New home sales

Sales of previously owned houses declined 3.7% month-on-month to 6.010 million units in March, marking the lowest level in 7 months and missing market expectations to edge up 0.8%. It was the second straight decline as home prices hit record highs and inventory has fallen to low levels. Nonetheless, properties are selling at a record pace of just 18 days on average. National Association of Realtors chief economist, Lawrence Yun, said, “Consumers are facing much higher home prices, rising mortgage rates, and falling affordability, however, buyers are still actively in the market. The sales for March would have been measurably higher, had there been more inventory.”

US existing home sales

To recap recent financial performance and James Hardie has delivered a string of strong results recently and in the fiscal third quarter (3 months ended 31 December 2020), James Hardie’s group net sales surged 20% to US$738.6 million, as sales volumes increased 16%. The result was propelled by higher net sales across all main geographic regions. Gross profit came in at US$272.0 million for the quarter representing an increase of 23%. Group EBIT jumped 49% to US$131.8 million with EBIT increasing strongly in all regions, as costs were well contained. Net operating profit expanded 50% to US$68.6 million, with a corresponding increase in earnings per diluted share to 15 US cents.

Looking at adjusted figures, which are the more closely followed metrics and adjusted group EBIT surged 57% to US$167.9 million. The result was driven by a strong increase in the key North American business, supported by a jump in Europe and solid increase in APAC. Costs were kept under control with the adjusted EBIT margin expanding 530 basis points to 22.7%.

Adjusted net operating profit (NOPAT) jumped 59% to US$123.3 million. Operating cash flow swelled 72% to US$285.0 million and cash flow generation in the fiscal year has benefited from continued improvement in the company’s LEAN manufacturing initiatives, the strong organic sales growth and integration of its supply chain.

Group summary

Source: JHX

James Hardie noted it had achieved global LEAN savings of US$83.4 million in the first nine months of the fiscal year. As a result, operating cash flow for 9M21 were up 72% to a record US$678.4 million. Management has done a good job in reducing working capital and inventory overhang.

Summary

Shares of James Hardie have continued to be solid performers year-to-date. The North America market remains critical to the group performance and housing industry metrics remain encouraging, due to ultra-low interest rates and a shift in housing preferences, prompted by the pandemic and now we have a recovering jobs market. The company continues to increase market share and is pushing into the remodel and repair market, which has a long runway of growth considering the aged housing inventory in the United States alone. The company has delivered a string of strong quarterly results, and we see strong trading conditions continuing.

We recommend James Hardie as a buy to Members without exposure.

Disclosure: Interests associated with Fat Prophets hold shares in James Hardie Industries.

The standout mine was Ernst Henry, that delivered a 10.6% yoy increase in gold production for the March quarter, to 22,408 ounces. Both gold grades and gold recoveries drove the result. Gold grades moved up to 0.62g/t gold from 0.60g/t for a year earlier and gold recoveries jumped to 73% from 70.3% for a year earlier.

For the reported quarter, Cracow was sold and did not contribute production, while Red Lake was acquired and contributed new numbers, both comparative to the March quarter 2020. Cracow contributed 22,227 ounces of gold to the March 2020 quarter, while Red Lake contributed 35,810 ounces to the March quarter 2021, for a total net gain of 13,583 ounces to the reported quarter. The acquisition of Red Lake is now paying dividends, as its fresh gold production has fully offset production lost through asset sales. We expect Red Lake’s overall contribution to the group in the near-term will accelerate, as Evolution has not sold any further assets.

Silver as a by-product printed higher numbers for the March quarter, with a 23.8% rise yoy, to 146,370 ounces. Evolution also produces a small amount of copper, with production up 3.8% yoy, to 5,013 tonnes. A pleasing aspect of the reported quarter was the delivery of higher silver and copper volumes into higher realised prices for both.

Operating costs rose on the softer production result for the quarter, with all-in sustaining costs (AISC) coming in higher. The following chart shows quarterly AISC:

Source: Evolution Mining

AISC printed a 28% rise yoy, to A$1,268 an ounce. Lower gold production was a key contributor to the result. Four of Evolution’s five sites, in Cowal, Mt Carlton, Mungari and Mt Rawdon all contributing headwinds to the AISC result. Ernst Henry ran against the trend with the reporting of an improvement in its AISC of 627% yoy, to negative A$1,027 an ounce. Higher production numbers and an improvement in by-product credits, on higher realised prices for both silver and copper, caused the result.

AISC guidance for 2021 has been upgraded and is forecast to be in the range A$1,190 to A$1,220 an ounce, from the previous forecast in the range of A$1,240 to A$1,300 an ounce. The guidance upgrade was a key standout, and we are pleased with Evolution’s cost competitiveness relative to its peers.

The average gold price received fell 5.9% yoy, to A$2,227 an ounce for the March quarter. We hold a positive view on the gold price over the remainder of 2021 and expect the price to close higher by years’ end on rising inflation and a weaker US Dollar. Realised sales prices for silver and copper on the other hand were both higher for the quarter. The realised silver price was 22.2% higher yoy and the copper price 48% higher yoy, to A$33 an ounce and A$12,137 a tonne, respectively. We hold a positive view for silver and copper prices on the same reasoning as for gold.

The weaker realised gold price and lower gold production number impacted net mine cash flow, which fell 36% yoy, to A$101.2 million for the quarter.

As of 31 March 2021, debt stood A$500 million and cash A$333.1 million, for net debt of A$166.9 million. This compares favourably with the net debt position from a year earlier of A$570 million. We have no concern with the structure of the balance sheet from the data provided.

Operationally, the March quarter numbers were a little disappointing, with a lower realised gold price amplifying the poor operational result. There were certainly gems hidden in the result such, as the higher silver and copper production numbers and 2021 production forecasts remaining unchanged. The standout feature was the upgrade to 2021 mine costs, an improvement that will maintain Evolution’s competitive position on the gold cost curve.

We believe Evolution is well positioned to leverage into our scenario of a higher gold price going forward. While a competitive downward shift in its mine costs will amplify the financial benefit. The weakness in the share price, we believe, is not reflective of our favoured gold price scenario playing out.

Consequently, we continue to recommend Evolution Mining as a buy for Members with no exposure to the stock.

Disclosure: Interests associated with Fat Prophets holds shares in Evolution Mining.

Gold production for the March quarter also fell, but by 2.7% yoy, to 9,100 ounces. The following chart shows quarterly gold production for the DeGrussa mine:

Source: Sandfire Resources

A lower milled gold grade was the primary driver, with the March quarter result reporting a grade of 1.5 grams per tonne (g/t) compared to 1.7g/t gold from a year earlier. Sandfire did however reiterate its 2021 guidance to be in the range of 36,000 to 40,000 ounces of gold. Sandfire expects gold production to come in at the top end of its 2021 guidance band. In 2020, Sandfire produced 42,263 ounces of gold.

Operating costs got an unpleasant boost for the March quarter. The following chart shows quarterly C1 costs for the DeGrussa mine (lb – pound):

Source: Sandfire Resources

C1 cash cost for the DeGrussa mine reported a 17.6% jump yoy, to US87 cents per pound. Primarily on the fall in copper production for the quarter, costs came in higher.

Guidance for C1 cash costs in 2021 has however been upgraded and is forecast to be in the range of US80 cents to US85 cents per pound, from the previous US85 cents to US90 cents per pound. Forecast upper end production for both copper and gold is the primary driver in Sandfire resetting costs lower. The upgrade is the standout feature from the March quarter result.

We have a positive view on the copper price over the remainder of 2021, as infrastructure spending stimulates demand. A weaker US Dollar will also, in our view, be a positive tailwind, as it succumbs to an increasingly leveraged US economy on rising US debt levels. Rising inflation will also increase the velocity of the tailwinds, as economic activity accelerates and creates supply chain bottlenecks.

A snapshot of the balance sheet, as of 31 March 2021, shows no debt and a cash hoard of US$463.6 million. The debt position from a year earlier was unchanged, while the cash hoard stood at US$242 million. We view the balance sheet as a sound platform to deliver future shareholder value from Sandfire’s extensive development and exploration portfolios.

