Forwood Thinking: Lowell Resources Fund’s John Forwood says energy and gold are the markets to play in these turbulent times
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Russia’s war in Ukraine may be driving oil and gas prices through the roof, but the foundations of crude’s run beyond US$100 a barrel have been building for years.
Crude was above US$110/bbl last week, translating to over $2 a litre at the bowser.
The emerging boycott of Russian oil and gas – Trafigura was last week unable to offload a Russian crude cargo priced at a massive US$18.60/bbl discount to the Brent benchmark – is just the match that set off the fire.
And when oil catches alight it can be hard to douse the flames.
Former rock kicker and professional stock picker John Forwood, the chief investment officer of the Lowell Resources Fund says years of underinvestment in oil & gas assets and supply shortages make it a good time to invest in the market.
“We’re around 50% gold at the moment and a bit under 10% oil and gas,” Forwood said.
A lot of that gold exposure is simply down to the make up of the ASX resources sector, which has a high concentration of gold juniors.
But Forwood says oil and gas is a field where small caps are showing good value over other sectors where prices are running hot like battery metals.
He says Lowell is looking to add weight in oil and gas at the moment as a priority, with the recently unloved gold equities space following closely behind in its investment strategy.
“At the moment we do think that there’s a pretty hot market in things like lithium stocks, and we are struggling to find good value there even though lithium prices just seem to go up 5% every week,” he said.
“But conversely, as mentioned, we think that oil and gas stocks are really unloved and there’s really deep value there. So we are looking to reposition the portfolio to increase our exposure to oil and gas at the moment.”
Russia’s war in Ukraine was an obvious catalyst for a supply shock. It is the world’s largest exporter of crude oil, supplying 5 million barrels a day or around 12% of global exports according to the International Energy Agency.
But Forwood said stockpiles at the moment were extremely low, leaving the market open to rapid and large price increases.
“The situation right now is that stockpiles are very low and that’s not just oil, I saw an interesting quote the other day we’ve just got a shortage of molecules across pretty much every commodity,” he said.
“But for example, the inventories in the US at the moment are at least at five year lows and that’s before the US “driving season” starts.
“So normally, you’d expect that stockpiles would be at their seasonal highs at the moment.”
OPEC’s planned 400,000 barrel a day increase will be too modest to have a serious impact. But fundamentals on the supply side are just as prescient.
Forwood says capital investments peaked all the way back in 2014, eight years ago now, with majors instead focusing on returning cash to shareholders via dividends and buybacks.
That paradigm shift is accelerating and shows little sign of reversing.
But oil will likely remain part of the commodity mix for decades to come. That suggests some companies will be making a serious dime when times are good.
“Forecasts are that oil consumption will continue to grow globally through to somewhere around 2040-2050 before peaking around then,” Forwood said.
“If oil prices stay high at 100 bucks a barrel or north of there that is going to accelerate the push into renewable energy, electric vehicles it’s just going to be a natural response.
“So we may not see 25 years of increasing oil demand, we might only see 10 or 15 years but it’s not going to turn around on a dime just as a result of say the war in Ukraine.”
Forwood says higher prices could be driven by the emergence of ‘self-sanctioning’, a rapid and organic boycott and divestment movement led by customers who no longer want to deal with Russian suppliers.
He’s seen analysts calling for prices to hit as high as US$200/bbl if the war stretches for weeks into months.
“We’ve seen western sanctions deliberately avoiding sanctioning Russian energy output because it’s such a massive supplier of energy,” Forwood said.
“That’s the official sanctions, but we’re actually seeing self sanctioning coming in quite quite significantly.
“So a number of banks have said they’re not going to finance Russia energy SocGen and Credit Suisse have apparently stopped financing commodity trading from Russia. And then you’re seeing, you know, big oil companies also getting out of Russia.”
Despite the positive outlook for prices, money has flowed out of the O&G sector into the “green metals” space in recent years due to environmental concerns. That’s creating great value in oil and gas, Forwood says.
“We think that in the equity space, there’s a lot of really good value,” he said.
“You’re seeing a number of companies trading at two times earnings in the oil space at the moment. So on an equities basis, we think there’s some there’s some really good opportunities there.”
Forwood says Lowell’s aim is to hunt for the value uplift to be found from companies chasing new discoveries and resource growth at the small end of the listed market.
He says one oil play and two gas explorers standout right now.
One is Melbana Energy (ASX:MAY), which is up ~92% over the past month after interpreting a “significant oil reservoir” at the Alameda-1 well in Cuba.
“Melbana is right in that spot at the moment, it’s drilling as we speak a really very substantial oil reservoir in Cuba,” Forwood said.
