What's The Next Shoe To Drop?

March 15th 2023

Hopefully, my house hunting in Dorset, a beautiful part of the UK, will soon be over. Simply an observation but in this area, house prices appear to be falling and many chains are collapsing. But it's rare to find an estate agent who will admit it! So, I am a little wary of the UK's house price figures. Anyway, back to my portfolio.

Yield curve inversion may send many people to sleep but this could be a sobering thought. The gap between the US two-year and the US ten-year Treasury bond recently inverted by more than 100 basis points, with the former offering a higher yield than the latter. According to research by Absolute Strategy Research, on only four occasions since 1920 has this gulf of 100 basis points been breached. They were in 1920, 1929, 1973 and 1980.? They all presaged serious economic problems. As it happens, I think that we are in unique monetary times with Quantitative Easing (Money printing) coupled with ultra-low interest rates (In recent years in the developed world, reaching 5,000-year lows). Events could pan out very differently. But it may raise serious questions about financial institutions that are in the habit of borrowing short and lending long.

As I write, that inversion has gone into reverse. Putting that volatility into perspective, the US two-year Treasury bond has fallen some 61 basis points in a day (March 13th 2023) - its largest one-day fall since 1982. Certainly a time for superlatives in the bond markets. The sharp gyrations make me suspect that the self-styled “Masters of the universe” are in the dark like most other investors. That raises the issue of valuations. If the markets are unable to accurately value US Treasuries, how wide of the mark are equity valuations? The upshot is a tightening in the credit markets and that makes me very wary of loss-making companies that are highly dependent on rolling over debt.?

Unfortunately, I have the awful impression that since 2008 Central Banks have been issuing what could be defined as “War Bonds”. You are not supposed to get your money back, at least not in real terms. Instead of promoting them to the public with slogans such as “Feed Our Guns”, they have been stuffed down the throats of institutions under the pretence of building capital buffers with much of this junk finding its way onto the balance sheets of banks, insurance companies and pension funds. Unlike ducks and geese in the foie gras industry, they have no one to stand up for them. Maybe if the cruelty had been exposed, events would be different. As for the banks, the biggest losers stand to be shareholders rather than depositors.

Will the demise of The Silicon (Silly con?) Valley Bank (It was recently rated as the 20th best-run bank in the US by Forbes) prompt a much wider run on banks? I doubt it. Just like FTX, this has the air of a controlled explosion. The bank was subject to much shorting before the crisis and it was tied into the Chinese biotech market (Time to pull the plug?). But I suspect there may be many people and companies spreading their savings around a variety of banks. The money may not leave the banking system but it could be shifted to favour the large banks. While sitting in the back of some minds is likely to be the question of whether the Fed has broken something and that implies a pivot when the struggle against inflation has only just begun.?As for Quantitative Tightening (Normalisation), that now seems unlikely to run to schedule.

Yes, despite the fear of repetition, I am still bullish about Gold, at least in terms of it retaining its purchasing power. I believe that Quantitative Easing (Money printing) coupled with ultra-low interest rates has produced one of the biggest monetary experiments in modern history and will end badly. Long term, I am very pessimistic about the purchasing power of fiat currencies. As with diversification, I tend to think that Gold may not make you rich but it could stop you from becoming poor. However, I am not a perma-bull of the yellow metal. Should the economic situation change then so will my views.

Gold miners offer me the prospect of growth and dividends. But they are also encumbered with low valuations while Gold is often located in precarious jurisdictions. So starting with the Gold miners.

Anglo Asian Mining announced a further investment in Libero Copper & Gold of US$355,000 and so maintains its 19.8% stake in the company. It has also begun construction of its Zafar mine (According to the Mine Design Scoping Study - The expected life of the mine is 5.25 years and its capital cost is estimated to be US$13.7 million(m), based on: Copper at US$8,000 per tonne, Gold at US$1,675 per tonne and Zinc at US$2,500 per tonne). Underpinning this mine, as well as its Gilar project, is the purchase of US$10m (40% cash with the remainder vendor financing) of capital equipment. It’s also expanding its flotation plant at Gedabek for a cost of US$3m, not only will it provide further Copper capacity but it will also give it the ability to produce a Zinc concentrate.

As for funding its growth projects, it announced a seven-year unsecured US$32.5m revolving credit facility with a local Azerbaijani bank. This runs from 1st March 2023. The US Dollar interest rate is 5.5-7% (From next year every 1% increase in the US Reserve Bank rate will attract an additional 0.5%) on drawings. By the way, this is not a company that’s in the habit of diluting shareholder interests and, in my opinion, its assumptions are conservative.?

