Alma Recurrent Global Natural Resources Fund

Market Review and Outlook

Despite increased demand for commodities critical to the energy transition, the four largest metals and mining commodity producers have reduced CAPEX by >50% since the last CAPEX peak more than a decade ago. With EBITDA for the four companies on average 9.7% higher than the previous peak, the financial wherewithal exists to invest more, but the companies remain hesitant to invest while valuations remain well below 2013 levels.

Please reach out for Recurrent’s 2022 white paper on Shale’s increased strategic importance in a time of ESG.

Performance Review

In the month of March 2024, the Alma Recurrent Global Natural Resources Fund rose +9.97% net of fees, outpacing the S&P Global Natural Resources Index’s +8.24% return. During the month, portfolio holdings Freeport McMoran and Alcoa each rose more than 24%, benefiting relative performance. The portfolio’s underweight position in gold mining equities detracted from relative performance, since the index’s gold sector rose 16.78% in the month.

Investment Discussion

While inflation gauges have fallen, we have not seen the surge in CAPEX necessary to keep commodity prices sustainably lower

As an investor in capital intensive businesses, we have long identified the impact of capital expenditures (CAPEX) on the operational and financial success of companies. Both the magnitude and efficiency of capital expenditures impact corporate returns, debt leverage, and free cash flows.

While the direct impact of CAPEX on business cycles is fairly well understood, in our July 2022 white paper, we additionally identified the predictive value between CAPEX in commodity sectors and broader economic inflation. In the paper, we highlighted that as commodity CAPEX increased, supply increased over time, reducing commodity prices which reduced economy-wide inflation.

Since the publishing of the white paper, inflation has broadly fallen, with US CPI falling from 9.1% in 2Q 2022 to 3.2% in March 2024. With moderate economic growth and inflation “under control”, many market observers have called for global Central Banks to reduce interest rates to spur growth. In fact, as of the time of the writing of this commentary, some global Central Banks have already reduced interest rates, with the Swiss National Bank cutting rates on March 21st.

While reduced interest rates should spur additional economic growth, our analysis of the 1970s showed that a period of high inflation in the early 1970s was met with significantly higher interest rates, which lowered economic growth and inflation. In an attempt to reinvigorate economic growth, the Fed reduced rates in the mid-1970s, spurring economic growth. Interestingly, since commodity supply remained constrained due to underinvestment, as economic growth returned so did inflation, which lasted until the early 1980s. See the graph for an illustration of the dual inflationary peaks of the 1970s.

CAPEX data indicate that commodity production is likely to remain muted, with implications for long-term inflation trends

With the 1970s experience in mind, in conjunction with the specter of lower interest rates, we wanted to revisit our 2 year old analysis of the CAPEX trajectory of the largest diversified mining companies. With continued economic growth combined with lower inflation, many investors perspective remains biased toward interest rates driving inflation. In contrast, our understanding of the CAPEX cycle can offer insights as to the evolution of inflation.

The comparison of Rio Tinto, Anglo American, BHP Billiton and Glencore 2023 CAPEX levels to the previous peak of 2012/2013 shows that aggregate nominal CAPEX remains 52.1% lower as of 2023, as seen in the chart. Moreover, on an inflation-adjusted basis, since the 2013 peak, CAPEX spending is -70%.

Interestingly, Anglo American, the company with the smallest CAPEX decrease over the last decade, announced a CAPEX reduction in December 2023 which will reduce company-wide production volumes by an estimated 4% in 2024, and an additional 3% in 2025. So while Anglo’s CAPEX decrease from the peak has fallen the least, forward looking CAPEX continues to fall, along with volumes.

Rio Tinto, BHP Billiton and Glencore’s CAPEX expectations are all higher in the coming years, while from a lower base compared to the 2012/2013 peak. In aggregate, the four companies’ estimated 2025 CAPEX will be 39.7% lower than the 2013 peak. With CAPEX levels only starting to rise off of trough levels, commodity supply is unlikely to materially increase for many years. Instead of deflation across the broader economy, as many analysts suggest, low commodity CAPEX is more likely to cause persistent inflation as global economic growth re-emerges.