shares in issue for various companies. For example, ArcelorMittal has reduced its share count by 31.0%, Glencore by 5.2% and Vale by 7.4%. The full impact of deploying capital in this way is yet to be felt during an upswing in markets and time will tell just how much value can be generated from them but the potential is very exciting.
In regard to dividends, it is clear that based on current levels of profitability and existing pay-out policies, dividends to shareholders are likely to be lower and in some cases significantly lower in 2023 than the prior year. This is to be expected but what should not be ignored is just how competitive the forecast yields continue to be versus the broader market e.g. the reference index has a dividend yield of 4.1% versus the MSCI All Country World Index at 2.2%.
Decarbonisation a multi decade driver for the sector
The low carbon transition is one of the most encouraging structural opportunities that we see in the market and creates a compelling growth opportunity for those companies supplying the materials that enable the transition. In 2022 global battery electric vehicle sales reached 10 million units, with the International Energy Agency (IEA) forecasting this to increase to 13 million units in 2023. Energy storage systems doubled in 2022 compared with 2021 and are on track to double again in 2023. We also saw record spending on renewable energy in 2022 at almost US$600 billion, with China alone adding 100GW of solar capacity (+70% versus 2021) where they are looking to increase this to 150GW in 2023.
Policy continues to be supportive of this trend where we have seen an acceleration in legislation to support the transition to a low-carbon economy over the last 12 months. The US Inflation Reduction Act (IRA), passed in August 2022, contains a range of measures to support the transition with nearly US$400 billion of public spending in the form of tax incentives, rebates and loans. The IRA has contributed to a doubling of real manufacturing construction spending since late 2021. In Europe, the Green Deal Industrial Plan has earmarked more than EUR 600 billion in public sector investment to incentivise European production of clean technology and critical raw materials to ensure Europe remains competitive in the global race to net-zero.
Base metals
It was a difficult half year for the base metals as concerns around global growth, the strength of the recovery in China and higher interest rates depressed demand. Base metal prices for the first half of 2023 were between 11% to 26% lower than the corresponding period last year. While physical markets remain robust, particularly in the case of copper, the impact of using higher rates to stem inflation overwhelmed prices in the first six months. Encouragingly, as we approached the end of the period, China’s two most senior politicians sought to allay concerns around China’s growth and have indicated that they will look to stimulate parts of the economy to support growth.
Copper has been caught in the crossfires of a macro versus micro debate this year. The fundamentals of the copper market look robust – inventory levels are low and drawing down and China’s apparent consumption is strong (copper imports into China reached a record level in May 2023). However, concerns around the growth outlook in China and the rest of the world depressed the price, with copper finishing the first half of the year flat (-0.5%) versus the beginning of the year. The copper price has benefited over the last two years from a number of project delays and supply downgrades. Whilst we do not see a wall of new supply entering the market, we will begin to see delayed production from assets such as Anglo American’s Quelleveco mine in Peru and Teck Resources’ QB2 project in Chile which began ramping up production this year.
With the long-term fundamentals of the copper market remaining robust, in particular copper’s role in enabling the energy transition, we continue to remain positively exposed to copper producers within the Company. Encouragingly, we saw a better performance from copper equities versus the underlying copper price during the period. A number of mid-cap and development companies performed particularly well. Lundin Mining (0.8% of the portfolio) delivered improved operational performance and acquired a 51% stake in the Casserone’s copper mine in Chile. This is located close to the undeveloped Josemaria project and provides Lundin Mining with a strong presence in the Vicuna district of Chile which is also home to the world class Filo del Sol project owned by Filo Mining, another Lundin Group company. Ivanhoe Mines (2.2% of the portfolio) continues to deliver as they ramp-up their Komoa-Kakula asset in the Democratic Republic of the Congo. Ivanhoe Electric (2.8% of the portfolio) announced a concurrent equity investment and 50/50 exploration joint venture with Ma’aden (Saudi Arabia’s leading mining company) to explore minerals in the Middle Eastern country which will see them invest US$126 million for a 9.9% stake in the company. This formerly private investment has continued to perform well now that it is listed on the New York Stock Exchange.