Underpinning its pivot towards Copper production, the company announced what appears to be very positive news from its Xarxar contract area. It has located what it describes as “Significant copper mineralisation”. This appears to be based on the data that it acquired from AzerGold CJSC in August 2022 for some US$700,000 (25% upfront) as well as its own studies. The upshot is that it's preparing an open-pit mining study and a geological block model that it intends to publish in the coming weeks.?

Although I have faith in the management, it’s operating in a very fragile environment. The peace agreement between Azerbaijan and Armenia from 2020 seems to be barely holding, with much friction centred around the Lachin Corridor linking Nagorno-Karabakh with Armenia. And this is a very complex region: Russian gas is being funnelled to the EU via Azerbaijan. The real prize for Anglo-Asian, in my view, comes from a durable peace agreement between Azerbaijan and Armenia.?

Caledonia Mining made two announcements over the month. One bad and one good. Sadly, the first was related to a fatal accident. An investigation into this is ongoing. The second, on a positive note, announced the results of an update to a 43-101 compliant resource and reserves estimate. It estimates that its Blanket mine has resources (1.095m oz) and reserves (395,000 oz) of Gold. Even with production of around 80,000 oz of Gold per annum (pa), in my view, the Central Shaft opens up many opportunities to grow its resources and, ultimately, its reserves.

Centamin made no major announcements over the past month.?But with the spike in Gold prices coupled with higher interest rates, it may be worth remembering that it's unhedged and debt-free.

Fresnillo announced its results for the year ending 31st December 2022. In summary, it was hit by a low Silver price, falling Gold production and higher costs. The result was a 10% drop in year-on-year revenue. While profit before income tax fell a whopping 59.4%. And its net debt increased to US$198.7m (2021: net cash of US$67.5m).

However, the Silver price is out of its hands. While its lower Gold output was flagged in advance - Herradura had lower ore grade and recovery. What concerns me is its rising costs. This includes: Labour (Average weighted cost +7.9%), electricity (+5.9%), Diesel (+4%) and operating materials (+19.8%). The total weighted average increase was 8.37%. What of these are one-offs? I am unsure. In fairness, it has reacted with a raft of measures to improve productivity at its three largest mines (In terms of contribution to gross profit). That is Fresnillo, Saucito and Herradura. Some 56% of its total capex (US$592.1m) was spent on these three mines in an effort to cut costs and improve productivity. But it’s also worth mentioning that Mexico’s labour reforms, which compelled the company to stop using contracted miners, meant that it had to buy new equipment that had previously been supplied by mining contractors. That seems to have caused problems with supply chain issues. While attempts to develop more of its own renewable energy resources (Wind) as well as using Liquid Natural Gas seem to have been met with bureaucratic hurdles in Mexico. For the moment some 35% of its electricity needs are met from renewable sources but it’s aiming for 75% by 2030.

With its Juanicipio plant expected to reach nameplate capacity by Q3 2023 and its Pyrites II plant expected to be connected to the grid by Q2 2023, present levels of production appear to be underpinned. And Juanicipio will make it less dependent on its three largest contributing mines. Both its Silver and Gold reserves look robust - equivalent to 7.4 years of Silver production and 12.9 years of Gold production. While sitting on the back burner are a range of early-stage (Preliminary Economic Assessment - Feasibility) projects: Orisyvo, Rodeo, Guanajuato and Tajitos. Mainly targeting Gold and collectively offering resources of some 14.2m oz of Gold and 179m oz of Silver. It appears to be planning on putting Orisyvo and Rodeo into production in 2026-2027. With a combined output of between 270,000-315,000 oz of Gold pa. Behind that, it has a pipeline of prospects at various stages. Moreover, it’s looking at spending some $175m on exploration over the next year with around 25% of that on “Advanced exploration”, “Early stage drilling” and “Prospecting and drill target generation”. The one caveat I would attach is the problems it seems to be having with permits and concessions. That is, with state bureaucracy. Not just in Mexico but also in Chile and Peru.?

Pan African Resources published its unaudited interim results for the period ending 31st December 2022. Incidentally, Edison research also produced a report on the company (Paid for by Pan African). I have incorporated some of their views. As it had earlier guided, production was down some 15% compared to H1 2022. However, it reiterated its production guidance figure for the year (2023) of 195,000-205,000 oz of Gold.?

Its all-in sustaining costs rose by around 10% to US$1,291 per oz for the period, unsurprising given its fall in production. While its cost issues appear to lie with its Barberton underground operations. In response, it has taken remedial action at its Consort and Sheba mines. Including moving Sheba (And Fairview) to 24-hour shift mining with imminent effect. Consort is adopting a contract mining system but this will not involve redundancies as employees will be transferred to Sheba and Fairview. It appears to have reached an agreement with the unions at Consort and Fairview. But the deeper it goes with Barberton, the less face-time and the more (Expensive) problems it has to deal with.?Nevertheless, it's doing much to mitigate its costs and that includes its Dibanisa project aimed at integrating the Fairview and Sheba mines infrastructure. It has even installed a far more efficient computerised mine planning system allowing vastly better variance analysis of budgeted and actual production.