“And this particular well is going down right now, it’s intersected its first two targets and exceeded the pre-drill prognosis of what might be in those first two targets.
“But the bottom target is actually the biggest one. So if that comes in, then the share price appreciation we’ve already seen — I think it’s up about three times already since the well started — It’ll probably double and possibly even double again from here.”
Some of the fundamentals driving the oil price up are “pretty much mirrored” in Australia’s east coast gas market, Forwood said, and he has a couple of choices there as well.
“So Comet Ridge (ASX:COI) is also at that early stage, with its Mahalo & Mahalo North projects which Santos (ASX:STO) has come in and taken an interest in, that is looking very promising in terms of potential gas production from that project.
“And Blue Energy (ASX:BLU) is sitting on some really substantial reserves in the Bowen Basin, which are undeveloped and to develop the biggest part of them does require additional gas pipeline infrastructure.
“But the outlook for that being put in place and support from government is improving all the time.
“They’re managing to expand their existing reserves.”
Gold prices have finally broken their months long holding pattern between US$1750-1850/oz on the back of the Ukraine invasion.
Since Putin began beating the drums of war prices have risen more than 6%, hitting US$1935/oz on Friday or around $2640/oz Australian. They briefly touched US$2000/oz yesterday.
While geopolitical drivers of precious metals may end up being short-lived, Forwood says the sector is Lowell’s next pick after oilies.
Forwood says the recessionary impacts of super high oil prices and tight supply chains could discourage the US Federal Reserve from raising interest rates, plunging them further into the negative.
“So you’ve got the US Federal Reserve really boxed in, in our view, that would like to raise interest rates to try and moderate inflation, but it just can’t because of the likely recessionary impact of doing that,” he said.
“So net effect of all that is that you are likely to have negative real interest rates for some time to come and those interest rates could perhaps even go significantly further negative than we’ve seen.
“We saw them bottom at about -1.2% last year, it could go even deeper into the negative given those factors. And then that is extremely positive for the gold price.”
Forwood says if an estimated US$250/oz geopolitical risk premium is maintained and real interest rates push further into the negative, gold could push back towards its 2020 all time highs in the US$2100/oz range over the next six months.
Forwood’s two sector picks are both at the exploration stage on different sides of the world.
In Australia, Lowell is strong on $177 million capped Musgrave Minerals (ASX:MGV), which is up ~380% since the start of the pandemic on the back of drilling at its Break of Day discovery near Cue in Western Australia.
“Musgrave is just a beautifully situated project. The current resource is only around 600,000 ounces, but that’s certain to grow in its next resource update sometime this year,” Forwood said.
“There’s a number of hungry, hungry, existing gold plants there which would be looking for nice high grade oxide feed. Or we think it’s highly likely that Musgrave will find enough ounces to develop a standalone project.”
MGV is also well placed as a potential takeover target if it doesn’t develop Break of Day on its own.
Musgrave has a JV with Australia’s third largest gold miner Evolution Mining (ASX:EVN) near Break of Day, while the Jake Klein chaired gold producer is already on its share register.
“The most obvious one is Evolution. Musgrave has a joint venture with Evolution to the north of its Break of Day deposit where Evolution is drilling largely on a salt lake and getting some very good intersections,” Forwood said.
“At the start of this year, Evolution announced they want to take over management of that joint venture and basically double the amount they’re projected to spend over the next six months. I think they’re looking at spending somewhere around $5 million.
But the acquisitive Ramelius Resources (ASX:RMS), Peter Cook’s Westgold Resources (ASX:WGX) and Dalgaranga mill owner Gascoyne Resources (ASX:GCY) are all within trucking distance meaning a potential bidding war is not out of the question.
“We’d love to see that but you don’t want to sell it out too cheap,” Forwood quipped.
His other gold pick is $295 million capped Predictive Discovery (ASX:PDI), which has quickly built up a 3.65Moz resource at the Bankan gold project in Guinea’s prolific Siguiri Basin and is a 250% gainer over the past 12 months.
PDI only made the north-west Bankan discovery in mid-2020 and Forwood thinks that resource will grow significantly based on recent exploration.
“Predictive Discovery is sitting on 3.6Moz at 1 & 1/2 grams a tonne in West Africa in Guinea,” he said.
“So it’s not everyone’s cup of tea, but it is a remarkable discovery, and we think it’s got the potential to at least double from here, given the drilling they’ve done around and outside of the existing resource plus immediately next to it.
“But also, the satellite regional drilling has been turning up some really exciting first pass results on completely new virgin ground. So we like the potential there and the economics of that project already look pretty fantastic.”