The aluminium price was down 13% compared with last year but has largely traded around its cost curve, which is used to estimate its price support level. This is a function of the move down in energy prices which are the largest cost component of producing aluminium. There have been risks to China’s aluminium supply base with production restrictions imposed in Yunnan due to low hydro levels, but overall supply and demand have been reasonably well balanced in China. While the demand for “green” or low-carbon aluminium continues to grow, we have seen an element of aluminium de-stocking year-to-date. The Company’s largest exposure to aluminium is via Norsk Hydro (2.4% of the portfolio) which is one of the lowest-carbon producers of aluminium by virtue of its access to hydro power in Norway and it continues to pursue its strategy of growing the low-carbon product mix via recycling and investing into renewable energy.
The nickel market was particularly challenged in 2023 as stainless steel production, its key source of demand, declined year-on-year. With Indonesian nickel pig iron supply continuing to grow, a substantial surplus has built up which caused the nickel price to decline 32% during the first half of the year. Nickel pig iron (NPI) producers are increasingly looking to adapt their facilities allowing production of nickel matte and other intermediary products. This move allows them to sell into the market for Class 1 battery grade nickel where demand is likely to remain high and could command a premium over time. The Company has two pure play* exposures to nickel – the first is Nickel Industries (0.9% of the portfolio), today a NPI producer which is transitioning towards LME grade nickel production which will improve earnings and margins. The second investment was done via a “PIPE” deal in 2022 that has now taken Lifezone Metals from private into a public company at the end of June. Lifezone Metals, in conjunction with BHP, owns the Kabanga project in Tanzania which is one of the world’s largest undeveloped nickel sulphide deposits. As at the end of July, Lifezone Metals was trading 19.7% above the capital raising entry price of US$10 per share.
* Companies with significant revenue exposure to the commodity.
Bulk commodities and steel
The outlook for the iron ore market at the end of last year was largely positive with most investors expecting to see a recovery in construction activity, particularly in China, leading to better prices during the first half of the year. To a large extent this proved correct with the iron ore price reaching US$125/t in Q1 and averaging US$112/t for the first half of the year. While this iron ore price does not support the record levels of dividends paid by the iron ore exposed diversified miners in 2021 and 2022 it is a very attractive price for these low-cost producers.
The Company’s exposure to iron ore is via the diversified majors BHP (8.9% of the portfolio), Vale (9.1% of the portfolio) and Rio Tinto (2.6% of the portfolio). Whilst iron ore prices have softened versus the prior year, so too have the share prices and the companies continue to offer an attractive and well supported dividend yield. In addition, the Company has exposure to two pure play high grade iron ore producers, Champion Iron and Labrador Royalty Company. Champion Iron is ramping up its Bloom Lake operation in Canada and targeting the production of high grade (69% Fe) iron ore which is a key component of low carbon steel production.
China’s domestic steel mills are currently operating at break-even margins, with the steel price largely tracking moves in its key cost inputs, iron ore and coking coal. As we look into the second half of the year, we would expect to see a moderation in steel production rates in China given the government’s goal of maintaining to reducing steel production year-on-year. During the first half of the year, China’s steel output was annualising at 1,050Mt versus their capacity target of around 1,000Mt. Addressing oversupply and measuring the carbon intensity of production in the Chinese steel market is positive for those producers (namely European) who compete against Chinese imports.
The US has remained a bastion of relative strength for steel, supported by domestic construction, government policy and a recovery in automotive demand from the chip-impacted production in 2020-2022. As we look forward there is an increasingly positive outlook for steel in the US with higher infrastructure and re-shoring investment. The energy transition is also supportive of steel demand, with steel intensity of certain renewable power more steel intensive than a natural gas fired power plant, such as onshore wind at 3.4x for the same level of energy generation.
The Company’s exposure to steel is focused on companies with a track record of capital returns through share buybacks and dividends, as well as disciplined growth and an industry leading approach to decarbonisation. Our preference in the Company is to have exposure to low carbon producers, such as the US EAF producers including Nucor and Steel Dynamics, or to be invested in those producers who might be carbon intensive today, but have credible plans to decarbonise their production as is the case with ArcelorMittal. During the first half, we saw Nucor (1.6% holding in the portfolio) announce a new US$4 billon share buyback plan in May – since 2020 Nucor has reduced its share count by 17%, with the newly announced buyback compressing this further. ArcelorMittal and Steel Dynamics (2.7% and 1.8% holdings respectively) have also reduced their share count by 27% and 20% respectively since the end of 2020 and we expect this trend to continue.