Although it has been in operation for around 130 years, Barberton still appears to have considerable exploration potential. Pan African conducted some 9,000 metres of drilling for 2022. That appears to have been successful. The drilling programme continues. And not forgetting that Barberton has a twenty-year mine life. The impression I have is that the company has a lot of scope for shuffling its cards and extending the mine life further. However, this is now a very deep operation and there will be a financial cost (Sustaining capital costs at Barberton were up around 95% in ZAR terms compared to the same period last year).

It appears confident of reducing costs even further. Using the figures supplied by Edison, Pan African is looking at reducing its cash costs for its Barberton underground operations by about 29% for H2 2023 to US$1,015 per oz. With an estimate of cash costs for 2023 of US$1,175 per oz. Again, using Edison's figures, it's looking at producing some 73,522 oz of Gold from this part of its business.

Its Barberton Tailings Retreatment Plant (BTRP) output was up 9.7% compared to H1 2022, while its AISC fell 10.9% to just US$725 per oz. Elikhulu’s output was stable but it's expected to nudge up slightly in H2 as it moves on to a new Tailings Storage Facility (TSF) and benefits from upgrades.

More broadly, it does not appear to be constrained by a lack of organic opportunities. Even its BTRP is being lined up to deal with the tailings from the development of its Royal Sheba project. In that case, BTRP will have a further 18 years of mine life.?

The reliable supply of electricity from ESKOM is still a problem in South Africa. The company estimates this reduced production by some 5%. So it’s worth noting that the company expects to commence construction of an 8.5MW solar plant by June 2023. It already has some 9.9MW of solar in operation at Evander saving it around US$145,000 per month. It’s aiming for some 40MW by 2027 (Around 15% of its energy needs). Incidentally, Sylvania Platinum's CEO made a point that it had been impacted by ESKOMS’ problems but saw those problems peaking in June or July before easing.?

It’s also worth pointing out that at the end of the period, Pan African’s net debt had increased by a tad over 90% to US$53.7m. However, it had significant financial headroom with just over US$52m available to it (A revolving credit facility as well as general banking). Very importantly, it was well within all its banking covenants. And, not forgetting, this is a business run by an accountant rather than a geologist.

It may be a protracted affair but the potential Blyvoor tailings acquisition is still alive. The company is yet to complete its initial due diligence. Strange, as I thought it completed it in April 2022 and was now working towards a definitive feasibility study. It may only be a small acquisition at around US$6m but if initial projections are accurate, it could add another 25,000-30,000 oz of Gold pa over at least a 15-year mine life.

As expected, production from Evanders' 8 Shaft pillar is declining. However, Edison suggests the development of Levels 25 and 26 (Bottom left-hand corner in the chart below) will give the Shaft 8 pillar 13 years of additional life with production of some 65,000 oz of Gold pa. The cost is expected to be around US$50m and funded internally. But this is not planned to commence for about another three years.

At last, the funding of its Mintails project is now complete. The total upfront package of US$135.1m has been agreed upon. In December 2022, it obtained US$43.3m from the issuance of a medium-term note plus US$70.3m of senior debt (The details are still being negotiated). In addition, for an upfront premium of US$21.6m, it will need to provide 4,846 oz of Gold per month?at a fixed price of ZAR 1,025,000 (US$1,723 per oz at ZAR18.5:1USD) per kilo for 24 months, starting from March 2023. For sure, it has not diluted shareholders but the deal takes some 30% of its Gold production over the period and it's still subject to permitting and environmental approvals. That said, it expects to begin construction of the project in June 2023 with stable production commencing in December 2024. With an expected payback period of around three and a half years and an overground, low-risk profile, plus a project life of at least 20 years (It has also begun planning work for the Soweto Cluster, which appears likely to extend the project from its original 13 years of life). Incidentally, the dumps appear to be pre-2004 and so are royalty free (Not a small point. For the financial year 2023, it's expecting to pay some US$8m in Royalties, using Edison's figures). Overall, I think it’s a good deal and it makes it a less risky business.

Sylvania Platinum announced its results for the six months ending 31st December 2022. It also made a presentation via Investor Meet and Edison produced a report on the company (Paid for by Sylvania). So I have incorporated all these sources. The headline figures appear strong. Net revenue was up 15.6% and net profit increased by around 33% compared to the same period last year. While output was up around 18%, again, over the same period. It has even increased its guidance from 68,000 -70,000 oz of 4E PGM to 70,000-72,000 oz 4E PGM.?