We believe the DeGrussa and Monty mines and the significant acreage around them and an extensive blue sky exploration portfolio, are key factors in determining our view on Sandfire. Innovations in mining practices such as installing solar power, well ahead of the pack for the DeGrussa mine, are now fully bearing fruit and being reflected in Sandfire’s financials, are added considerations. A positive view on the copper price delivers the leverage.

Despite the rally in the share price, including the recent surge through A$6.00 to a tad over A$7.00, we believe Sandfire Resources is well positioned, operationally and financially, to retest new share price highs.

Consequently, our recommendation for Sandfire Resources as a buy for Members with no exposure remains unchanged.

Disclosure: Interests associated with Fat Prophets holds shares in Sandfire Resources.

Synergies on track

Source: Amcor

The quarterly dividend of 11.75 cents was declared, up a tad from 11.50 cents a year ago. The ex-dividend date is 25 May 2021, with a payment date on 15 June 2021. Holders of CDIs on the Australian Stock Exchange will receive 15.12 Australian cents per share.

Turning to the segments briefly and net sales year to date for the Flexibles segment of $7,350 million were 1% higher than the prior period in reported and comparable constant currency terms, driven by 1% higher volumes. Demand remained relatively broad-based with growth in North America, Latin America and the Asia Pacific regions, while Europe was flat with a year earlier. Notably there was double-digit growth in China and India. There has been growth in a range of end markets, including protein, coffee, cheese and petfood, partially offset by lower healthcare volumes beginning from the June 2020 quarter, with this due to fewer elective surgeries and prescriptions.

Adjusted EBIT for the segment increased 9% in comparable constant currency to $1,005 million, which was helped by 4% organic growth (higher volumes and improved cost management). The other 5% came from synergy benefits linked to the Bemis acquisition. The adjusted EBIT margin improved 1.1 percentage points to 13.7%. Management noted that input cost rises had been manageable.

Year to date net sales in the Rigid Packaging segment of $2,059 million were a smidgen higher on a reported basis compared to $2,047 million a year ago but up roughly 7% on a comparable constant currency basis. Volumes increased 4% with growth in North America and Latin America, while price/mix had a 3% benefit, which included pricing to recoup input cost inflation in Latin America. Beverage volumes in North America were a notable 7% higher and hot fill container volumes were up 13%. Specialty container volumes grew in certain categories such as spirits, personal care and home planning.

Segment adjusted EBIT increased 9%, driven by higher volumes and positive price/mix. The adjusted EBIT margin expanded 50 basis points to 10.1%.

Outlook

Regarding the outlook and the strong results to date have given the company the confidence to lift its EPS growth guidance to a range of 14% to 15%, up from the previous range of 10% to 14%. This followed on from earlier hikes in guidance during the fiscal year.

Summary

Packaging giant Amcor has continued to deliver, as shown by the impressive cost control and earnings performance in the latest quarterly update. Amcor continues to be well placed to cater to trends that were already in place. E-commerce has been accelerated by the pandemic and Amcor will also benefit from the shift to smaller individual portions and premiumisation. Additional synergies and other benefits from the Bemis merger, which is on track, bolster the investment case, as does pricing power and an appealing dividend yield in this low interest rate environment.

We rate Amcor as a buy for Members without exposure.

 Disclosure: Interests associated with Fat Prophets hold shares in Amcor

With the Australian gold price current trading around A$2,409 an ounce, operating margins will be substantial. We expect synergy savings will, as managements’ understanding of the merged group and the operation of each mine is more understood, lead to savings flowing. A lower AISC guidance range for 2021 does provide us with considerable comfort on this front. On synergies, post the merger, savings of A$1.5 billion to A$2.0 billion could be unlocked and we viewed this as a key benefit for Saracen shareholders.

Guidance for 2021 AISC is forecast to be in the range of A$1,390 to A$1,520 an ounce and was left unchanged.      

The March quarter activities report has provided the first glimpse of the combined balance sheet. Northern Star indicated debt of A$658 million and cash (A$637 million) and bullion (A$59 million) of A$696 million, to give a net cash of A$38 million. As of 31 March 2021, Northern Star held A$16 million in equity investments. On this snapshot, we would have no concerns over the structure of the merged balance sheet.

The merger has brought with it a clear pathway for Northern Star to produce 2.0 million ounces of gold per annum, with the trajectory to this target shown in the following chart:

Source: Northern Star

We are of the view Northern Star has significant brown and green field opportunities and the financial capacity to deliver on this target. With growth of +30% expected, this profile was another key feature for Saracen shareholders in the merger.

As of 31 March 2021, Northern Star carried a hedge of 844,309 ounces of gold with an average delivery price of A$2,203 an ounce. Deliveries are on the June/December months out to December 2023. We consider the position as a prudent risk management tool.

The Kalgoorlie Super Pit and the potential this piece of dirt has now that it is controlled by one savvy explorer is a key feature for Saracen shareholders, despite both Northern Star and Saracen owning half each pre the merger. The following image shows the local region of the Kalgoorlie Super Pit:

Source: Northern Star

A 1.1 million ounces of gold production target is now crystallising around the Super pit region. At Mt Percy (second name from centre top) there is a 8.1 million resource graded at 1.2 grams per tonne (g/t) gold for contained gold of 317,000 ounces and at Croesus (dead centre name) there is a resource of 10.5 million tonnes graded at 1.7g/t gold for contained gold of 588,000 ounces. While at Little Wonder (third name from centre top) there have been returned outstanding assays of 182 metres graded at 2.3g/t gold and at Jacks Reward (very bottom centre name) assays returned 72 metres graded at 1.0g/t gold and 15.9 metres graded at 3.2g/t gold. Given these sites are within trucking distance of mills they are outstanding results in their own right and more so with mills nearby.

With the financial capability to explore and develop ground and with the ground to do this and not just the Super Pit region, we find Northern Star a compelling story. Add our positive view on the gold price over the remainder of 2021 and beyond and the story is complete.

Consequently, we continue to recommend Northern Star as a high conviction buy for Members without exposure. Members already exposed to Northern Star, through the Saracen merger, and have yet to top up their exposure should take this opportunity to do so.

Disclosure: Interests associated with Fat Prophets holds shares in Northern Star.

ANZ continues to progress with its strategy to simplify and streamline the bank and reported a 1% fall in expenses over the past six months and a 2% decline year-on-year. The goal is to further reduce the cost base by a further $900 million over the next couple of years, which will include continued modernization and faster transaction processing from digitalization.

Summary

ANZ reported a strong improvement in cash profit in 1H21, with a significant net provisions release. The worst appears to be well in the rear-view mirror given the strong momentum in both the Australian and New Zealand economic recoveries. Credit quality was good leading into the crisis, and the levels of soured loans are lower than earlier anticipated. Accordingly, the dividend has already bounced back faster than the market has expected and we expect further net provisions releases going forward.

ANZ entered the pandemic with a simplified business model, after withdrawing from many Asian markets and is well placed to return to finding the right balance between a leaner operation and growth on the far side of the crisis. A strong balance sheet provides support.

We recommend ANZ as a buy to Members without exposure and a medium-term or longer investment time frame.

Disclosure: Interests associated with Fat Prophets hold shares in ANZ

Importantly China, which remains critical for Australia’s economy despite rising tensions between the two countries, has rebounded strongly. The Chinese economy expanded 18.3% year-on-year in the March, accelerating sharply from the 6.5% pace in the fourth quarter and a little below the market consensus of 19.0%. It was the strongest pace of growth since the data series began in 1992. The latest print was up against a low base a year ago when Covid-19 froze activity and supported by a strong rebound in domestic growth, a recovery in global demand and domestic monetary measures. Chinese authorities have a 6.0% growth target for 2021, which I suspect will easily be exceeded and follows on the heels of 2.3% growth in 2020 when the Chinese economy was one of the few economies to log growth.