Coal markets have been some of the most interesting commodity markets over the last couple of years with record prices achieved for both metallurgical and thermal coal during 2022. While coal markets have continued to be interesting, the price performance has been the worst among the commodities, primarily due to an elevated starting point and lower demand due to a warmer than expected northern hemisphere winter. With coal demand in Europe, Japan and South Korea relatively muted year-to-date, China has been dominating imports with their coal burn up 16% year-on-year in May. From here, the outlook for coal is largely weather dependent. If the northern hemisphere winter is colder than average, inventories will need to be replenished which should be supportive of prices.
The Company’s thermal coal exposure is via our 8.0% position in Glencore which is using elevated thermal coal prices to deleverage the business and remains focused on decreasing its coal exposure over time. During the first half of 2023, Glencore made a proposal to Teck Resources to merge their two businesses and subsequently demerge the combined coal business to create two separate companies – a metals business and a coal business. While the Teck Resources board has not accepted the proposal from Glencore, Glencore is separately pursuing an acquisition of Teck Resources’ coking coal business that they have indicated will allow them to separate coal from the rest of the business over time. As a reminder, the Company has no exposure to pure play thermal coal producers.
A consistent feature of the metallurgical coal market has been its susceptibility to upside price surprises due to seasonal weather effects during the first half of the year. This has resulted in prices spiking to over US$600/t in recent years when Queensland, Australia’s key coking coal region, was heavily impacted by extreme flooding. While not to the same extreme, volatility has been a feature of the hard coking coal market this year with prices reaching close to US$400/t in February as exports from Australia hit 6-year lows, to subsequently decline to around US$230-250/t at present as supply recovered. Limited investment into new supply and ongoing supply side risks are likely to keep this market well supported over the medium term. The Company’s exposure to metallurgical coal remains in the two leading producers, BHP and Teck Resources, which have been able to generate very strong levels of free cash flow from their coking coal businesses to support returns to shareholders in recent years.
Precious metals
The last three years have seen a range bound environment for gold with the average annual price in a range of circa 10%. Whilst the price in US Dollar terms has been relatively stable, the performance of gold in non-US Dollar terms has been far stronger. In 2023 gold has traded at the top-end of its recent trading range surpassing US$2,000/oz, supported by persistent inflation concerns, heightened geopolitical tension and currency debasement. As we look to the remainder of the year, the performance of gold will be likely dictated by the outlook for inflation and in turn rates. If inflation proves to be more persistent than expected, yet central banks choose to pause on interest rate hikes, we will see real yields compress and a positive gold price environment emerge.
The silver price has modestly underperformed gold when looking at average prices during the first half of 2023 versus the same period last year. Longer term we see upside potential from greater solar penetration (the greater proportion of solar within the energy mix) and increasing usage of semi-conductors.
An encouraging feature of the gold equity market over recent years has been the increased focus on shareholder returns, free cash flow and dividends. Cost inflation has been a challenge for the gold producers over the last couple of years. However signs are suggesting the cost inflation is reaching a peak and the move up in gold prices is also supporting margins.
The Company has modestly increased its exposure to gold producers during the six-month period given the improved outlook. However, we have maintained our strategy of focusing on high quality producers which have an attractive operating margin and solid production profile and resource base. This includes the Company’s exposure to the royalty companies Franco-Nevada (2.2% of the portfolio) and Wheaton Precious Metals (3.1% of the portfolio) which have generally outperformed the gold equities during the year given their stronger margins and lack of exposure to cost inflation. We have also seen further consolidation in the sector with the Newcrest Mining (2.4% of the portfolio) board recommending Newmont Corporation’s (3.2% of the portfolio) proposal to acquire Newcrest Mining to create the world’s largest gold producer.
