Today, three Franklin Equity Group portfolio managers who offer their insights on the natural resources sector: Frederick Fromm, CFA, portfolio manager and senior security analyst; Steve Land, CFA, portfolio manager and research analyst, and Matthew Adams, CFA, portfolio manager and research analyst.
FRANKLIN EQUITY GROUP®
Frederick Fromm, CFA, Portfolio Manager and Senior Security Analyst
Steve Land, CFA, Portfolio Manager and Research Analyst
Matthew Adams, CFA, Portfolio Manager and Research Analyst
The environment in 2012 was rife with economic and political cross-currents that can divert investors’ attention away from long-term goals and investment strategies. During times like these, we believe it is important to refocus on what can make natural resources attractive as an asset class. Global consumption increases driven by a combination of world population growth and per-capita consumption trends are likely to continue, in our view, driving demand for commodities longer term. However, over time, we believe it is inevitable that we are likely to experience periods of slowing economic expansion and consumption growth, which should not be mistaken for a long-term shift. Large portions of the world’s population still consume far less than those living in the developed world, and it is likely they will continue to aspire to higher standards of living, in our view. As consumption grows, we believe certain commodities are likely to face supply constraints and robust pricing dynamics, and though fundamental supply and demand trends could shift over time, we expect many companies could benefit from the potentially robust fundamental environments.Given what we see as a likely positive long-term backdrop, short-term periods of market weakness can and, we believe, should be viewed as potential investment opportunities. Although select sub-industries within the natural resources sector have performed well over the past year, most have languished in an environment that has favored dividend-paying stocks. We cannot predict the duration of such periods, but history has shown us that market shifts like the one we have been experiencing do not last forever, and we are therefore optimistic for the long-term potential of the investment opportunities we have been finding.
Investors have been frustrated by a lack of capital return generated by mining companies given the strength of the cyclical upturn and resulting rise in metals prices over the past decade. In response, many miners have refocused their spending in the past year to focus on developing only the most-promising projects and returning capital instead of the growth focus they have followed for the past decade. In theory, this should result in less supply growth for many metals, which in turn would be expected to support prices and potentially improve returns on existing operations. Although gold stocks broadly underperformed gold bullion during 2012, correlations recently returned to their historical positive high levels, leaving many investors hopeful that gold stocks may benefit from any further rise in gold’s price. Inflation currently remains low in most countries around the world, given the weak economic backdrop, but looking forward many investors seem concerned about the long-term impact of government stimulus measures around the world, and they have looked to diversify some of that risk by increasing their exposure to hard assets, such as gold.
Stock market participants have been largely unwilling to look through economic and political turmoil, and volatility seems to have led to a shortening of investment horizons. We believe this situation can create attractive investment environments, particularly for companies we think have the potential to generate attractive rates of return and growth over time, and we are actively seeking such investments. Our core energy investments in large integrated oil companies are generally complemented by exposure to the exploration and production and oilfield services industries, which we believe have strong potential. Although these industries had by late 2012 recovered from summer lows, we believe many of the stocks have remained depressed due to short-term issues and the broader market factors mentioned earlier.
Fears related to slowing growth in Asia and elsewhere in the world have led many investors away from mining stocks. However, several companies have already begun to reduce planned spending levels, which in our view could lead to tighter balances between supply and demand in the future. Meanwhile, we are beginning to see early signs of recovery in some of the most important consuming markets. Although we cannot predict the timing of a recovery, we believe global consumption trends could likely continue to create a favorable investment climate for natural resources equities over the long term.
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