SPRING 2010
(Q1-2010 Data)
Volume 7, Number 2

ewgate’s Global Resources Portfolio rose 3.2% vs. a 5.0% decline for the Dow Jones-UBS Commodity Index during the first quarter.

Market Review. Natural resource equities had significant gains over commodity futures. During most of 2008 and 2009, commodity markets were highly correlated; commodities and related equities rose and fell more or less together. Macroeconomic forces and fears were the root cause of most activity. As the global economic recovery accelerates, economic factors have become secondary to individual market fundamentals.

The 5.5% gain in crude oil (the largest component of the Index) and strength in base metals such as copper (up 8%) were offset by the 30% decline in natural gas. Grain futures, a significant allocation in traditional commodity indices, were down 10-20% depending on the contract. Commodity equities generally matched or exceeded the returns of commodity futures.

Strength in the oil market was largely a result of improvement in the US economy; the US consumes roughly 25% of global oil production. Oil refiners are still unable to pass along the gains of crude oil and are taking capacity offline. Despite low prices and weak industrial demand, gas production companies have not curtailed production as expected. New drilling technologies are making production cheaper, which is also depressing prices. The result was a strong quarter for energy service companies: the OSX Index of energy servicing companies was up 5.8%, and the broader XOI energy company increased 1.9%.

Looking beyond short term market activity, there have been a number of corporate actions, including takeovers, divestitures and the trading of drilling rights. The recent market for gas and gasfocused companies has been negative, and we have reduced exposure in the sector. However, corporate activity and the decision by the Obama administration to allow more drilling off the US coast strongly suggest the country is moving to a more gas-fueled future. While gas is expected to be a multi-year theme, valuations will determine the extent to which gas companies are held in the Portfolio at any given time.

Portfolio Review. Global reacceleration and expected infrastructure spending have had a positive impact on companies that make steel as well as those that supply iron ore and coking coal. Metals and mining companies were among the best performers in the quarter. The HSBC Global Mining Index rose 6.2% and the S&P Steel Index was up over 15%. Steel related investments, including minerals such as zinc, used to galvanize (rustproof), and molybdenum, used as a strengthener, comprise over 20% of Newgate’s Portfolio. We also increased allocations to dry bulk shippers, which capitalize on the same market dynamics as steel, to 4% of the Portfolio.

Although gold was up slightly during the quarter, gold stocks were down marginally. Gold is the exception to the general rule regarding the importance of economic variables: the US dollar is the primary determinant of its performance. The dollar has been rising since mid-December when the US began to show greater economic recovery relative to the other developed markets. Our view is that the dollar is likely to remain relatively strong; as a result, gold and silver are now less than 3% of the Portfolio.

The allocation to energy stocks was reduced at the end of the quarter as we look toward opportunities in the natural gas environment that are not dependent on the price of gas itself. These include pipelines and utility companies. Servicing companies now represent 7.5% of the Portfolio, a modest allocation, as low prices for gas may delay new drilling and stocks in the sector are near full valuation.

Outlook. The relative health of the US economy is visible through its market impact, from the rising dollar to rising oil prices. The theme that is running through the commodity markets is that global growth, no longer just Asian growth, will be the determining factor for the sector. Commodity markets are also weighing the positive effects of a strong US economy with the negative effects of the resulting stronger dollar. Thus far, the impact of the economy has been far stronger – we think this trend
will continue.