It was a torrid period for the platinum group metals (PGMs) with destocking driving prices significantly lower during the first half, with the platinum price down by 16%, palladium down by 30% and rhodium falling a spectacular 65% during the half given the elevated price levels over the last 18 months. It has been a challenging period for the PGMs with global auto production still tracking circa 15% below pre-COVID-19 levels, with Battery Electric Vehicles (BEV) continuing to take market share from Internal Combustion Engine (ICE) vehicles. We expect to see a modest recovery in auto sales in 2023 as chip shortages begin to ease, but an environment of rising inflation and interest rates is challenging for auto demand.
Among the PGMs, platinum has fared better than palladium which faces the structural challenge of declining diesel vehicle demand. Platinum continues to see autocatalyst demand growth, with increasing emissions standards requiring more platinum loading for autocatalysts in China. While the demand outlook has well recognised challenges, the supply of PGMs has come under significant pressure in recent years due to the lack of reinvestment and operating challenges (mainly power related) in South Africa. A key question for global PGM supply is whether sanctions are placed on Russian materials, which would significantly tighten the market.
As at the end of the period, the Company had a combined exposure of 2.3% to PGM producers through Bravo Mining, Impala Platinum, Northam Platinum and Sibanye Stillwater versus 2.0% at the same time last year. In addition, the Company has reduced its exposure to Anglo American (2.4% of the portfolio) which owns 79% of Anglo American Platinum. The clear bright spot for the Company’s PGM exposure was from Bravo Mining, a Brazilian-based PGM exploration and development company which the Company invested in pre-IPO in April 2022 at US$0.50/share due to our belief in the assets and management’s potential. Since our initial investment the company has successfully done an IPO and as at 30 June 2023 was trading at C$4/share, which represents a 500% return on our initial investment. They continue to have great success with the initial exploration phase confirming the occurrence of rhodium in the orebody, along with the potential for nickel sulphide.
Energy transition metals
It was a volatile half for lithium, a critical component of batteries, with the prices beginning the year at elevated levels and subsequently falling by 60% between January and April, due to de-stocking along the battery supply chain. Lithium demand is expected to remain solid this year at +20%, with the market to remain in balance which should support the recent rally in prices. Much has been said around the potential for meaningful supply growth in lithium. However, project delays have become a feature of this market in recent years. Concerns around the future availability of lithium has seen a number of OEM’s (Original Equipment Manufacturers) including Ford and General Motors look to fund lithium projects and producers through a combination of equity investments, off-takes (the amount of goods purchased during a given period) and loans. Following the pullback in lithium equities alongside the fall in spot prices during Q1, the Company added to its lithium holdings through Albemarle (1.6% of the portfolio) and Mineral Resources (1.3% of the portfolio). The Company’s lithium holdings constitute 7.8% of the portfolio.
A critical component of the electric car is also the e-motor, which most commonly uses a Praseodymium-Neodymium (NdPr) magnet, an alloy of two rare earth elements (REEs). REEs are commonly mined and processed in China and have been deemed of strategic importance by both Europe and the USA. The Company has exposure to REEs through Lynas Rare Earths, a REE miner and processor crucially based in Malaysia and Australia, as well as through Iluka Resources which is building a rare earths conversion facility in Western Australia to process its Eneabba rare earths concentrate. It has been a challenging first half for Lynas Rare Earths, with the Malaysian Government confirming that no cracking and leaching of rare earths will be allowed at their facility in Malaysia from 1 January 2024. While Lynas Rare Earths is building a cracking and leaching plant in Western Australia, there was hope that both cracking and leaching assets could operate in both Malaysia and Western Australia, allowing Lynas Rare Earths to further grow volumes.
Other metals with uses in support of the energy transition include cobalt, where prices are down by 65% from their June 2022 peak. Demand has been challenged, with higher cobalt battery chemistries the slowest growth among the battery chemistries, but still up by 28% year-on-year. From a supply perspective, the market looks well supplied with China Molybdenum increasing both production and the processing of stockpiles. Supply growth is also set to continue, with cobalt being a by-product of many of the Indonesian Nickel projects announced. The Company’s only exposure to cobalt is via Glencore.