Australia experienced a more modest drawdown in economic growth in 2020 than most other developed countries due to its lower Covid-19 infection rates. Despite several minor flare-ups this year, Australia has still managed to maintain case rates at very low levels and the Australia/New Zealand travel bubble was a first step towards reopening borders, although there has been a few ‘pauses’ there and a broader reopening is still some ways off. The vaccine rollout has also been relatively slow.

Still, the Australian economy has rebounded strongly in early 2021, with momentum improving rapidly. At its May 4 meeting, the RBA upgraded economic growth and employment forecasts yet maintained a commitment to keep rates where they are for the next two years, and despite acknowledging the inflationary pressures that are clearly pushing through the system.

The RBA’s central scenario for GDP growth has been revised up further, with growth of 4.75% anticipated over 2021, followed by 3.5% in 2022. A pick-up in business investment is expected, with household spending to be supported by the strengthening in balance sheets over the past year. The unemployment rate is expected to continue to decline, to be around 5% at the end of 2021 and at 4.5% by the end of 2022.

We note that the unemployment rate had fallen to 5.6% in March, from 5.8% in February and a recent peak of 7.5% in July 2020. The fall in unemployment was despite the participation rate ticking higher to 66.3%. Total employment rose by 71,000 during the month, although the numbers were taken prior to the end of JobKeeper so there will be a lot of interest in next month’s print. We don’t think we will see a massive reversal and given a number of economic tailwinds coming through.

The number of jobs in the economy has surged past pre-COVID-19 levels with more than 2000 new jobs returned per day. The recovery has certainly been stellar with Treasurer Josh Frydenberg noting that “Australia’s labour market is recovering 4.5 times faster than the experience of the labour market during the 1990s recession.”  There are now more Australians in work today than at any time in history.

Australia unemployment rate

At the May RBA meeting, Governor Philip Lowe wrote, “Despite the strong recovery in economic activity, the recent CPI data confirmed that inflation pressures remain subdued in most parts of the Australian economy. A pick-up in inflation and wages growth is expected, but it is likely to be only gradual and modest. In the central scenario, inflation in underlying terms is expected to be 1½ per cent in 2021 and 2 per cent in mid 2023. In the short term, CPI inflation is expected to rise temporarily to be above 3 per cent in the June quarter because of the reversal of some COVID-19-related price reductions.”

Monetary policy is set to remain accommodative for some time, with significantly higher wages and further tightening of jobs market conditions. The RBA believes tightening is likely years in the future (2024) and has placed a high priority on full employment.

IHS Markit PMI survey data for April showed a significant upturn in manufacturing and services activity at the national level. There were early signs of a renewed expansion of exports, although tourism and education will continue to face headwinds for a while yet.

The economy and the stock market can be two very different beasts sometimes though, so it is pleasing to see that Australian equities advanced modestly in the first quarter and have pushed higher since, setting a record high on Monday (yesterday). The new record has been powered by the twin engines of banks and resources. While we believe a retest of the breakout level at 6800 is plausible this month, we expect the market to continue moving higher.

We believe the market can push on much further in the months ahead after we get through May. This is as the ‘V’ shaped economic recovery, which we called during the COVID lows last year, continues to gain momentum. Outcomes continue to be better than feared across the board, thanks to how effectively Australia has dealt with the pandemic, both from a health and economic perspective.

Rising commodity prices have played a big part in the resurgence of the economy, and not least of which is iron ore that has been rising at a breakneck pace. This is clearly going to be a big feature of tonight’s budget and given the government has vastly underestimated the pricing strength of the steel-making ingredient. In December the Treasury’s mid-year economic and fiscal outlook included a forecast that iron ore prices would decline to around US$55 a tonne.

With a near 50% leap in iron ore prices since the start of the year, the budget is therefore going to look a look healthier than was anticipated. This is as both China and the world looks to undergo an economic reboot following Covid, through massive infrastructure investment initiatives.

This is all obviously great for the iron ore producers BHP, Fortescue and Rio which rose by 3.1%, 7.9%, and 4.6% respectively yesterday, making record highs in the process. BHP is a member of our Income Portfolio.

ASX 200 resources sector

A rebounding economy has not surprisingly increased confidence, on the part of investors, consumers, and businesses. The NAB’s business conditions and confidence levels have both hit new record highs in April. And while the ‘sugar rush’ has moderated a bit, the consumer is in a good place as well – March retail sales rose 1.3% month on month.

Source: ABS

Increasing confidence in the economic recovery is manifesting itself in rising levels of M&A activity. The stakes have been raised for casino operator Crown as Star Entertainment has proposed a merger – which values Crown at over $14 a share. This trumps a revised bid from US global investment business Blackstone at $12.35 a share, made yesterday morning. We think a bidding war is about to ensue now that James Packer is a seller.

As noted above, a strong rebound in bank shares has been a key driver of the Australian market as well, with the financial sector the largest in the Australian share market by market capitalization. Fears about bad debts have proved excessive and three of the big banks recent reported upbeat results. Provisions are being released and dividends are firmly back on the table, while government bond yields have risen this year, boding well for higher profits on loans. Banks form the backbone of the Income Portfolio, with ANZ, Westpac, NAB and Bank of Queensland all constituents. The other financial constituents, QBE Insurance and Suncorp have also re-rated upwards over the past year.

ASX 200 banking sector

The upshot of this has been that markets have ticked up 4% since our last Income Portfolio review in February, with the record high reached yesterday.

The results season has confirmed many doing well, although there is a clear bifurcation with the likes of tourism still struggling given an effective border closure, although the travel bubble with New Zealand is a welcome development for the sector.

Our notional portfolio of income stocks has also performed well in that time, led by the banks/financials and strong cameos by the likes of BHP, Collins Foods and James Hardie.

The A$ has strengthened a smidgen to US$0.78 (from US$0.77) since our last review, and the 10-year Aussie bond yield has risen materially to 1.66% (from 1.23%), although much of the rise was in late February and the yield has effectively traded in range since.

A$

Interest rates aren’t about to shoot up any time soon and this combined with solidly improving fundamentals for the economy and corporates, in our view continues to underpin the case for holding a high-quality portfolio of strongly yielding income stocks.

Income Portfolio Performance

As summarised below, we have updated the Fat Prophets Income portfolio using stock and index prices as at the close of ASX trading on the 10th of May 2021.

On the income front the portfolio has a return to date of 22.7%. It should be noted that this is an average income return, and it has inched higher from the 22.3% level at the last update, which we view as solid given the influx of new constituents over the past year.

A re-rating in share price values has also seen the average capital return improve from 22.3% at the last review, to 26.4% at this update. The total return on the portfolio has also increased to 48.6%, versus 44.1% at our last update.

Portfolio performance table

(Note to Members, please click here to download the file)

The average yield (FY21) sits at 4.4%, and is 4.6% for FY22 which is impressive given the share price appreciation that has been seen. The average yield has pushed up materially since our last review (the FY21 yield was 4.0% back in February), with the banks and BHP driving the show. The portfolios yield is some way above that for the ASX200 which is at 3.8%, as tech and growth stocks don’t tend to have dividends, or if they do, very low yielding ones. We are comfortable with the positioning of the Income Portfolio on the dividend side overall.

Portfolio composition table

(Note to Members, please click here to download the file)

Portfolio commentary

We remain positive on the banks with our investment stance predicated on an ongoing ‘V’ shaped economic recovery, and a robust property market. The long-end of the yield curve (which the RBA cannot control) has risen this year and this will support bread-and-butter banking operations.

Source: Trading Economics

Our thesis of better than feared bad debts (and rising dividends) from Covid-19 has been playing out and we have seen this in the recent reports from the big banks. Last week, ANZ released a significant $491 million net provisions release and announced a bigger-than-expected 70 cents interim dividend (fully franked).

