172. Making the most of a multi-decade period of strong commodity demand

10 February 2022 (pre-recorded 7 February 2022)

Below is a transcript of the episode, modified for your reading pleasure. Please check the corresponding audio before quoting in print, as it may contain small errors. Please remember we’ve been discussing individual companies to bring investing to life for you. It’s not a recommendation to buy or sell. The fund may or may not still hold these companies at your time of listening. For more information on the people and ideas in the episode, see the links at the bottom of the post.

[INTRODUCTION] 

Staci West (SW): Welcome back to the Investing on the go podcast. This week we’re considering the role of commodities in the world’s transition to net zero, as well as how commodities fit into a wider investment portfolio. In this interview, Darius sits down with the co-managers of the BlackRock World Mining Trust to discuss the opportunities in mining and metals companies, and how it is positioned to tap into a number of global trends.  

Darius McDermott (DM): I’m Darius McDermott from FundCalibre and today I am joined by the co-managers on the Elite Rated BlackRock World Mining Trust, that’s Evy Hambro and Olivia Markham. Good afternoon and welcome to you. 

Evy Hambro (EH): Good afternoon.

[INTERVIEW]

[0:16]

DM: So this is our first chat on podcast about this particular trust. Maybe we just do a fairly gentle introduction and tell us what types of metals and minors that you invest in.

EH: I think the first thing to remind everybody with regards to the BlackRock World Mining Trust is that we don’t actually invest in metals. We invest in the companies that produce those commodities and as such, we are exposed to moves in the underlying commodity prices, as those companies, you know, sell their production and they get exposure to rising and falling prices, and that influences their profitability. 

So commodity equities act a lot like the underlying metals, but have a high degree of sensitivity to those moves. And so that’s what we’ve done throughout the trust’s history, going back to 1993. We do have the flexibility to invest in commodities via futures contracts, but that’s only a very small part of what we do. And it’s where we are unable to find value in the underlying equities or the shares of those companies. 

In terms of the mix that we’re exposed to. What we try to do is to generate a superior total return through the mining cycle. So that’s the investment objective of the trust. And that’s made up of a combination of income, as well as share price appreciation from the investments that we have in the portfolio. And so we try and optimise the mix of commodities to meet our expectations with regards to where those prices are likely to trend. Today, we have a large exposure to copper. And I know we’ll talk about this later, but it’s likely to be a significant beneficiary of the move to net zero in the global economy. We’re exposed to other commodities that are also going to be beneficiaries of this trend, like steel, iron ore, nickel… Some of the commodities that are going into batteries, such as lithium, which is going to be a big beneficiary of the move to electric vehicles. We also have exposure to precious metals as well, commodities like gold, silver and the platinum group metals as well.

[2:33]

DM: And you touched briefly on income, because I know you made, or the board made a change to this trust a number of years ago. This does actually – unusually, I think for commodity vehicle – has a stated income target. Would you just quickly touch on that please?

EH: Yep. So we don’t have a stated income target, but what we do is we have an income policy where we will distribute all of the, or substantially all of the income generated, in any 12 month period. And our goal – driven by the objective of delivering a superior total return – is to maximise the income potential of the portfolio. And the reason why we made that change in 2011 is because when we looked back in history at the resources sector, in nearly all circumstances, the largest component of total return comes from income. And therefore, if we can maximise the income from the portfolio, that would give us a really good chance of meeting the investment objective of the trust. 

We have four different sources of income inside the portfolio: ordinary dividends, special dividends, which are paid in addition to the ordinary dividends when the companies are doing well. We invest in the bonds that are issued by resource companies and where we can borrow at a lower cost than the companies are paying us, we capture the difference between the two. We make occasional use of options to sell volatility out to the market. This sector is, as most people know, very volatile, and some people are prepared to pay a high price for that volatility. And because we are naturally exposed to that by being fully invested, it’s an opportunity to get income from that. And then we also into kind of the last components of that, we invest in royalty companies, which I know we’re going to talk about a little bit later on, but these are the companies that are directly exposed to commodity prices without operating costs. And by diversifying the income, we have historical been able to deliver a superior yield to the underlying sector.