Royalty and unquoted investments
Over the last year the Company has enjoyed a number of successes from the unquoted part of the portfolio with two private holdings, Ivanhoe Electric and Bravo Mining, going public at a substantially higher level than the Company’s initial investment. The Company’s long-standing Brazilian copper and gold royalty previously operated by OZ Minerals was transferred to BHP following its acquisition of OZ Minerals in 2023. Jetti Resources, a copper leaching company, completed a US$100 million fund raising at a substantially higher level than the Company’s initial investment and finally two PIPE investments completed their business combinations and are trading above our entry price.
As at the end of the first half of 2023, the unquoted investments in the portfolio amounted to 6.9% of the portfolio and consist of the BHP Brazil Royalty, the Vale Debentures, Jetti Resources and MCC Mining. These, and any future investments, will be managed in line with the guidelines set by the Board as outlined to shareholders in the Strategic Report in the 2022 Annual Report.
BHP Brazil Royalty Contract (1.5% of the portfolio)
In July 2014 the Company signed a binding royalty agreement with Avanco Minerals. The Company invested US$12 million in return for Net Smelter Return (net revenue after deductions for freight, smelter and refining charges) royalty payments comprising 2% on copper, 25% on gold and 2% on all other metals produced from mines built on Avanco Minerals’ Antas North and Pedra Branca licences. In addition, there is a flat 2% royalty over all metals produced from any other discoveries within Avanco Minerals’ licence area as at the time of the agreement.
In 2018 we were delighted to report that Avanco Minerals was successfully acquired by OZ Minerals, an Australian based copper and gold producer, for A$418 million. We are now equally pleased to report that OZ Minerals was acquired by the world’s largest mining company, BHP, in early 2023, with BHP now operating the assets underlying the royalty. Since our initial US$12 million investment was made, we have received US$27.1 million in royalty payments, with the royalty achieving full payback on the initial investment in 3½ years. As at the end of June 2023, the royalty was valued at £19.4 million (1.5% of the portfolio) which equates to a 330.8% cash return on the initial US$12 million invested.
In 2021, OZ Minerals achieved a significant milestone and commenced mining of Pedra Branca ore. Since then we have seen production at Pedra Branca increase, with the company targeting production of 13kt-16kt of copper and 11koz-13koz of gold production in 2023 (Source: 2023 guidance, as at end 2022). We continue to remain optimistic on the longer-term optionality provided by the royalty via the development of Pedra Branca West, as well as greenfield exploration over the licence area. Following BHP’s acquisition of OZ Minerals in early 2023, BHP is now the operator of the royalty. BHP’s strong operating focus, balance sheet strength and ESG credentials leaves the Brazilian operations in a very strong set of hands.
Vale Debentures (2.5% of the portfolio)
At the beginning of 2019, the Company completed a significant transaction to increase its holding in Vale Debentures. The Debentures consist of a 1.8% net revenue royalty over Vale’s Northern System and Southeastern System iron ore assets in Brazil, as well as a 1.25% royalty over the Sossego copper mine. The iron ore assets are world class given their grade, cost position, infrastructure and resource life, which is well in excess of 50 years.
We currently expect dividend payments to grow once royalty payments commence on the Southeastern System in 2024 and volumes from S11D and Serra Norte in the Northern System improve later in 2023 where project ramp-ups have been challenged in 2022 by licensing. In December, Vale reduced its longer-term iron ore production profile in light of licensing challenges and also a greater focus on high grade material. This now sees Vale target modest volume growth from the Northern System out to 2026. However, the improvement in grade will aid received pricing which the royalty will benefit from.
The Debentures continue to offer an attractive yield of circa 10.2% based on the 1H-2023 annualised dividend. This is an attractive yield for a royalty investment, with this value opportunity recognised by other listed royalty producers Franco-Nevada and Sandstorm Royalties, which have both acquired stakes in the Debentures since the sell-down occurred in 2021.
Whilst the Vale Debentures are a royalty, they are also a listed security on the Brazilian National Debentures System. As we have highlighted in previous reports, shareholders should be aware that historically there has been a low level of liquidity in the Debentures and price volatility is to be expected. We continue to actively look for opportunities to grow royalty exposure given it is a key differentiator of the Company and an effective mechanism to lock-in long-term income which further diversifies the Company’s revenues.