The financials have been strong since our last review, with ANZ (we issued a note on ANZ’s interim result today) rising 8%, NAB up 6%, Bank of Queensland advancing 7% and Westpac the strongest, gaining nearly 18%. Amongst the insurers Suncorp (also part bank) ticked up 4%, while QBE put in an impressive 26% upward spurt. Hardening premium rates are a major supportive factor for QBE (and other insurers like Suncorp), along with likely improved investment income. QBE’s investment income has been pressured by falling interest rates, but for QBE what is more relevant is the yields on longer dated bonds (to where the portfolio is tilted). These have already inflected higher in 2021 and the trend could gain further momentum. This bodes well for QBE’s investment income and bottom line going forward. The appointment of a high-quality CEO to join in September was welcome news and provides what had been a missing part of the puzzle.

BHP is a prime beneficiary from the booming commodities market and particularly the surge in iron ore prices we discussed above. A strong economic recovery playing out in China should dovetail with a broader global economic recovery this year as the vaccine rollout has been rapid in the US and UK, and is progressing throughout Europe. BHP shares are up 17% since the February review.

Shares of KFC and Taco Bell operator Collins Foods have advanced 11% since our February review. Although full year results aren’t due until June, we remain bullish about the long-term investment case and along with the growth we believe is on the way, should come higher dividends over time. The company in our view has a long runway for growth, both in Australia and as management continue the European expansion post COVID-19. KFC demand has been very strong during the pandemic, amid a significant advertising campaign, and increasing brand awareness. This should set up for a strong set of numbers when full year results are released.

James Hardie shares have advanced 7% since our February Income Portfolio report and we have been more than content with its operational and financial execution. We view the rise as justified as the core US housing market continues to look robust and James Hardie has continued to pick up market share, with more likely to come. Under CEO Jack Truong, the operational and financial performance has continued to impress, with cost-out manufacturing initiatives combined with strong sales boosting margins. New product initiatives should boost sales further in upcoming years.

Low interest rates and bond yields have supported REITs, including Scentre Group and Stockland although both are relatively little changed from our February review (when they had pushed higher). We added Vicinity Centres to the Income Portfolio in February, as a reopening play given that occupancy rates were holding up well without the foreign tourists, and with the domestic consumer in an upbeat mode – something that has continued. We also cited an attractive yield and discount to net assets. The shares are little changed from February, and we believe the positive investment case is intact.

The telcos Telstra and Spark New Zealand have been a mixed bag since February, with Telstra advancing 10% and Spark sliding 6%. Rolling out 5G networks bodes well for both businesses with prospects to improved ARPU (average revenue per user), key to growth and supporting dividends.

Summary

All in all, the Income portfolio appears to be doing its job quite well, and providing exposure to companies that have made it through the pandemic in reasonable shape (and excellent in some cases). We remain comfortable that the basket of stocks provides strong exposure to companies with robust cash flows, and dividends, along with the prospect of some share price upside.

We would once again like to remind our Members that it is up to them to decide how they make use of the Fat Prophets Income portfolio that is discussed in this report.

Investors should be aware of the 45-day rule as a relevant factor. This rule requires investors to hold a stock for at least 45 days (including the ex-dividend day) to be entitled to the franking credits attached to a dividend payment.

A self-managed Superannuation Fund (SMSF) must also hold company shares for the 45-day period (plus the day of purchase and day of disposal) to be entitled to the franking credits. However, the 45-day rule does not apply to individuals whose total franking credit entitlement for a financial year is below $5,000. All SMSFs must adhere to it though, irrespective of the size of the franking credit amount.

In any event the current bidding situation is a win-win for investors.

Mainstream has now received nine takeover proposals from four separate parties. Vistra’s initial bid at $1.20 certainly seems like a long time ago (and almost derisory). Our view that it was too low, and would only be the first shot, has proven correct. The latest offer is 2.17x what Vistra put forward.

It ain’t over till it’s over and with the shares trading around the most recent offer, there could still be further bids to come. It remains to be seen whether either party will be prepared to go ‘all in.’ Although the bidding increments have clearly slowed. There is still almost an element of FOMO it would seem as sector participants appreciate what a great business Mainstream has, and a mandate pipeline in the US that could still be worth as much, if not more, than Mainstream itself. And with the industry in consolidation mode, there is clearly a rush to secure the most prized assets.

We recommend Members continue to hold their Mainstream shares.

Disclosure: Interests associated with Fat Prophets hold shares in Mainstream

Group underlying EBIT surged 40% to $73.8 million and underlying profit after tax was up 41% higher at $67 million. Statutory profit surged 31% to $68.2 million. Underlying earnings per share was 38% higher at A$42.9 cents. Elders announced a fully franked interim dividend of A4 cents per share and lower from A$9 cents from last year (-55.5%). The lower dividend payout this time around likely reflects the cautionary stance in light of uncertainty from the ongoing COVID-19 pandemic. The concerning fact, however, is that management originally issued press releases noting a A20 cent dividend payout (+122% yoy) but suddenly – about an hour later – released a correction noting the actual dividend of A4 cents. This could just be an honest mistake but it is still worth monitoring as such lapses do influence price action.

Source: 17 May 2021 Elders Presentation

Operating cash flow was lower year-on-year down 13% with the much higher payout for incentives with stronger performance this year but also due to much higher working capital requirements for the Rural Products division. Elders’ return on capital has improved a tad up 1.2% to 20.1% reflecting the higher earnings from all divisions. This result is pleasing above the 18.5% 3-year average and the 15% target in the Eight Point Plan – this is likely to keep at pace as the sector continues to see a bumper year. The leverage ratio of 1.5 times was well below 1.9 times a year ago.

Looking at the performance by product margin, and Retail Products was the greatest beneficiary having seen a bump of $18 million with a bumper crop supported by strong demand. There were also improving margins as a result of ‘pricing techniques.’ Wholesale Products also reported a strong performance with AIRR contributing an additional $11.9 million in gross margins – a performance above management expectations.

Agency Services was another solid contributor up $6.2 million as a result of strong livestock prices for cattle and sheep – a result of limited domestic supply. Wool prices have also recovered and the boost in demand also resulted in a much strong comparison on a year-on-year basis given that last fiscal year saw subdued global demand, particularly in China as factories were shut down.

Source: 17 May 2021 Elders Presentation

Real Estate services margin increased $5.2 million reflecting much stronger turnover across residential and broadacre volumes – likely the result of positive expectations for the sector. The Financial services margin was up $1.8 million with stronger performance in the insurance business as well as interest income from a new offering: livestock funding.

Costs this year were up substantially by $16.5 million due to the effects of acquisition, higher insurance costs and investment in IT modernisation. Despite the bump, these are all worthwhile. Overall we’re pleased with the strong result.

Briefly on the geography side, there were broad-based improvements at home, while international showed some slight improvements – likely reflecting the logistical difficulties during the pandemic. Corporate overhead, however, has increased reflecting the continued investment in the Eight Point Plan.

Source: 17 May 2021 Elders Presentation

On that note, we look at the company’s progress of its third Eight Point Plan. According to management, Elders continues to develop greenfield sites as well as acquisitions and also improved its frontline sales teams and IT solutions. The company looks to be well on track to achieve its key financial goals where they are targeting 5% to 10% growth in EBIT and EPS through the agricultural cycles at a return on capital of 15%.

Finally, outlook for the remainder of 2021 remains positive with positive expectations for the winter crop and cattle prices are expected to remain strong. Other segments are also expected to maintain momentum. The only downside is cost expectations which are pegged to hit higher but are meant to support the Eight Point Plan.

We maintain a buy on Elders for Members without exposure and who have a longer-term investment horizon.

Disclosure: Interests associated with Fat Prophets hold shares in Elders.

3Q21 Trading Update

Looking at the trading update, 3Q21 performance continues to reflect impressive momentum that started in 1Q21 and FUA continues to trail higher breaching a new record level. It’s also pleasing to note that the pace has also increased with the average monthly net inflows up 35% year-on-year to $556 million.

Moving on to FUA metrics, Custodial Platform FUA reached $35.61 billion at the end of the period, which surged over double (+135.8%) on a year-on-year basis. Total FUA has nowe ballooned to $51.39 billion, including the $15.77 billion of non-custodial FUA from the Ord Minnett PARS acquisition (+100x). This stellar result was driven by record platform quarterly net inflows of $1.92 billion – up 40.9% on the net inflows year-on-year – while the acquisition strategy has provided a large chunk of the growth. It seems that management’s platform FUA target (~$43bln to $49bln) are well within reach.