Nevertheless, like many miners, it's impacted by inflation (Indirect operating costs are up around 34%). Moreover, I am mindful that much is outside of its control. Not only in terms of the basket price that it receives but also the quality of the feed that largely determines its recovery rates. And it’s under cost pressure. Its operational cost of sales to produce the PGM concentrate increased by around 21% compared to H1 2022. With milling and reagent costs rocketing by almost 55%. Thankfully, those costs are largely in ZAR while its revenue is almost exclusively in US Dollars.

The biggest question mark I have with this investment is its dependency on its host mines. The mines are owned by Samancor which is privately owned, so it’s difficult to find reliable information concerning the life of its portfolio of mines. According to Edison, Samancor has some 30 years of reserves and resources available from its Bushveld complex seams. And that excludes its other assets.?While Sylvania appears to have life of mines contracts with Samancor. So it's sourcing from dumps and hosts mines. Very importantly, Sylvania produces no estimates of its resources or reserves.

By the way, Sylvania has adjusted its dividend policy with, what appears to be, the abandonment of special dividends. The new policy is a distribution of a minimum of 40% of adjusted free cash flow for the financial year. With one-third paid as an interim and the remainder as a final. The justification it gave was largely related to the requirements of institutional investors. It claimed that paying special dividends made modelling the company’s performance difficult.

It cannot rest on its laurels due to the depletion of its dumps. So, it's looking for new source feeds as well as investing in research and development (Chromite ore pellets to reduce energy consumption - it expects this "..to yield positive results"). Over the period, it spent US$0.9m on exploration and is looking to spend some US$5m for the year. Its main exploration projects are: Aurora, Hacra and Volspruit. They are all based in the Northern Limb of South Africa's Bushveld complex: with the first two in the north of the Northern Limb and the latter, and more advanced, in the south.

It aims to produce an updated Mineral Resource Estimate and scoping study for its Volspruit North and South Body (And including Rhodium - excluded from an earlier report) in Q1 2204. However, should it develop this asset, it's looking at going into production some four years after its final investment decision. While it expects to produce a scoping study on La Pucella (A target in its Aurora project) in early 2023, so presumably within months. Its initial mineral resource estimate was some 1.37moz of 2E+gold and this was near surface. However, this estimate only covered 12% of its combined Aurora project area. It aims to commence a drilling programme in H2 2023 that will move it towards an evaluation of the combined Aurora project. As for Hacra, according to the Investor Meet interview on 22nd February 2023, it plans on completing an updated mineral resource estimate within 6-9 months.

It's also worth mentioning that its cash balance at the end of 2022 amounted to some US$124m. For the period its finance income was around US$2.36m (H1 2021: US$731,855). In a world of rising interest rates and falling asset prices, it seems to be well positioned.

My sole collective investment exposure to precious metals, Golden Prospect Precious Metals continues to underperform. The agility I expected from this relatively small-sized fund was not there. But it has a bias towards Silver and I am bullish long-term about the prospects of the metal. But is this the right vehicle?

Moving from the precious metals-focused miners to a much larger mining outfit but still with much growth potential.

Rio Tinto issued its final results for the year ending 31st December 2022. Needless to say, it runs a complex global operation. So, I have only covered what I believe to be some of the most important points. Compared to 2021, the results look poor. But it requires a good deal of examination. Firstly, 2021 captured a period when the world was coming out of lockdown. And, in my view, this is a company that demands a long-term perspective. Compared to 2021, the following fell: Profit after tax (-41%), free cash flow (-49%), net cash (-36%), dividend (-53%). While its net debt rose from US$1.6 billion (b) to US$4.2b. Some 77% of its debt is floating rate. That said, it's a financially robust outfit. It finished the year with interest cover of 33 (2021: 59), net gearing of 7% (-3%) and delivered a return on capital employed of around 25%. While its debt has a weighted average length of 11 years. And it reiterated its policy of paying 40-60% of its underlying earnings “In aggregate through the cycle”. That is underpinned by strong cash generation.

