My top picks in the resources sector

In this video David Buckland and I discuss how the reopening of China is having a positive impact on the resources sector, specifically copper. The Montgomery Small Companies Fund is currently overweight industrial metals and I share three stocks we like in this space as well as three lithium producers that we think have bright prospects.

Transcript:

David Buckland:

Hello, I'm David Buckland, and welcome to this week's video insight. Today, I'm being accompanied by Gary Rollo, portfolio manager of the Montgomery Small Companies Fund. What a great start to 2023 it's been. Gary, we've seen the pull-up effect from China with the opening, and we've seen copper, for example, jump I think about 30 per cent to $4.20-$4.25 a pound just in the last four months. Tell us about the opening of China and the pull-up effect for the resource sector that makes up approximately a quarter of your index.

Gary Rollo:

Absolutely China is now part of the reopening agenda for investors. That's a positive. China's zero COVID policy had been a big negative headwind for the resources sector and copper more specifically. We've seen some of the elements of China opening up, and we've seen the copper price respond. We think copper's particularly interesting as it's been one of the areas of the market where we should have seen decarbonisation-type investors move to that sector. But they've been put off with the headwinds associated with China being closed because of its zero COVID policy. So copper looks to us to be very investible here at the moment.

David Buckland:

Can you tell us about a couple of stocks that have done well or may have a very exciting outlook in the foreseeable future, Gary?

Gary Rollo:

In our portfolio exposures, we're overweight industrial metals, and embedded in that are three copper stocks that we've had in the portfolio for some time, the biggest of which is Sandfire Resources (ASX:SFR). It's a big, liquid, go-to copper stock. Whilst that has attractive fundamentals in the medium term, we think it's also benefiting from the fact that BHP has taken over OZ Minerals and Sandfire's the next go-to copper stock on the ASX. So there's a heap of money that's in OZ Minerals that's probably looking still to play copper, and Sandfire will obviously be a beneficiary.

We also hold a high-cost copper miner in the portfolio. That's Aeris Resources (ASX:AIS). We know that's high cost, but it's got good growth and a very cheap valuation in our view. It has had some tough times recently when the copper price has been on the nose, but in the environment that we see ahead, that particular stock we think should do quite well.

Then we have a more speculative position in the portfolio in a company called Rex Minerals (ASX:RXM). They are a developer, not a producer, but given the landscape for copper, we think it's appropriate to take that type of risk in the portfolio and look further down the value chain for good investment options over the medium to long term. Rex fits that bill.

David Buckland:

Thanks, Gary. Now, onto other decarbonisation matters. Electric vehicles, we've obviously see the lithium price do superbly well in the recent several quarters, and it seems to remain very high. It seems to me that the lithium stocks must be producing oodles of cash flow as we speak.

Gary Rollo:

That's absolutely right. They are cash flow printing machines if they are in production. One of the key elements to our strategy in focusing on the lithium sector has been to focus on those stocks that are in production because when lithium prices or commodity prices associated with the sector are high, in our view the principle beneficiaries are those that are in production. There is no doubt investors will want to go along the risk curve and play more of those development plays, but in our opinion, many of those got very quickly repriced. So we tilted the portfolio toward the producers, and those high prices mean exceptionally strong cash flows, which alters the quality of the balance sheet optionality that these producers have to fund their own growth profile. We think that story's playing out. Lithium prices remain strong, and therefore cash flows for producers remain very strong.

David Buckland:

Could you just name one or two of the producers that you own?

Gary Rollo:

We own three lithium producers in the portfolio, Pilbara Minerals (ASX:PLS). It's obviously focused on spodumene production, which is one of the intermediate minerals that goes into lithium chemical production. We also own the old Orocobre business now called Allkem (ASX:AKE). It produces lithium directly from brines. We've also got IGO (ASX:IGO) with its joint venture at Greenbushes. Those are three very high-quality lithium producers. That's the nature of the portfolio positioning at the moment.

David Buckland:

Just a very quick summary for 2023 with the China opening trade, I guess, that we've experienced over recent weeks. It does look possibly like the worst is behind us.

Gary Rollo:

Possibly, but as you know in resources, it's what you don't know that can come along and change your view. Based on everything that we can see just now and learning from the events that we've seen occur, say just for example in last year, when externalities come along and change the relative power of demand and supply in resources, you get significant price changes.

Last year, it was all about the demand shock for the lithium memes or the supply shock in oil. This year, we think that the largest impact, as we can see it today, will be the demand shock on industrial metals, or as we've talked about, copper with China reopening. That's how we have set the portfolio up in the resources book, taking advantage of what we think are good medium-term fundamentals for some of that decarbonization pricing that went into lithium perhaps to arrive into copper.

David Buckland:

That's all we have time for, ladies and gentlemen. Thanks very much for continuing to follow us on Facebook and Twitter. Gary, thanks very much for your insights in the China opening story and resources that is about 26 per cent of the small ordinaries index.