The image below illustrates the impressive results:

Source: 20 April 2021 HUB24 Filing

Recent trends in the area have been encouraging, as more Financial Advisers seek to be ‘independent,’ and open their own boutique Advisory/Licensee firms and then transition clients toward independent Financial Services Platforms. That said, the company has since attracted more Advisers and brought the tally to 2,758, up 41% year-on-year.

Source: 20 April 2021 HUB24 Filing

Given the company’s offerings (platform, managed portfolios, super) are attractive and market-leading, we expect to see more growth with more Boutiques, Brokers and Independent Advisers onboarding. Going forward, HUB24 maintains an impressive new business pipeline with the signing of 28 new licensee agreements during the March quarter. These include agreements with both large boutique licensees and self-licensed practices as well as cross-selling from Xplore solutions. Growth in this area should lead to more FUA inflows as well as transaction fees.

We retain our long-term positive view on HUB24, and indeed on the other financial service platform operators which we cover, given the degree of implicit operating leverage. A high degree of fixed costs will see the current lofty earnings multiples drop away over time, as HUB24 continues to grab market share in a fragmented sector, and with Australia’s underlying pot of investable funds growing strongly.

We maintain a Buy rating on HUB24 for Members without exposure.

Disclosure: Interests associated with Fat Prophets declare a holding in HUB24.

KFC drive thru queues in Sydney

Over in Europe ,management reports that the German KFC restaurants continue to trade through take-away, drive-thru and delivery channels whilst certain Government restrictions have reduced dine-in turnover. SSS for the five-week period was -28%, a hefty fall, but a sizeable improvement over the initial sales drop at the onset of Covid-19. Sales continue to strengthen.

In the Netherlands, where dining in is banned, SSS for the last five-week period was -40%. Collins has been impacted by having a high degree of central city exposure, and these areas have been quiet. However, excluding these, the drive-thru restaurants have performed comparatively well, with SSS around -15% over the last five weeks of FY20.

Elsewhere, management notes that Taco Bell (which is in the early stages of a multi-year rollout plan) has seen sales rebound to pre-COVID levels. Sizzler Australia, has also now implemented take-away and home delivery services.

All in all, the update is very encouraging from Collins Foods, with sales in Australia performing very well, and the European operation starting to see an improvement. The expansion plan in the latter is clearly in a holding pattern for now, and we are not surprised to see that a key exec, Newman Manion, has transitioned back to a non-exec role. His appointment was always meant to be temporary and we are not concerned by this. We however continue to see tremendous upside earnings potential with Collins Foods’ European operation (and indeed Taco Bell in Australia), longer term.

The issue in Europe for now is that drive-thru is not as prominent in the overall mix. As a result, management has taken actions to ‘preserve cash’, minimising operational expenditure, and delaying capital expenditure where possible.

A positive for Collins is that Europe is a much smaller part of the pie versus Australia (which has around 6 times the revenue). While the expansion may now go into a holding pattern (and possibly until Covid-19 ‘flattens out’ or a vaccine is produced), the European footprint offers substantial blue-sky earnings potential in our view.

Meanwhile the Australian business is going well, and will likely maintain the previous momentum (robust same store sales growth) once restrictions are removed, and people are ultimately encouraged to go outside more.

Regardless of the timeline for the restoration of dine-in, Collins Foods is well placed in our view. We believe that Collins Foods’ business model is relatively defensive with its digital and delivery channel having built up and making substantial progress (and accounting for the majority of ‘normal’ turnover). It also helps that a number of food delivery apps are readily available to support this channel. This is also as the company’s balance sheet remains strong.

On the daily chart of CKF, the support line on the daily around $7.38 gave way during the virus crisis, and a bearish moving average crossover (where the 50 day (red line) goes below the 200 day (green line)) has evolved. Strong support however was encountered at the multi-year lows around $3.50, and has provided the foundation for a decisive bounce. A move back above the resistance line at $7.38 confirms the tide has turned upwards.

With reference to the monthly chart, support provided by the longer term uptrend has given way during the virus crisis, as did that at the  50% Fibonacci retracement of $5.89. This has since been reclaimed recently, and a move above back above the 38.2% Fibonacci at $7.05 and above the long term support line, confirms that the correction has run its course, and momentum is back with the bullish camp.

We retain a buy on Collins Foods for Members without exposure.

Shares in master franchiser Domino’s Pizza Enterprises have also performed well over the past month. While operations offshore have been impacted by the lockdown, delivery services have mostly continued unabated, and the company is also well positioned with Covid-19 infection and fatality rates plateauing in many countries. This is also while in Australia, delivery and takeaway sales will have been going strongly.

Domino’s released another Covid-19 update on 24^th April, and the company reported strong progress across a number of geographies.

Australian performance, of course, has been in full swing during the lockdown as it relates to food delivery, which is the crux of the company’s business model. SSS in Australian have remained ‘consistent’ at a national level. Across the Tasman NZ has had an effective ban on food deliveries (supermarkets the main exception), but this changed last week.

The kiwis have moved to a ‘Level 3’ lockdown and opened up for contactless food deliveries. As we have suggested this has seen a ‘surge’ in pent up demand for well branded ‘take-aways’ such as Domino’s. The company was well and truly prepared for this, and had offered 1,000 new jobs as part of the reopening. Anecdotally there has been strong demand for all things take-away in NZ in the first week of Level 3.

Meanwhile in Japan, food delivery is allowed and companies are scrambling to keep up amidst the pandemic. Domino’s Pizza Japan is aiming to take on 5,000 part-time employee including delivery drivers and 200 full-time employees from April to June. The company has more than 600 outlets in Japan, but it plans to expand to 1,000 over 2025-8. The company’s latest Covid update said that the sales performance in Japan has remained strong. The company is, as is the case elsewhere, pushing the message hard that is delivery measures are ‘safe’ and ‘contact-free.’

Source: Domino’s

In Europe, the story is similar. Delivery is allowed in Germany, and it has been leading the region. Re-openings have also occurred in France in the first week of April, with 70% of the store footprint in the country back up and running. Benelux sales have been more affected by a move away from carry-out sales. With Europe also starting to come out of the worst of the crisis, we believe that well branded delivery companies such as Domino’s should continue to flourish, as people’s sensibilities, and perhaps also pockets, may demand.

The company’s low price point means that its offering is relatively defensive even should consumers emerge from the lockdown with greater caution over the economic outlook and their expenditures. A strong store roll-out plan will also still likely occur over the next few years. And with more traditional retailers (e.g. clothing and other non-food retail stores) likely to come under pressure (and potentially shutter) as the consumer becomes more ‘wallet conscious’, ‘defensive foodies’ such as Domino’s may also benefit from the ensuing downward pressure on commercial rents.

While Covid-19 will have taken some momentum out of sales growth as the Domino’s targets $3 billion in sales this financial year, we continue to favour the stock. Indeed, we continue to see international growth as a key strength. The company has not provided short term guidance, but sees the ‘medium term’ outlook as unchanged, with new store openings up 7-9% this year, SSS +3-6%, and net capex of $60 to $100 million. Liquidity remains strong and Domino’s has undrawn committed debt facilities and cash in excess of $260 million.

Turning to the charts, and on the daily, DMP staged an upside reversal in August last year, coincident with a bullish moving average crossover (where the 50 day (red line) goes up through the 200 day (green line)). This has seen resistance around $47.85 cleared and provided the basis for further upside momentum.

On the monthly chart, after hitting highs around $80 in 2016, the stock entered a multi-year corrective phase. This appears to have terminated earlier last year, with support at the 61.8% Fibonacci at $33.87 not tested. A move above the 38.2% Fibonacci at $51.75, and towards the 23.6% Fibonacci at $62.81, since our initial coverage bolstered the outlook further, and opened up the way for further gains. This remains the case given the support region around $51.75 (which has recently been tested on the downside) has been reclaimed.