However, it’s highly dependent on two interconnected factors. The first is the demand (Price) for iron ore and the second is the economic development of Greater China. Some 53% of its 2022 revenue came from the sale of iron ore, where its cash costs were up around 14.5% in large part due to rising diesel and labour costs. It estimates that a 10% move in the average price of iron ore over a year will impact its EBITDA by US$2.608b. While around 54% of last year’s revenue came from sales to Greater China. That said, it’s not a one-trick pony. It strongly argues that its core offering (Iron ore, Aluminium, Copper and Minerals) plus its exploration and development projects (Including Lithium) dovetail into the Net Zero agenda. And it’s positioning itself as a major provider of Copper for the US market as reshoring takes hold. Moreover, it's planning to spend some US$7.5b up to 2030 on decarbonising capital expenditure. In the Pilbara alone, it’s aiming to generate 1GW of renewable energy. The goal is to put it in a position where it can provide its customers with ESG-compliant raw materials such as Green steel so it can differentiate its output and get a premium price.

Overall, its EBITDA was adversely impacted by weak commodity prices coupled with inflation, from the cost of diesel to the cost of labour. Its underlying EBITDA was down across the board: Iron ore (-33%), Aluminum (-16%), Copper (-40%) and Minerals (-7%). Its EBITDA margins may have fallen but at 45% (2021: 57%), they remain strong.

Importantly, it does not appear to be post-growth but getting its big projects off the ground is often a Herculean task. This can be seen with its Resolution project in the US. It believes that this could supply some 25% of the US’s Copper needs. However, bringing the project to fruition is taking a huge amount of time and effort. While it involves many stakeholders including a variety of native American tribes. It has also encountered serious issues with its Simandou and Jadar projects. The upside is that few companies can navigate these waters and bring these types of large-scale developments onstream. Over the year, it spent around US$897m on exploration and evaluation, with a focus on materials crucial in the transition to Net Zero. And it’s still pushing ahead with those difficult and large-scale projects.

It’s worth mentioning that it appears to be positioned as both a beneficiary and a casualty of the US’s Inflation Reduction Act. Broadly, reshoring and a pivot towards green technologies favours Rio as its output, especially Aluminium, will be in higher demand. But it seems to have been impacted by the Corporate Alternative Minimum Tax regime of 15% on accounting profits. The upshot is a US$820m write-down of its Federal deferred tax balances.

Regardless of the figures, 2022 was a year of progress for the company. With the purchase of Turquoise Hill, it has tidied up the financial structure at its Oyu Tolgoi asset in Mongolia and looks set to develop the mine’s huge underground Copper potential. But this is not quite done and dusted. Negotiations over tax arrangements and a new power plant are ongoing. In October 2022, it agreed to "Modernise" its Rhodes Ridge joint venture in the Pilbara. That appears to pave the way to developing this huge iron ore project. In March 2022, the purchase of the Rincon Lithium project in Argentina for US$825m was completed with work soon beginning on a US$194m mini-plant that will go into production in 2024. While planning for a full-scale plant has already begun. Its iron ore joint venture with China Baowu Steel Group will develop the Western Range in Pilbara, Western Australia (WA) with production (Reaching 25m tonnes pa) expected to begin in 2025. Rio has already committed US$1.2b to the project. Again in WA, its Gudai-Darri iron ore mine was commissioned in June 2022. It argues that this is one of the most technically advanced mines in the world and, with a life-of-mine of 40 years, will underpin its “Pilbara blend”. It plans on reaching its nameplate capacity (43mtpa) in 2023.

Separately, Rio concluded an agreement with the Securities and Exchange Commission relating to its Simbandou project in 2011. The result is that it has agreed to pay a US$15m civil penalty without denying or admitting guilt concerning a violation of the Foreign Corrupt Practices Act (FCPA). Incidentally, looking at research carried out by Stanford University (Foreign Corrupt Practices Act Clearinghouse), it appears that nine of the ten largest settlements related to FCPA violations are non-American companies. It may be worth watching events in Ukraine very carefully.

Will the price of oil and gas nosedive? Possibly, if a resolution to the terrible conflict in Ukraine can be reached or the global economy goes down the pan. But that still leaves the reality of a chronic lack of exploration to replace depleting fields.

BP appears to be under pressure from two major British pension funds (Universities Superannuation Scheme and Borders To Coast) to speed up its transition out of fossil fuels. Strange but I thought their remit was chiefly concerned with the financial well-being of their members but there you go. BP had previously targeted a 40% cut compared to its 2019 output. The amended aim is a 25% cut. I must admit, I think it’s a very brave move on the part of the pension funds. Apparently, the CEO of Apple is looking at a US$49m pay packet for 2023. Presumably, both funds will not invest in Apple on the grounds of income inequality in the US. Incidentally, Saudi Aramco had just posted profits of US$161b. It seems to me reasonable to expect national oil companies and private equity firms to step in and fill any commercially viable voids left by the likes of BP.?

