Natural Resources Newsletter Q3 2018

Quarterly Review Q3 2018



It was a very quiet quarter for oil prices with the WTI crude spot price ending September at $72.15 per barrel, not much changed from the $74.13 per barrel price at which it began the quarter. Natural gas prices showed even less excitement ending the quarter are $2.96 per million cubic feet, identical to the quarter’s starting price. Perhaps not surprisingly, exploration and production stocks (as measured by the XLE) were also little changed rising a mere 0.02% during the quarter.

While the investment community was wallowing in the doldrums of summer, the same can not be said for energy management and the investment banking community. Merger and acquisition activity was robust highlighted by Concho Resource’s acquisition of RSP Permian and Diamondback’s announced takeover of Energen Corporation. Clearly the Permian Basin remains an active area of interest with larger players in the area looking to add property.

Energy futures continue to show modest improvements as contracts move outward. Drilling activity remains healthy having rebounded from depressed activity during the lull witnessed a few years ago when energy prices were lower. New demand associated with strong economic conditions is being met by new supply and pricing seems stable. We foresee this stability continuing for several quarters absent any major international incident that causes an oil price spike.


Mining companies (as measured by the XME) declined 3.7% during the September quarter versus the broader S&P 500 index return of +7.2%. During the third quarter, the price of gold and silver fell 4.9% and 9.0%, respectively, to $1,191.41 and $14.64 per ounce. The gold/silver ratio at the end of the quarter was ~81x versus a 15-year average of ~63x. If silver prices remain at recent levels, we anticipate some pain among silver producers. Producers are already beginning to focus on higher-grade production and low prices could have a chilling effect on mine development, particularly among smaller, high-cost producers.

During the third quarter, strong U.S. economic growth, the outlook for higher interest rates and issues related to trade were supportive of the U.S. dollar which weighed on precious metal prices. Base metals will continue to be affected by the economic growth outlook and trade issues. In September, the Federal Reserve Open Market Committee increased the target range for the federal funds rate to 2 to 2-1/4 percent; the third 25 basis point increase this year. Further increases could be supportive of the U.S. dollar. However, we think patient investors will be rewarded for selective investing during a period the sector is out of favor.

In our view, rising geopolitical risks, concerns about a maturing business cycle and growing government debt could eventually coincide with tighter supply-demand fundamentals that could enhance precious metals’ investment appeal. During the third quarter, merger and acquisition activity gained pace. In our coverage universe, Marlin Gold agreed to be acquired by Golden Reign Resources, Coeur Mining announced an agreement to acquire Northern Empire, Great Panther Silver agreed to acquire Beadell Resources and Pershing Gold agreed to be acquired by Americas Silver. Notably, all four are stock-for-stock transactions. In the broader universe, Barrick Gold announced a share-for-share merger with Randgold Resources Limited. During this period of weakness in precious metals prices and valuations, it appears stronger players recognize value and have seized the moment to acquire new assets to better position themselves for an eventual recovery.

We think publicly-traded equities of metals producers offer an attractive way to invest given the disproportionate percentage impact higher commodity prices may have on a company’s bottom line and valuation for a given percentage increase in the commodity itself. Because exposure to metals is appropriate for diversified investment portfolios, we think now could be a good time to average into positions.