We continue to recommend Domino’s Pizza Enterprises as a buy for Members without exposure.

Disclosure: Interests associated with Fat Prophets hold shares in Colins Foods and Domino’s Pizza Enterprises.

As Members can see from the above chart, global GDP growth has collapsed into negative territory in the early part of 2020. This collapse occurred as key economies including China, the United States, the European Union, Japan the United Kingdom and a host of countries including Australia, literally shutdown.

Commodity prices were swept along in the turmoil, as demand “actual” and “forecast” collapsed. The nickel price was swept into the maelstrom. The following chart shows the nickel price (in US Dollar per tonne):

Source: Trading Economics

The nickel price had recently, as Members can see from the above chart, caught investor attention on the back of its use in lithium batteries. The source of this interest was the pending electric vehicle (EV) revolution with a lithium ion battery powerplant and the nickel content in these batteries. The arrival of the COVID-19 pandemic in very late 2019 and its presences still quick drove the nickel price down.

Already, as Members can also see from the above chart, the nickel price has recovered from recent lows, as the grip of the pandemic in some countries is already loosening. Many countries are now planning and implementing COVID-19 exit strategies.

The price recovery in nickel is under way as forecasts for global GDP growth improves, and the shape of its steep dive and recovery gains investor confidence. The following chart shows real global GDP growth forecasts including key economies:

Source: Reuters consensus

There is no doubt that Global GDP growth will be negative in 2020 being the peak year for the COVID-19 pandemic. The recovery is however forecast to be a classic “V” recovery. There are still risks in the pandemic, as countries move toward restarting economies, with the biggest being a second wave, given there is no readily available vaccine, so caution, in our view, is warranted.

The driver of this classic recovery is the concerted efforts by governments and central banks to “spend their economies back to life.” Governments cumulatively are spending trillions on stimulatory packages – Donald Trump alone is seeking a further US$2 trillion of spending. As a percentage of GDP, government fiscal spending for 2021 is forecast to turn negative. The following table shows forecast fiscal spending by the G20 countries as a percentage of total GPD:

Source: Bloomberg

G20 government fiscal spending in light of the COVID-19 pandemic is forecast to rise by circa 200 basis points to a positive 1.75%. This is a significant reversal in government spending that will, we believe, shape the global recovery and also act as a medium to longer term tailwind for commodity prices, including nickel, as this spending rolls out into each country’s economy. Adding to this tailwind are the actions of central banks in lowering and sustain at low levels cash rates. Cheap debt will allow economies to leverage recovery spending with higher dollar amounts.

A key takeaway with the consensus forecasts is that for China, the country first impacted by COVID-19, is the first looking to the light at the end of the tunnel. Although China’s GDP growth is forecast to slow significantly, it is expected to maintain growth. This is heartening, as China is the biggest consumer of nickel by far. Nickel demand was circa 2.4 million tonnes in 2019. The following chart shows China’s 2018 appetite for nickel as a percentage of total demand:

Source: International Nickel Study Group

With China moving toward normal life, post its brush with the COVID-19 pandemic, we would expect China’s demand for nickel to return. With nickel primary used in steel and China’s steel industry returning to post COVID-19 levels, bodes well for nickel demand out of China. Currently, some 70% of nickel is used in the manufacturing of stainless steel, with 5% going into batteries. The other usages are in alloys 8%, plating 8%, castings 8% and other 1%. The minor usages will play only marginable role in demand. We expect in the near-term that the steel industry will be the main driver of the nickel price, and we are of the opinion this industry has a robust future, given the expected government spending on infrastructure.

We recently reviewed the lithium market and the coming EV revolution. Our view on this market, has not changed, even with the advent of the COVID-19 pandemic. The production of auto batteries to power EVs will play a major role in nickels future. The reason the EV revolution is crucial to nickel is that a current EV battery requires some 50 kilograms of nickel for some 60% of a batteries content. There are battery applications being developed with that could see nickel usage increase to between 80% and 90% content. Nickels availability and cheaper price makes it an ideal substitute in batteries for the likes of cobalt and lithium. Members can view our Lithium report here.

With demand for nickel in a recovering, from the COVID-19 pandemic, global economy starting to look more secure, supply will also play a key role. We do expect to nickel production to remain robust over the years ahead. The nickel market was on our estimates in surplus in 2019 with nickel production coming in around 2.43 million tonnes, to give a surplus of 50,000 tonnes on demand of 2.38 million tonnes. In 2021 we expect nickel production will grow by around 4% on 2019, to 2.53 million tonnes, with COVID-19 have only a minor impact of production. Demand however will be impacted and although we expect a “V” shaped recovery in the global economy, demand will fall around 3% on 2019, to 2.3 million tonnes. The surplus will grow to 230,000 tonnes in 2021. We expect this surplus will shrink in 2022 and 2023 and beyond, as the first of several mega battery factories come on stream. We do however remain circumspect around the industry’s ability to sustain the supply of nickel.        

We believe the US Dollar will play a role in driving commodity prices higher with a view that the US Dollar should weaken. A key factor is building for this to occur. The aforementioned US fiscal spending programmes will swell already high debt levels, from the current circa US$23 trillion and spiral higher to put pressure on US Dollar. We see a weak US Dollar as a tailwind for commodity prices including nickel over the remainder of 2020 and 2021.

With the COVID-19 pandemic on the wane in China and many governments throwing major spending programmes at their economies, an inflection point for commodity prices including nickel is here. We do however remain cautious over the ability of supply to react. We will continue to seek out quality producers in the vein of Western Areas and Independence Group, which are both already in the portfolio, that have a low-cost profile and long-life production potential.

Disclosure: Interests associated with Fat Prophets hold shares in Western Areas and Independence Group.

Gold production for the June 2020 quarter was 26% higher year-on-year (yoy), at 108,612 ounces, with annual production 5.4% higher yoy, at 381,887 ounces.

The Atlantic mine, as Members can see from the above table, was the standout for the year, with annual production coming in ahead of 2020 guidance. While on the disappointing side was the Simberi mine with operational issues impacting performance over the year. The Gwalia mine operated as expected over the year.

Turning to the technical picture, and from a daily view there have been a number of encouraging developments since the March lows. Prices have moved above dynamic resistance at both the 50 and 200 day moving averages – being $2.72 and $3.18 respectively. A bullish moving average crossover has formed, and a new buttress has been established at $3.40. A near-term target is for a move above resistance at $3.77.

Data on the balance sheet shows that it remains in good shape at end June 2020. Cash stood at A$406 million and debts at A$316 million, to give St Barbara a net cash position of A$90 million. From the data provided we have no concerns over the structure of the balance sheet.

St Barbara did not provide cost details or 2021 guidance. Full clarity on costs will be provided with the release of the June quarter and full year operational results later in the month.

The June quarter and full year operational update revealed, in our view, a good result on rising quarterly and annual gold production for 2020. The result reflects the importance of the Atlantic acquisition, with this mine delivering an outstanding result for 2020.

On the monthly chart, downward momentum appears to have dissipated last year, after a deep correction from the highs around $5.32, with support coming in around the 50% Fibonacci retracement at $2.70. The subsequent bounce has seen $3.32 eclipsed, being the 38.2% Fibonacci retracement. The 23.6% Fib at $4.08 is in sight, as the next target.

Overall mine production returned, for the first time in two years, to gold production of over 100,000 ounces in a quarter (excluding production from the Atlantic acquisition). A production metric we were looking for when returning St Barbara to the portfolio back in February 2020. St Barbara will release its 2020 operational results on 29 July 2020, at which time we will provide a full review.

In the meantime, we continue to recommend St Barbara as a buy for Members who have an appropriate risk tolerance and medium to long-term investment horizon.

Disclosure: Interests associated with Fat Prophets holds shares in St Barbara.