Trinity Exploration & Production issued no RNSs of any material interest aside from the continuation of its buy-back programme. However, it released two Tweets. The first relates to its ABM-151 well. The inference from this is that the well is now in production and producing 60-110 barrels of oil per day. At least that was the expectation. The most recent Tweet reveals that drilling activities for its Jacobin well had begun (22nd February) and would last for 35 days. It’s targeting a mean oil-in-place volume of 5.7m barrels. Success could turn its lacklustre stock price around. But this has proved to be a tougher grind than I anticipated as its opportunities fell by the wayside. So I will make a decision on whether to dispose of my holding largely based on the success or otherwise of Jacobin.?

I hold the following two funds from the same stable but I hold them for different reasons. The first is priced at a huge discount to its net asset value in a more orderly market. The second gives me coverage of a part of the world that is increasingly calling the shots.

JPMorgan Emerging Europe, Middle East and Africa's?stock price has perked up over the last month only to deflate somewhat over the past few days. In my opinion, the investment case remains. Its assets are large Russian companies (It was formerly JPMorgan Russian Securities. I referred to it previously as JPMorgan Emea). The discount to the fund’s net asset value in a free-functioning market is huge. But that value can only be unlocked with a peace agreement for the terrible war in Ukraine. Until that happens its assets have little value. In my view, it comes with a degree of risk that I am willing to accept - I think the upside outweighs the downside

JPMorgan Asia Growth & Income saw its earlier gains made largely on the back of the reopening of China pared back as China’s National People's Congress announced a “Modest” GDP growth target for 2023 of 5%. The fund is not solely a Greater China-focused enterprise. But China sets the tone for the rest of Asia, including countries such as South Korea.

My defensive stocks continue to do what I ask of them. So long as any drawdowns are not too large, I am fine.

Greencoat UK Wind issued its final results for the year ended 31st December 2022. At the end of the period, it had 45 wind farms providing a net generating capacity of 1,610MW of energy. Importantly, its dividend for the year was covered some 3.2 times. Although it paid ￡175.8m in dividends it was still in a position to reinvest some ￡340m in the business. Year-on-year, its net asset value was up around 25%. Needless to say, it benefited from rising energy prices (Especially gas), as well as rising inflation. While that was tempered by its increased discount rate.?And, not forgetting the ￡176.9m electricity generator levy (Windfall tax).

Its largest investment is a 12.5% stake in Hornsea 1. This makes up around 19% of its total portfolio. It asserts that it provides it with stability as a result of its index-linked Contract For Difference (CFD) income. With the latter, the Government effectively underpins the price of the output. Should it fall beneath a pre-agreed level, it will provide top-up subsidies. Should it rise above a pre-agreed level, the difference is paid to the state. For good or ill, Greencoat is focused on the UK. Ultimately, its protection against a decline in the value of Sterling comes from its RPI linkage. Should Sterling fall substantially, this is likely to fuel inflation and that should allow the company to maintain its dividend in real terms.?

However, the UK offshore wind energy has been hit by higher financing costs, rising supply costs and is threatened by the competition from subsidies being offered under the US’s Inflation Reduction Act. While Greencoat’s energy generation was 5% below budget (Mitigated by higher energy prices). But the key factor that it points to is the variability of long-term wholesale electricity prices which largely determines its net asset value. Over which, it has no control.

Its gross debt at the period end was ￡1.78b. This comprised ￡900m of fixed (￡300m will mature before March 2025), ￡200m from a revolving credit facility and ￡680m of limited recourse debt related to Hornsea 1.

With it owning around 6% of the UK’s 28GW windfarm capacity, I suggest it can benefit from economies of scale. And it points to the average age of its portfolio as seven years. This, in my view, is important. According to a paper produced by the University of Kent in 2021, wind turbines installed in the 1990s and early 2000s are often no longer safely functioning. It suggests these earlier models have a life expectancy of some 20-25 years. While the backdrop is the UK targeting 50GW of offshore wind power by 2030. So there appears to be much to play for. But the picture onshore is far from clear. In 2015, the present Government put in place planning measures that largely prevented the construction of new onshore wind farms. It appeared to be on the cusp of relaxing those planning controls. It’s not clear whether that’s now the case.

In terms of Government policies, it may have a say but it has no control. However, it states that in terms of energy generation, it faces an annual standard deviation of 10%. Which is less than 2% when taken over 30 years. I would add that over the long term, energy storage capacity will markedly improve. In which case, wind volatility will not be a major issue when considering its overall financial performance. But it’s not all plain sailing. New operational management was appointed for five wind farms. They experienced an average 14% decline in budgeted versus actual output over the period. That compares with an average fall of just 5% across its portfolio. It can be prone to management issues. That said, its portfolio is wide enough to iron out most aberrations. Interestingly, it uses six different turbine manufacturers. So, it should be able to avoid generic technical issues. Again, mitigating risk. But, looking at its carbon payback period for offshore wind turbines, it suggests 8 months (3% of its asset life). That implies a 22-year asset life. And yet, later in its report, it refers to a “Base case” asset life of 30 years.?