[4:44]

DM: Yeah, that’s really interesting. I know when we talked about this before at the end of last year, that was a real differentiator and I think of interest. So let’s just touch on the different commodities that you invest in, and how you judge what’s going on in the economy to decide which metals to favour or not to favour. And are there any sort of particular metals where, that you hold throughout the cycle?

Olivia Markham (OM): Yeah. So this is a really interesting question. I think it’s also important to remember that, you know, when we’re looking at the commodity, we also need to marry that up with the commodity equities of the commodity companies. So we do have a broad exposure to the commodities with the BlackRock World Mining Trust, everything from the bulk commodities like iron ore, and coking coal used in steel, you know, the base metals such as copper, aluminum, nickel, the precious metals: gold, silver, platinum, and then also onto the sort of the newer you know, quite interesting factory-related materials as well. And we are very dynamic in the way that we move this around. 

So if we have a look at the portfolio today in the single largest commodity allocation we have currently is to copper. You know, we really like the outlook for copper demand over the next 5, 10, 20 years. And it’s all very much linked to the energy transition and the role that copper has to play in terms of you know, electrifying the world. But then similarly on the supply side, you know, this is an industry that’s really struggled to bring new production into the market. So net net, that points to a tight market for us, that we like. 

We’ve also been very dynamic over the last couple of years in terms of our gold allocation. You know, if we look back to the summer of 2020, the significant, you know, debt issuance that we saw globally, you know, that was a very good environment for gold. And we had, you know, close to 40% of the portfolio in gold-related equities at one point in time. Today, it’s almost half that amount. So we are very dynamic in the way that we do that. But essentially, we really want to ensure that we provide a broad exposure to the commodities through the equities, in order to maximise the total return from the sector.

[7:06]

DM: So to me, that sounds like 2 D’s, both diversified and dynamic, which I suppose we would expect from a team with your vast experience and knowledge. Now we’ve just briefly touched on these royalties. So this is a new concept, I’m guessing for most of our listeners. Maybe you could just give us a simple understanding of what these royalties are. Evy, I know you touched on them with respect to the overall income of the trust, but explain, explain in a bit nice and simple language, if we can what actually that means.

OM: So in terms of you know, royalties, you know, it is – for people who may not be familiar with this – it’s actually quite easy to compare to a set of music royalty. You know, if we look at royalties over mining assets, essentially you are receiving a set percentage of the revenue that’s generated by an asset every year. Now, what drives that revenue, it’s directly the commodity price, the production, and then also how long that production lasts, or how long you sell music royalties for. So there, there are a lot of similarities there. So it is providing direct exposure to a commodity price. And importantly, in the context of the mining sector, it does not have any exposure to cost or capital cost inflation. So it’s a really nice exposure to clean sort of commodity prices. 

In terms of the BlackRock World Mining Trust today, we have two direct royalty investments in the portfolio. We have a royalty over a copper and gold mine in Brazil. It’s been a fantastic return for the portfolio and it’s going to continue for many more years and hopefully they will find more resources and it keeps continuing on and there is no additional capital required. And we also have a royalty over Vale’s iron ore assets in Brazil. Now there’s another way you can also have royalty exposure within the sector, and this is through listed royalty companies who are essentially doing the same thing – they’re investing in royalties – but they are in listed companies that we can invest in as opposed to owning the royalty outright.

DM: A couple of different ways of getting exposure to that niche part of the commodity market.

EH: Darius, it’s also just, one other additional thing to highlight with regards to royalties, is that you asked earlier on about income. And I mentioned about how we’ve diversified our sources of income into four different areas. One of the great things about a royalty is a company can’t turn it off. So when they’re doing badly and commodity prices are low, mining companies often turn off their dividends. And there’s plenty of examples of that. By us owning royalties in the portfolio that allows us to smooth the income journey. So when the rest of the sector is doing it pretty tough we still have those royalties coming in, which allows us to compliment the income that we’re generating from elsewhere. 

[10:18]

DM: Yeah, no, really, really interesting. Now, obviously mining is an extractive industry, and it would be inappropriate not to touch on some of the environmental risks, risks to people going down mines to extract those commodities. And I know the second part of that then is in the link to the electrification, which you’ve touched on already, but maybe you could give us a view as to how you look at the risks associated with extraction and just some observations on the sector and ESG generally, and how you guys do it. 