The step-up in iron ore production, given Rio Tinto’s reliance on it, is the reason for our satisfaction with the result for the quarter. Bauxite was again a bright spot for Rio Tinto, on the back of another solid performance with alumina also adding a little more value to the aluminium segment. Unfortunately, the finished product for the segment, in aluminium, again disappointed. Copper again delivered a disappointing quarterly result, with Rio Tinto, it appears, yet to fully get on top of this segments ongoing operational issues. Overall, we view the operational result as reasonable and expect it will, thanks to iron ore, have a small positive impact on Rio Tinto’s first half result for 2020. Rio Tinto will report its first half financial result to 30 June 2020, on 29 July 2020.

Rio Tinto’s key commodity offering is iron ore and it delivered a good result for the June quarter. The following chart shows quarterly iron ore production:

Source: Rio Tinto

The segment delivered a 5.2% rise in production year-on-year (yoy), to 71.7 million tonnes. The Hamersley mines (Rio Tinto must purchase 100% of the iron ore produced from these mines) was the driver, with the group of mines delivering a 6.2% yoy increase, to 53.2 million tonnes. Operational availability and efficiencies, on better third-party demand drove the result.

Iron Ore Company of Canada (Rio’s interest 58.7%, IOCC) reported a rise in production for the quarter of 9.1% yoy, to 2.8 million tonnes of concentrate and pellets. An improvement in utilization levels, on better third-party demand, drove the result.

Rio Tinto kept its 2020 guidance for iron ore unchanged with a forecast in the range of 324 million to 334 million tonnes (100% basis). IOCC guidance for 2020 was also unchanged with a forecast in the range of 10.5 million to 12.0 million tonnes.

The aluminium segment delivered two bright spots for the June quarter, reporting better upstream and mid-stream performances. The following charts show quarterly production for both bauxite (left chart) and alumina (right chart):

Source: Rio Tinto

Up-stream bauxite production increased by 6.0% yoy, to 14.6 million tonnes. Rio Tinto’s Weipa operation drove the result, following the reporting of a 9.7% yoy increase, to 9.4 million tonnes. Driving the result were productivity improvements and infrastructure availability. Including Weipa, Rio Tinto reported increased production from three of its four sites for the quarter, with only its Porto Trombetas mine (Rio’s interest 12%) delivering a fall.

Mid-stream alumina production for the June quarter also came in higher by 6.0% yoy, to 2.0 million tonnes. Rio Tinto reported higher alumina production across all four of its refineries for the quarter, with its three key sites all reporting better quarterly numbers. The standout was Sao Luis (Rio’s interest 10%), following the reporting of a 9.3% increase yoy, to 945,000 tonnes. Queensland Alumina (Rio’s interest 80%) and Yanwun delivered yoy increases of 6.6% and 8.3% respectively, to 889,000 tonnes and 820,000 tonnes.

On 2020 guidance, bauxite production is forecast to be in the range of 55 million to 58 million tonnes and alumina in the range of 7.8 million to 8.2 million tonnes, with both unchanged.

Disappointing was downstream aluminium, following the reporting of a fall in production for the quarter, with the segment again failing to deliver. The following chart shows quarterly aluminium production:

Source: Rio Tinto

The segment reported a fall of 2.2% yoy, to 785,000 tonnes of aluminium for the quarter. Rio Tinto’s six wholly owned Canadian smelters drove the result, with the reporting of a 7.5% fall yoy in production, to 370,000 tonnes. Infrastructure availability was the primary driver of the result. The Becancour smelter (Rio’s interest 25%) was a bright spot, as it successfully ramps up, with the reporting of a 550% yoy increase in production, to 26,000 tonnes. At the other extreme, Rio Tinto has announced the closure of its New Zealand smelter, on operating cost grounds, and will wind down operations over the next 14 months. The Tiwai Point smelter (Rio’s interest 79.4%) contributed 82,000 tonnes to the segments June quarter. The results from its remaining aluminium smelters, for the quarter, were generally flat to marginally higher.

Production guidance the aluminium for 2020 remained unchanged and is forecast to be in the range of 3.1 million to 3.3 million tonnes.

The challenges faced by Rio Tinto’s copper segment have returned, with both mined and refined copper production numbers falling for the quarter. The segment has proven, like aluminium, to be difficult to manage.

Refined copper production headed the copper segments’ charge in the June quarter. The following chart shows quarterly refined copper production:

Source: Rio Tinto

Production of refined copper fell by 67% yoy, to 26,900 tonnes. The Kennecott operation drove the result, reporting an 89% fall in production yoy, to 7,200 tonnes. An earthquake caused the suspension of operations during the quarter, with the mine now heading back to normal operational levels. Rio Tinto’s other remaining site in Escondida (Rio’s interest 30%), reported a flat operational result of 19,700 of refined copper for the quarter, compared to 19,000 tonnes from a year earlier.

Pleasingly, refined copper production guidance for 2020 remained unchanged and is forecast to be in the range of 165,000 tonnes to 205,000 tonnes.

Mined copper also came in lower for the June quarter. The following chart shows quarterly mined copper production:

Source: Rio Tinto

The Bingham Canyon mine (part of the Kennecott operation0 was the primary driver after delivering an 11.25 fall yoy in production, to 36,500 tonnes. Mine sequencing and lower copper grades impacted the June quarter numbers. Escondida partially offset the Bingham Canyon mine performance, with the reporting of a 1.6% yoy increase in mined copper, to 84,000 tonnes. Oyu Tolgoi reported a modest fall in mined copper production for the June quarter, to 12,200 tonnes from 13,100 tonnes from a year earlier.

Mined copper production guidance for 2020 was unchanged and is forecast to be in the range of 475,000 tonnes to 520,000 tonnes.

Diamonds turned in a lower result for the June quarter 2020, following the printing of a 5.5% fall yoy, to 4.2 million carats. The following chart shows quarterly diamond production:

Source: Rio Tinto

The Diavik mine (Rio’s interest 60%) reported a fall of 18.9% yoy, to 963,000 carats and was the primary driver behind the lower result. Lower diamond grades drove the Diavik result. The Argyle mine reported a flat performance of 3.27 million carats for the June quarter compared to 3.29 million carats from a year earlier. Argyle operated as expected, however activities to cease production, on end-of-mine-life, by end 2020 are ongoing.

Guidance for diamond production in 2020 is forecast to be in the range of 12 million to 14 million carats and remained unchanged.

Turning to the charts and looking at the daily chart, our move back to a buy on Rio in early April has since coincided with a strong rebound in the share price. Resistance levels at $82.42 and $87.25 have been successfully probed, while that at $93.95 and more recently $103.27, have also fallen. A strong move above the red 50 day (red) and 200 day (green) averages adds to the positive picture, and a bullish moving average crossover (where the 50 day goes above the 200 day) is also forming. Our prediction a few months ago that ‘triple digit’ prices would return for Rio has proven on the money.

Looking at the monthly chart and Rio Tinto has made strong headway since 2016, taking out the 38.2%, 50%, and 61.8% Fibonacci retracements in the process. Support at $85.75 held up well during the Covid crisis, and a sustained move above the 78.6% Fibonacci retracement at $102.65 could well be in the offing.

Of Rio Tinto’s minor product offerings, gold, both mined and refined, reported significantly lower production numbers for the June quarter. Mined and refined gold production fell 43% each yoy, to 63,600 ounces and 30,100 ounces respectively. Rio Tinto reported lower numbers across all three of its gold producing sites in Bingham Canyon, Escondida and Oyu Tolgoi, on lower gold grades and the same factors that impact on primary metal production.

Exploration expenditure came in at US$136 million for the June quarter, representing a yoy fall of 16.6%. Central exploration consumed approximately 44% of the amount spent, copper and diamond exploration consumed 41%, energy and minerals 10%, with the remaining 5% spread across iron ore and aluminium. We believe Rio Tinto has enough Tier 1 assets that can generate future brownfield growth, without having to spend significant exploration dollars. Our view on this advantage has remained the same for some years and reflects the quality of Rio Tinto’s asset base.

We expect iron ore prices will be supportive over the remainder of 2020 and certainly beyond, when it comes to Rio’s financials.