It expects investment management charges of 0.91% of NAV for 2023 with no performance or acquisition fees. While the Board’s remuneration appears reasonable. The highest paid was the Chairperson on around ￡85,000 for the last year. For sure, these are not full-time positions. But they appear to be pulling their weight. However, the wind farms have Boards and the Investment Manager (Part of Schroders Capital)? has representation on each Board. While everything is overseen by the non-executive Board team. With the Investment Manager reporting quarterly to the Board. So it comes with a fair degree of oversight.

NextEnergy Solar Fund’s quarterly operational update forecast a 1.5 times covered dividend for this financial year with what it describes as a high degree of visibility (For the financial year 2023/24 some 74% of its budgeted generation is fixed). However, it comes with a degree of gearing (Risk) at 43%. But this is mitigated, to some extent, with 50% of its revenue coming from Government subsidies. As for the electricity generator levy, that had an impact on its year-end net asset value of around ￡1.6m. At the end of December, around ￡42m of its ￡205m revolving credit facility remained undrawn (It can increase its debt to 50% of its gross asset value). With much riding on its RPI-linked agreements, it’s no surprise that it uses external consultants to estimate the direction of inflation. These estimates can be seen below (It may also illustrate why capital preservation funds are so keen on index-linked bonds).?

Inflation Rate (UK RPI) Assumptions

Importantly, it owns the project rights to most of its assets. So, there’s the possibility of developing battery storage facilities (And avoiding energy windfall taxes) and it’s in a joint venture with Eelpower. The company looks set to seek shareholder approval to increase battery storage from 10% to 25% of gross asset value. That sounds fine but I am a little concerned with supply-chain issues in this area. In response to the rising and volatile price of Lithium Carbonate many battery storage suppliers have adopted raw material indexed (RMI) pricing. It may also indicate an increasingly challenging environment for solar projects.

Tritax Eurobox released no significant news since I last wrote. And, so I believe, its investment case remains the same.?It has a blue chip client base, it's focused on the digital space, it has a portfolio of modern buildings and most of its debt is at fixed rates.

British American Tobacco posted no impactful RNSs over the month. However, it did release its Annual Report for 2022 which I thought may reveal some interesting points. It refers to tight labour markets and inflationary pressure. And, no matter how hard I look, I can find no indication of New Category losses. While it describes the Transfer of its business in Russia and Belarus as “Unprecedented, complicated and complex” which makes me think that it may never happen. It may not sing it from the hilltops but it bought a minority stake in Sanity Group, a German cannabis company. It also bought Charlotte’s Web, a US Hemp business. And it created KBio to research and develop plant-based solutions to rare and infectious diseases. This builds on its established plant-based technology platform.

Over the year, its adjusted net debt to adjusted EBITDA ratio decreased from 2.99 to 2.89 (It’s targeting a “Corridor” of 2-3 times). It may sound contradictory but the company places a high emphasis on sustainability/ESG capital expenditure. Although it's rapidly developing its New Category business it sees “Continued value growth in combustibles”. Buy-backs appear highly likely and part of its offering. By the way, rather than repeating what its major categories contain, I thought this may be useful for reference.

To a large extent, BAT comes down to the following. Combustibles generate some 83.3% of its total revenue while New Categories contribute only 10.4%. The former is highly profitable but is in slow decline while the latter is losing money but growing rapidly. New Categories comprise three brands: Vuse (Vapour), Velo (Modern oral) and glo (THP). Frankly speaking, I am a non-smoker. But I am a regular (But moderate) drinker of alcohol. From experience and observation, drinkers seem to be very attached to brands. I believe the same to be true of BAT’s New Category product range and BAT has a great deal of experience in building brands. Unless there is a complete change in the human condition, pleasure will continue to be pursued and BAT is offering that at a modest risk (Risky activities: rugby, soccer, horse riding, skiing, etc, etc).

I am prepared to take a long-term approach to both my capital preservation funds. After looking at them very carefully, I agree with much that the managers put forward in terms of economic prognosis. But the real test will be how their tactics play out. The one concern I have is that both seem to acknowledge that they are sailing in uncharted waters.