Jetti Resources (2.2% of the portfolio)
In early 2022, the Company made an investment into mining technology company Jetti Resources (Jetti) which has developed a new catalyst that improves copper recovery from primary copper sulphides (specifically copper contained in chalcopyrite, which is often uneconomic) under conventional leach conditions. Jetti is currently trialling their technology across a number of mines where they will look to integrate their catalyst into existing heap leach SX-EW (solvent extraction and electrowinning) mines to improve recoveries at a low capital cost. The technology has been demonstrated to work at scale at Capstone’s Pinto Valley copper mine, as well as Freeport-McMoRan’s Bagdad and El Abra operations. If Jetti’s technology is proven to work at scale, we see valuation upside with Jetti sharing in the economics of additional copper volumes recovered through the application of their catalyst.
During the second half of 2022 we were pleased to report that Jetti completed its Series D financing to raise US$100 million and a substantially higher valuation than when our investment was made at the beginning of 2022. This sees the company fully financed to execute on their expected growth plans in the years ahead.
MCC Mining (0.4% of the portfolio)
MCC Mining operates as a mineral exploration company focused on exploring for copper in Colombia. The company has several large porphyry targets which we believe could have significant potential. Shareholders include other mid to large cap copper miners, which is another indication of the strategic value of the company. The valuation of the Company is based on the US$170.7 million equity value implied by the April 2022 equity raise. The money they raised will fund a drilling campaign, which commenced in Q4 2022 at their Comita project, a joint venture with Rio Tinto, with drilling on two other projects (Urrao and Pantanos) commencing during the first half of 2023. Whilst it is still very early days, initial drilling looks encouraging. Importantly, MCC’s three projects are located in the Forestry Reserve in Colombia which allows for exploration drilling in the forestry reserve based on new regulations introduced in Colombia in early 2022.
Derivatives activity
The Company from time to time enters into derivatives contracts, mostly involving the sale of “puts” and “calls”. These are taken to revenue and are subject to strict Board guidelines which limit their magnitude to an aggregate 10% of the portfolio. In the first half of 2023 income generated from options was £2.5 million. Volatility levels for most of the period were lower, making option writing less value accretive to the Company, but nonetheless a number of opportunities presented themselves allowing healthy levels of income to be earned. At the end of the period the Company had 0% of the net assets exposed to derivatives and the average exposure to derivatives during the period was less than 5% of net assets.
Gearing
At 30 June 2023 the Company had £150.2 million of net debt, with a gearing level of 9.6%. The debt is held principally in US Dollar rolling short-term loans and managed against the value of the portfolio as a whole. During the period the Company reviewed the use of gearing given the sharp increase in rates, which had an impact on the returns for using debt to make investments. Less debt was used during the period than in prior years, which softened the impact of the negative drag on returns during the six months. At present we remain optimistic that, as some of the macro risks fade, opportunities will present themselves for gearing levels to rise back to normal levels even though the debt will have a higher cost. On the back of this, facilities were refreshed with our lenders and remain at £200 million for the revolving credit facility and £30 million for the overdraft. The current total cost of debt for the Company remains low at 5.99% and is linked to SONIA following the demise of LIBOR.
Outlook
The first half of the year was weaker than expected both in absolute terms and versus the broader market. Valuation multiples compressed alongside lower than forecast metal prices leading to reduced levels of profitability. As mentioned previously, we believe these poor returns are due both to the short-term focus on interest rates and to Chinese economic data. The energy transition appears to be happening faster than expected with EV car sales beating estimates, deployment of renewable infrastructure accelerating and corporate decarbonisation spending becoming mainstream. Supply of materials remains constrained and growth projects seem to be taking longer and costing more.
In this environment, shareholders should expect the portfolio to remain fully invested with a focus on stock specific outcomes rather than just market related factors such as commodity price sensitivity. This approach has delivered strong results over the last few years and the current mix of holdings has a high degree of exposure to similar dynamics, which we consider bodes well for the future.
In addition, the Company will continue to seek out opportunities to maximise income during the balance of the year in order to try to offset recent reductions to dividends from core holdings. Achieving this is integral to the goal of delivering a superior total return for shareholders through the cycle.
Evy Hambro and Olivia Markham
BlackRock Investment Management (UK) Limited
24 August 2023