We take comfort in Rio Tinto maintaining its 2020 guidance numbers and are of the view that its operations will have a modestly positive impact on the interim result, to be released on 29 July 2020.

Despite the recent rally in Rio Tinto’s share price, we believe the momentum is building in the broader economy, as government throw dollars at their economies. The ripple effects of infrastructure building will impact on commodity demand not just in 2020, but well into the years that follow. Consequently, our recommendation for Rio Tinto as a buy for Members with no exposure remains unchanged.

Disclosure: Interests associated with Fat Prophets holds shares in Rio Tinto.

As Members can see from the above chart, since March the iron ore price has gained around 23%, which is a very pleasing outcome for iron ore producers, including Rio Tinto and BHP. Certainly, in the months from March, the US/China trade war has receded, although rhetoric from US President Donald Trump on this topic is never far away. While the COVID-19 pandemic, although still having an impact, investor focus has shifted to the economic remedies to counter the pandemic and there has been a shift of the virus epicentre away from China. Both these events have proven to be very beneficial for the iron ore price.

The remedies come in the form of stimulatory programmes, as governments globally attempt to counter the economic impact of COVID-19. The following chart shows the forecast impact of COVID-19 on the Gross Domestic Product (GDP) for the world and key economies for 2020 and recovery in 2021:

Source: World Bank

It has been estimated that the total stimulatory spend in 2020 is fast approaching US$10 trillion, with the aim of this spending to stimulate GDP into a classic “V” shaped recovery, as clearly seen in the above chart.

Governments focus stimulatory spending programmes on infrastructure as a means to generating useful and longer term employment for their populaces. As an example, when building the Hoover Dam in the Great Depression, the US Government purchased 45 million pounds of reinforcement steel, 21.7 million pounds of gates and valves, 88 million pounds of plate steel and outlet pipes, 6.7 million pounds or 840 miles of pipe and fittings, 18 million pounds of structural steel and 5.3 million pounds of miscellaneous metal work. There was 96 million pounds of steel and metalwork used in support of building the dam (there is 2,204.62 pounds in a tonne), and 4.5 million cubic yards of poured concrete was used in the dams’ construction. In preparation for building, some 5.5 million cubic feet of earth was removed from the site and 1.1 million cubic feet of material brought in. A total of 21,000 persons worked on the dam and importantly, it took five years to build.

These are the exact types of worker numbers and employment period that governments of today are looking for with their dollars. Importantly, for commodities more broadly and iron ore especially, the demand impact on commodities to feed such a project. The Hoover Dam cost US$49 million in its day, which is perhaps around US$1.0 billion in todays’ costs. The multiplier effect of the US$10 trillion that goes into infrastructure, on commodity demand, could not be clearer, and especially for steel and ultimately iron ore.

China, as the major producer of steel to the world has not experienced any drop off in steel production, as the trade war raged and was replaced by the COVID-19 rage. The following chart shows China’s annual steel production on a monthly basis:

Source: World Steel Association

China’s steel production for the 12-months to May 2020 hit a record 999.8 million tonnes for a 4.1% increase year-on-year. Certainly, this growth rate is significantly higher than the annual 1.5% we had forecast for 2020. This is a great result, given that global GDP growth is forecast, by the World Bank, to be negative 5.2% for 2020 (see earlier chart of GDP forecasts). This growth has come as the global stimulatory spend is only just, we believe, getting underway, and if the Hoover Dam time frame fits, there is more years to come. Our expectation in March was to see such growth but not this earlier. There will be a moderation in growth in steel demand in the future, but we see this as being someway off, so China’s steel mills will plough ahead, we believe, for some years.   

The rub-off for iron ore, with our scenario playing out, is shown in the appetite China has for importing the stuff on a monthly basis over the past 12-months:

Source: China Customs

As Members can see from the above chart, there has not been any significant fall off in China’s demand for importing iron ore. China’s monthly imports of iron ore in the past 12 months has twice hit 100 million tonnes in a month, a feat reached only once before for the 12-months to January 2018, when the trade war was just a glint in Trumps eye and certainly no COVID-19. China’s peak appetite of 103 million tonnes of imported iron ore occurred in September 2017, with the latest May 2020 read sitting just below that at 102 million tonnes.

China’s steel industry has it appears passed unscathed, operationally, through the peak of the COVID-19 pandemic’s impact on that country. Although there are concerns of second waves impacting economies and physical operations including China, given how the Chinese steel industry navigated the initial and from ground zero outbreak, we expect a similar response outcome with any further outbreaks.

COVID-19 has been a global curse, but the remedies to repair the damage, economically, are now getting underway and this is what, we believe, is driving the iron ore price and will continue to do so well into the future. The next positive wave, economically and in human terms, will be a vaccine, the timing of which is for now unclear, but it will come.

Disclosure: Interests associated with Fat Prophets hold shares in Rio Tinto and BHP.

We espoused our year-end gold target upgrade on the collective action by governments to stimulate individual economies, to counter the economic disaster brought on by the COVID-19 pandemic. Accumulatively, spending has been estimated to be in the range of US$9 trillion to US$10 trillion. From a time perspective, little has changed since our June update, with only the narrative by governments tightening around a determination to defeat COVID.

We said in June that the onset of the COVID-19 pandemic had amplified several factors, we believed, would push the gold price higher over 2020. It appears we should have said “turbo charged.” 

With the gold price now sitting just below our year-end price range, some caution is now required, and we would not likely be chasing gold stocks at current prices.

So, what has changed in the past month that has further stimulated the gold price to hit a new record? There is one clear data read that captures growing government debt pools and growing government budget deficits and has, we believed, been the catalyst to push the gold price to a new record high.

When talking about gold, the focus much shift to the US, as gold is priced in US Dollars. On the US front, there has been a significant change in the rate of growth in the M2 money supply in the economy. The following chart shows the medium-term movement in M2 and the gold price (in US Dollars):

Source: US Federal Reserve

As Members can see from the above chart, there has been a clear acceleration in the rate of growth in the US M2 money supply. The M2 can be defined as M1 which consists of physical currency and coin, at call demand deposits and cheque accounts with the addition of near money being accounts that cannot be converted to cash as quickly.

The onset of COVID-19 has seen the US government directly provide wage supplements to its citizens, in a move to counter the loss of wages, as unemployment in the US skyrocketed. The following chart shows the US unemployment rate with the onset of the COVID-19 lockdowns:

Source: Trading Economics

These supplements are directly included in M2, and in doing so have accelerated the rate of its growth. More money circulating in the system, devalues fiat money on extra supply; a topic we have addressed on many occasions in our dailies. We would expect, as the unemployment rate in the US continues to require the US government to provide wage supplements, the US M2 will continue to expand at extraordinary rates and hence continue to drive the gold price higher, as the US Dollar deflates.

Already, as Members can see from the above chart, the rate of unemployment is on a downward trajectory, as the services sector in the US cranks back into activity. Some 71% of the US workforce is employed in the private service sector or around 108 million people, and it was this sector that was severely and quickly impacted by the lockdowns. In the near-term, we cannot see a scenario were this will change, until there is a readily available vaccine. The time horizon for a vaccine is as close as by years’-end and as far as two to three years. All we can add is “it will come” and likely, given the resources being thrown at the finding of a vaccine, soon rather than later.

Gold will continue to act as a “safe haven” in times of turmoil and uncertainty, with the COVID-19 pandemic certainly delivering on this front. The added pressure on the gold price has come from the direct stimulatory action of the US government. The following chart shows the long-term growth in US M2:

Source: US Federal Reserve

A scenario that was last seen in the wake of the Global Financial Crisis, with what was then extraordinary M2 growth rates and a gold price that hit a, then, new record. The difference to then and now is the direct nature of the current stimulatory packages and the quantum, some US$9 trillion to US$10 trillion compared to then circa US$4 trillion to US$5 trillion.

We will persist with our end-year price forecast for gold in the range of US$1,925 to US$2,000 an ounce and recommend that gold stock not be chased in the current gold pricing environment.