​The lesson from 2017 has been the same as in previous years: avoid high cost producers and highly indebted companies at all times. David Whitten, Head of Global Natural resources, explains how sentiment towards natural resource equities has turned for the better and which sectors, he and the Global Natural Resources Team, favour in 2018.

What lessons have you learned from 2017?

In addition to reinforcing the cyclical and unpredictable nature of commodity prices, the lessons learned over 2017 continue to be the same as in previous years — avoid high cost producers and highly indebted companies at all times. The Janus Henderson Global Natural Resources Strategy’s investment process is designed to minimise risk to these factors and commodity price cycles. It is also important to concentrate on operations that are characterised by long lives, which often means there are options to progressively expand.

What are the key themes likely to shape the markets in which you invest in 2018 and how is this likely to impact portfolio positioning?

After several difficult years for the mining and energy sectors, sentiment towards natural resource equities rebounded sharply through 2016 and, for the most part, this has continued into 2017. A combination of vigorous cost-cutting, stronger commodity prices, earnings upgrades and improving demand led the Janus Henderson Global Natural Resources Team to tilt the strategy towards mining. This was reinforced throughout the year by the decision from the Chinese government to curtail production by highly polluting marginal operations in the coal, aluminium and steel sectors.

Below are the team’s current views on key resource sectors:

Mining: many of the major mining companies have reduced operating costs and capital expenditure. The next generation of improvement is coming from productivity gains as new technologies come to bear, including unmanned trucks and rail. High debt levels have fallen as companies sold assets and raised capital, and miners have now moved to return capital to shareholders, a trend which is likely to accelerate. Additionally, the consolidation of mines and supply restrictions in China, have started to boost many mineral commodity prices, even as we begin to see signs of a synchronous recovery in global growth.

Favoured sub-sectors still include diversified miners, copper and zinc companies and selected gold companies bringing on new projects. The global move towards electric vehicles and battery storage of renewable energy has accelerated. This is driving prices higher and strengthening demand for battery grade lithium carbonate and companies with lithium exploration and production assets. Many US-based resource companies are likely to benefit from a potential increase in US infrastructure spend, although to date this has been slower than expected.

Energy: the supply and demand balance for oil has been mixed, but once again is looking more favourable as the US onshore producers look to more capital discipline measures. The collapse in oil and gas capital expenditure resulting from more than two years of weak oil prices will impact production output, oil field decline rates and reserves. In order to meet future demand, a return to higher oil prices is needed to attract the required levels of new investment. The Organization of the Petroleum Exporting Countries (OPEC), as always, remains the wildcard. The team continue to believe that there are considerable opportunities in the oil sector and that energy stock sentiment will continue to respond accordingly. We envisage this sector will be an important contributor to performance in 2018.

Agriculture: a wave of consolidation by the world’s biggest agriculture companies is transforming the dynamics of the industry. The globalisation of agriculture is continuing as the sector leaders strive to advance food production and crop protection technologies and benefit from global diversification of supply, production and trading. Our focus is on large, global companies that use technological advantages and innovation to increase crop yields and reduce agricultural input costs. This sector is attracting a lot of attention from Chinese consumers looking to purchase high quality, safe food products.

Interesting sectors include seed technology, crop protection and fertiliser companies. New advances in precision farming, technology breakthroughs in areas such as agricultural biologicals, and changing consumer diets provide additional investment opportunities. We continue to find growth opportunities in several specialist food production areas such as salmon, horticulture, dairy products and other protein producers.

Where do you currently see the risks within your asset class and where are the most compelling opportunities?

With renewed confidence in many mineral commodities, we have tilted the portfolio back towards upstream mining and energy sectors, such as diversified miners, base metals and oil and gas exploration and production companies. In more recent times we have positioned the portfolio more toward the oil and gas sector and taken some profits from mining, although we maintain an overweight position. We hold significant positions in selected US-based resource companies that are likely beneficiaries of increased infrastructure spending. We also retain high conviction positions in several gold and lithium companies that are opening new, high quality, low cost mines.The earnings upgrade cycle is in full swing and share price valuations appear reasonable if commodity prices remain at or above current levels. With the improvement in many mineral commodities, natural resource production companies are likely to report improved earnings through 2018, although the rate of growth is expected to slow. With balance sheets in good shape and capital expenditures continuing to be curtailed, we expect to see significantly higher dividends and scope for impressive capital management initiatives.