Ruffer Investment issued its half-year report for the period ending 31st December 2022. First off, it has a complicated portfolio that I will not try analysing in depth. Instead, I will look at its broad views on the direction of the market and take some, of what I believe to be, the most important points. In its preamble, it points out that in a market where most asset classes struggled to make any positive returns, it managed a 4.8% increase in net asset value as well as a 4.1% increase in its stock price (Compound growth of 7.8% pa since inception in 2004). While it appears to view interest rates as key in determining economic activity and returns from the financial markets. Incidentally, it aims to achieve a return for investors that is twice the prevailing Bank of England base rate. This could be challenging - for 18 of its 22 years of existence, the rate was less than 2%. It’s also worth mentioning that it uses hedging instruments not as a way of timing the market but as protection against what it describes as “Extreme scenarios”. That said, its “Equity downside protection” added 4% to the portfolio’s performance over the period. At 1.08%, its annualised ongoing charge is not inexpensive. But you do get something with a pedigree that is incredibly difficult to replicate at a lower cost ie using tracker funds.

As for ESG issues, its approach, in my view, is quite cute. It works with high carbon emitters in a quest to encourage them to reduce emissions.?

Worryingly, it seems to believe that inflation is becoming embedded (With disinflation anticipated over the short term) and will be difficult to subdue. Its investing style is largely based on its outlook for inflation over the next decade. It anticipates this averaging 3-4% pa. It illustrates this stickiness with the following chart.

Although it received a kick in its “Crown jewels” ie long dated Index-linked bonds, it still believes they are a worthy investment in an environment of financial repression. Incidentally, it seems to have profited from the gyrations in the market for these bonds caused by the Truss/Kwarteng fiasco. So, although it lost on the bonds it held, it more than made up for that by its trading in the same type of bonds (Adding 2.8% to its returns). More broadly, it expects increasing financial market volatility as well as inflation volatility (With inflation uncertainty becoming a problem in itself). And the backdrop, it argues, is a reversal of the long-standing trend of globalisation and that means an end to “Cheap”. While big Government programmes such as “Build Back Better” will eventually stoke inflation. It suggests that, ultimately, politics will trump Central Bank policies with the possibility of a resetting of inflation targets.?

As it currently stands, it’s taking a bearish short-term stance on equities with a net position (Including downside protection) close to zero at the period end. Some 56% of the fund was held in Government securities. In essence, an opportunistic stance. Since I bought into it, the fund has performed well and I largely agree with its economic outlook which provides a framework. In my view, it has a solid bedrock but also the nimbleness to trade in turbulent times. That said, we are in uncharted waters.?

Its February update, in my opinion, points to a dichotomy between the bond and equity markets. With the former taking on board the Fed’s hawkish comments while the latter largely ignored them. Its core argument, which dictates how the fund is positioned (Its largest single holding at around 30% of the fund is short-dated bonds), seems to boil down to this. Disinflation and growth appear to be incompatible, at least for now. And it has returned to the VIX market using call options. Lest we forget this is the outfit that made huge profits in 2020 betting on the VIX under the sobriquet of 50 Cent (Rapper: “Get Rich Or Die Tryin”).

Capital Gearing Trust’s monthly factsheet (28th February 2023) points to its extensive exposure to index-linked Government bonds. Around 44% of its assets are allocated to this category. While it has a 52% exposure to Sterling and a 26% exposure to the US Dollar. With 261 holdings, it’s a complex fund. At a more basic level, it began a share buyback programme on 21st February 2023, it’s authorised to buy up to 14.99% of issued share capital. But with it trading at a 2% discount to its net asset value, I don’t expect this to make a huge difference. At the end of the day, it will be judged by how it ducks and dives in these turbulent times.

It may difficult to categorise but the following stands to benefit from market volatility. Remembering that it has an institutional as well as retail client base.

CMC Markets has not issued any eventful news over the past month. However, market volatility has returned. And that should be good for business. While it benefits modestly from higher interest rates. However, that’s tempered by poor-performing stock markets hitting its non-leveraged business. Taking a look over the past five years, its stock price has outperformed both Plus 500 and the IG Group. Its two larger UK quoted rivals.?

If there is one overriding theme for this year, it could be uncertainty. In my opinion, it will be the outlandish and not the unlikely that will upset the financial markets. Something from within the system rather than external. It reminds me of a comment from Liberation Management by Tom Peters, to the effect that when you are in control, you are actually out of control. Centralisation makes the situation more unstable - the former Soviet Union is a case in point. And right now, the financial markets are very centralised. Much has been riding on the success of a handful of large US tech companies. While the financial news is dominated by a relatively small number of big names - both individuals and companies. That makes me think that something major could go wrong. In short, a time of opportunity.

Just For The Record

For the mothers of invention at Ruffers.?

Gender diversity is often at the top of the ESG agenda, so I thought this training video from the 1970s could be useful.

I try to keep things simple so in these increasingly constrained monetary times, I could not resist this.

From those who sweep the streets to those who run the Government, this song is a must.

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