EH: Yeah, sure. I’d be delighted to tackle that, and I think one of the things that you’ve mentioned in the question there is the big kind of contradiction in a way. You know, the mining sector is producing the commodities that are going to be needed – a near-on essential component of the tools that we use to decarbonise the global economy. You know, you simply cannot achieve this decarbonisation goal without commodities. So on the one hand, you’ve got an essential nature to the activities of the companies are doing. And on the other side of the equation, you’ve often got in some cases, a misunderstanding, but sadly too frequently, negative headlines that come out about the activities of mining companies. 

And so therefore we take it as our job at BlackRock, and obviously asked by the board of the Mining Trust, to make sure that we are investing in the best possible companies through time. Now, clearly, you know, things happen and occasionally there are unfortunate events. Sometimes those unfortunate events are being created by, you know, an unlucky situation, but also they can be created by a mismanagement of assets. And so the board of the trust has asked us to, you know, make sure that ESG is embedded in our investment process. And that’s one of the things we’ve been doing since the launch of the trust back in 1993. The combination of meeting with management teams regularly, engagement with companies through our governance team, site visits to assets around in the world, allows us hopefully to avoid most of the unfortunate events that can happen from time to time. 

And I think the other important part of this, is for us as managers, to make sure that where a company has made a mistake, it’s our job to understand whether or not that is going to be resolved. If the investment that we’re evaluating has a chance of recovering through time, because management has put in place a recovery plan, they’ve put in place a cultural change inside an organisation, they put in place a whole bunch of rules and restrictions, which would prevent this from happening in the past, yet the shares are trading at a massive discount because of perceived ESG risk – that’s one of the opportunities that we have to be able to back management when they’re trying to do the right thing. And if that, if that does recover then there’ll be great return potential from a) the company doing a better job and b) being rewarded for that, with a higher share price in the future. And so hopefully through our engagement, we’re able to be part of that recovery journey that some companies go on from time to time.

[13:45]

DM: Now, another part of this is with respect to batteries and electrification, which I find fascinating. Because if we want to get to electric vehicle fleet globally and other electric power sources, we, as you’ve rightly already said, we need big chunks of lithium, cobalt, et cetera. Would you give us a little bit more on that please?

OM: Yeah. I mean Evy’s already alluded to this in comments here, but I really think when we look at the theme around electrification, the energy transition and move towards net zero. It just simply cannot occur without the commodities to enable it. And with that obviously the mining sector. So it is a very important driver both today, but actually over the next, you know, 5, 10, 20 years for this sector.

So when we think about the commodity that this is the commodities that this is really impactful, it comes back to commodities like copper, you know, the battery-related materials of lithium, nickel, cobalt, you know, the rarer sort of use in magnets and electric vehicles. These are, you know, commodities that are going to see double digit increases in demand over the next, you know, five years or so, very, very substantial improvements in demand. Yet you know, these are commodity markets, which today are quite small, particularly in the case of copper battery-related material. We do believe that we’re going to be in an environment where the prices need to be at an attractive enough level to continue to incentivise new material into the market. 

Now if we think about these areas of, what we would describe as green demands, so investment into renewables, electric vehicles, you know, the grid, solar… You take copper, a very well-established large commodity market today, you know, that that area of demand is going to in and of itself double over the next five years. That’s very, very substantial for a industry like the copper industry, which is struggling to bring on supply. So, you know, you look at numbers like electric vehicles use four times more copper than what internal combustion engines do. But 65% of the world’s use of copper is all related to applications that deliver electricity. You can really see the key kind of underpinning role that the commodities are going to play in this transition. And I think that there is a degree of people under-estimating the challenge that this sector is going to have in terms of actually being able to meet the projected and needed supply growth over the next couple of decades. 

DM: Well you’ve just beaten me to my supplementary question, because you’re the expert. Do you think the mining industry has the ability to double that copper demand? If we just stick with that one, I mean, doubling the commodity in a five year, well, as you say, you can’t just click your fingers and have a copper mine tomorrow, it’s a bit more complex than that.

