Manager Insight

Healthy economic activity bodes well for resource companies; no imminent recession, says Brahm Spilfogel.
By Jade Hemeon | 28/06/18

Brahm Spilfogel, co-manager of RBC Global Resources as well as vice president and senior portfolio manager of Canadian and global equities at Toronto-based RBC Global Asset Management, sees more road ahead for the current economic cycle to advance, despite the fact that the nine-year expansion has been one of the longest in history.

About the Author
Jade Hemeon is a Toronto-based freelance financial journalist with more than 20 years experience. She has previously been a staff reporter for the Financial Post and Toronto Star, and has also held positions in the mutual funds and financial planning industries.

Healthy economic activity bodes well for the fortunes of resource companies producing commodities like oil, copper and lumber as inventories are consumed around the world, he says. Growing employment, tightening wage pressures and burgeoning government deficits could also be laying the ground for higher inflation and possible revival of gold, a commodity that has languished for several years.

"The length of the economic expansion would suggest we're in the latter part of the cycle, but we don't yet see the end and are not facing imminent recession," says Spilfogel, who co-manages RBC Global Resources with fellow senior portfolio manager and vice president Chris Beer. "We expect resource markets to chug along, but beyond the next year to year and a half it's hard to say. We are always on the lookout for reasons to get more defensive."

Getting more defensive would mean moving away from companies directly tied to the commodity price cycle and increasing the emphasis on secondary industries such as packaging and specialty chemicals. But for now, the fund is most heavily weighted in the energy sector, at 55% of assets, and basic materials at 43%, concentrating on companies that have healthy cash flow and control over costs.

The price of oil, as measured by the Brent benchmark for crude, has risen strongly from a low of around US$26 a barrel in 2016 to a high of around US$80 in May 2018. In late June, the price had settled to around the US$75 level. Spilfogel says the market reflects the success of global supply management by key producers like Saudi Arabia and Russia. While U.S. supply has been growing, there aren't many large development projects in the pipeline, Spilfogel says. There could also be reductions in supply from Venezuela and Iran, which are facing sanctions.

Meanwhile, he expects global demand to increase in the second half of this year. The favourable supply/demand scenario will be a boost for oil and gas producers, and the focus of the fund is currently on the global "super majors" with viable long-term projects. Prominent in the portfolio are integrated energy giants such as  Royal Dutch Shell (RDS.A),  Chevron (CVX),  Total (TOT) and  ConocoPhillips (COP).

"Many of these super majors used to need to get US$100 a barrel to be profitable, but now they've become more efficient," Spilfogel says. "They have good long-life assets and have sold off lower-return projects."

He also likes a handful of U.S.-based companies that he expects will be able to increase production and raise return on capital. Among his favourites are  Diamondback Energy (FANG) and  EOG Resources (EOG), which have valuable resource bases and superior technical teams. He also owns Parex Resources (PXT), which is listed in Canada but has assets in Colombia.

"We look for companies that can grow their reserves and their cash flow even in a flat environment for commodity prices, and that have achieved a higher return on invested capital than the average in their space," Spilfogel says.

Another commodity of interest to Spilfogel is copper. He says inventories have come down from an oversupply situation and prices have firmed. First Quantum Minerals Ltd.'s massive Cobre project in Panama should be in production early next year, but Spilfogel says there are currently no other large projects scheduled to come on stream to meet growing global demand.

Along with  First Quantum Minerals (FM), on the mining side the fund owns  Rio Tinto (RIO), which produces iron ore, aluminum and copper, and  BHP Billiton (BHP), which focuses on iron ore and copper.

"We also look for opportunities in the mid-caps," Spilfogel says. "These companies often have a development project that could be bought out, or they might benefit from a merger with a larger company."

As an example of such a win, the fund recently hit pay dirt with its stake in Arizona Mining (AZ), a Vancouver-based company with a zinc, lead and silver mine near the U.S.-Mexican border, after it agreed to a $1.8 billion buyout by South32 Ltd. of Australia at a 50% premium to stock market price. It's one of the biggest mining deals of the year, and will be voted on by shareholders in September.

RBC Global Resources has 4% of assets in gold stocks, including Kirkland Lake Gold (KL). Hovering in the US$1,300 range, gold bullion is well below its mid-2011 high of US$1,900 but has bounced off a low of around US$1,050 in late 2015. Spilfogel says the bottom has been seen, and he has become more positive on gold stocks in the past year or so. "Some gold companies have struggled during the past few years, but many have reduced their costs and are now running lean and mean," Spilfogel says.

He has a couple of investments in forest products, including  West Fraser Timber (WFT), due to a rosy outlook for building, repair and renovations in the United States as well as "decent" Chinese demand. But he took some profit and reduced exposure during the past six months due to some nervousness about the lofty price of lumber. The benchmark softwood price soared to a high of US$650 per thousand board feet in May 2018, almost triple the level of US$225 in 2015.

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