May 2017 Fund Performance & Market Commentary

The Delbrook Resource Opportunities Fund (the “Fund”) posted a return of -3.9% for the month of May vs. the S&P Metals and Mining ETF, the Fund’s closest benchmark, which was down -3.0%.  During the month, long positions generated gross returns of -5.2%, while short positions added +0.4%.  The Fund maintained net long exposure throughout the month, with a focus on selectively adding long exposure to precious metals and initiating new positions in base metals, specifically zinc.  We believe the former will grind higher this summer as geopolitical uncertainty continues to increase while the pathway of US monetary policy becomes clearer (i.e. Federal Reserve goes dovish after June 14th).  Our top base metal long continues to be zinc, as we will discuss below.
We are seeing a divergence of historical price correlations in the commodities complex. Unlike the supercycle of 2003-2015, where a ‘rising tide lifted all boats,’ we believe the sector is going to have very specific winners and losers going forward. After a lengthy period of underinvestment in mineral production capacity in the 1990’s, unanticipated demand growth from China caused commodity prices to rise dramatically during the 2000’s. This growth in demand resulted in a period of over-investment in production capacity, which eventually led to the broad decline in commodity prices. As we approach a new cycle, technological innovation will play a leading role in determining which commodities will be over supplied and which ones will be relatively scarce.

​Copper: We are living through fascinating times where nearly every aspect of our lives is impacted by technological innovation that at the most basic level relies on copper. Half of current copper demand is from the electronics industries and about one quarter is from construction. The remainder feeds into a range of industrial machinery, vehicles, and consumer products including home appliances. Nowhere is the commodity shift (oil to copper) more pronounced than in the area of automobiles -- electric vehicles require four times as much copper as internal combustion engines, and the number of electric cars on the road has doubled annually since 2012. Solar and wind power generation are also more copper-intensive than traditional thermal power. Consequentially, we believe demand fundamentals for copper will remain robust over the next two decades as global consumption leads to higher spending on electronics and investment dollars flow into renewable technologies.

As a result of this technological shift, McKinsey Consulting estimates that annual primary copper consumption may increase from 22 million tonnes in 2016, to 35 million tonnes by 2035 - see chart below. To put this into context, annual copper demand grew by about seven million tonnes over the past 15 years. It is shocking to consider that the potential required supply expansion over the next 10-20 years will represent a larger investment into copper production capacity than the world needed during the last 15 years while trying to keep up with the supposedly once in a lifetime Chinese “supercycle” of commodity demand growth.  In contrast, the longer-term copper supply outlook is challenging. Declining ore grades and increasingly difficult mining environments could result in supply constraints as ongoing investment becomes more expensive. We will need to see higher copper prices to trigger the necessary supply response.

Gold: Even in a rising interest rate environment, the consistent news flow of geopolitical uncertainty around the word continues to create tailwinds that are propelling investors into safe haven assets. We feel that next week’s expected US Fed increase is already priced into the market. However, what is of greater interest to us will be the sentiment coming from the Fed press conference and subsequent meeting minutes. Given last Friday’s US jobs report, which showed low unemployment at 4.3%, but also sluggish wage growth, it’s our view that the Fed won’t raise again until at least Q4 2017.  There simply is not sufficient evidence of inflation in the US economy to warrant a rapid rate increase.  As such, we will selectively look to increase our long exposure to precious metals over the coming weeks to take advantage of the lull in Fed tightening.

Zinc: As mentioned in past newsletters, zinc stockpiles havebeen declining since 2012, resulting in a 35% increase in the spot price of zinc over the same period. Global zinc stocks now represent only 13.5 days of annual consumption, down from 14.6 days last month and 60 days in 2012. As inventories move toward the perceived critical level of 10-days, we expect prices to move substantially higher as they did the last time stocks fell below ten days of global consumption in 2006.  Overall, the fundamentals in zinc are shaping up favourably for further price appreciationin the near term.

As always, please contact our office at 604.229.1450 with any questions you might have.

Matthew Zabloski