OM: Yeah, it’s doubling the use in those particular areas over the next five years.

DM: So not doubling the production, but doubling the use. 

OM: So I think it’s the bigger challenge is going to be with some of these smaller, newer areas, particularly in the battery-related materials area. I think, you know, when we take a step from it maybe, the industry is working very hard, we’re see technical advances, but I think, you know, when you step back from it, you know, we are going have to remain in an environment where prices stay at a sufficiently attractive level so that, you know, all available material you know, is economic to bring into the market. And we should also add on this as well, you know, ESG focus, rightly so that the industry places on it, makes it an even greater challenge to bring new supply to the market. 

[17:41]

DM: Yeah, absolutely fascinating. So maybe then just one final question to wrap up, and you might both have different opinions on this, but how do you see the Trust fitting into a wider portfolio? What role does it play? And maybe there’s an inflationary angle that you might want to mention given inflation rates as we sit here in Q1 2022.

EH: Yes, absolutely. I’ll have a go at that. I think you, well there’s a number are ways of answering that question. To me, and maybe I’m biased because I’ve been exposed to this throughout my entire career, is I feel there’s always a role for exposure to commodities within a broader portfolio. The reason for that is that they play an essential part of life. You know, we can’t live with higher standards of living, we can’t industrialise other parts of the globe, we can’t bring people from below the property line to above it without the use of commodities. So as the world evolves and grows and develops, there is a greater use of commodities through time. And, as Olivia said, you know, the challenge on production now is getting greater and greater every day. You know, the world’s best and easiest and closest deposits have already been mined. They were probably mined hundreds of years ago. And now they’re getting harder and harder with more complex jurisdictions, more challenging production techniques and far greater amounts of money going into their development. So from a structural point of view, I think there’s always a role. 

You mentioned inflation, in times of inflation commodities always perform well, especially when inflation surprises to the upside. They are an inflation beneficiary. Now commodity equities give you an exposure to commodity prices, as we mentioned earlier on. But they act like a leveraged way of getting exposure to those commodities. So if you are thinking that commodity prices are likely to rise, then a portfolio of commodity producers will likely outperform the underlying commodities. 

And the last thing that I’ve mentioned and that, and this is a relatively new one. And we touched on it with regards to income, is that mining companies have been for decades characterised with poor capital allocation. But what we’ve seen over the last kind of six years, is we’ve seen them doing exactly the opposite: instilling capital discipline into the way that they run their business, paying off all of their debt and returning surplus cash to shareholders. Now, it’s only been six years since they’ve really kind of bottomed out on this. It’s been about 10 years since they started the kind of decline in reinvestment back into their business. But during that time period, they’ve really re-earnt investor trust. And I think it’s fantastic that we’re seeing this just at a time where we into, as Olivia has said, and I totally agree with, a multi decade period of strong commodities demand. 

So the last point I’ll mention in terms of what role should they play in a portfolio, is that they are going to be one of the biggest beneficiaries of this net zero goal for the global economy. And so they do bring to your portfolio all of the characteristics that we’ve mentioned earlier on, plus exposure to the transition to a net zero economy, but they also come – and it’s healthy for me to say this – with a high degree of volatility. And so you shouldn’t have all of eggs in one basket, but there is always a role for exposure to commodities and commodity-producing equities in a broader portfolio.

DM: Evy, Olivia, thank you very much. That’s absolutely fascinating, not just about the trust, but about that transition to net zero and electric vehicles. 

SW: No one knows what 2022 has in store for stock markets, or central banks, for that matter. Some might suggest holding gold as a hedge against central bank mistakes (which are a real possibility) or, as we’ve just heard, use mining as a play on the transition to a cleaner economy. To learn more about the BlackRock World Mining Trust visit fundcalibre.com and don’t forget to like and subscribe to the Investing on the go podcast for more episodes each week.

Please remember, we’ve been discussing individual companies to bring investing to life for you. It’s not a recommendation to buy or sell. The trust may or may not still hold these companies at the time of listening. Elite Ratings are based on FundCalibre’s research methodology and are the opinion of FundCalibre’s research team only.