Navigating the Market: Opportunities in the Breakage
April 3, 2020
Jenna Dagenhart: Joining us now with his quarterly outlook is Jan van Eck, CEO of VanEck. Jan, some people have said that the stock market is way overvalued after the rebound from the March lows. Do you think investors should be worried about their portfolios right now?
Jan van Eck: Actually, I think investors should be very comfortable if they're maintaining their strategic allocations to stocks and bonds. There are some very negative scenarios out there, and I really think that has been taken off the table. And let me explain why.
Jan van Eck: I think there's this factor in markets. They hate uncertainty. And in March, we just had so much uncertainty, specifically about whether we could flatten the curve or not. Since it's very clear that country after country has been able to flatten the curve—you can judge how quickly—we know that that has happened, so the uncertainty has gone from the market. We really have a lot of visibility as to the recovery from this recession.
Jan van Eck: I would just add quickly, we know it's a recession with very high certainty, because oil and copper prices did not go below their 2015 lows. That's when China basically had a mini recession. So, I think worrying about a depression is really an unlikely scenario right now.
Jenna Dagenhart: If you're calling it a recession, what will the dimensions of that be, and what kind of recovery will we see? I know [Federal Reserve Chairman Jerome] Powell said recently in an interview with CBS 60 Minutes that he believes the economy will recover, but it could take until the end of next year.
Jan van Eck: Well, we know there's so much damage being done because of the unemployment. So again, I would say what the market consensus is, is pretty much what we see here at VanEck. Meaning, there are some sectors—the work at home sectors—that companies are actually not even seeing recession conditions at all, like esports and Amazon. Then there are other areas like banks, which are very much affected, because there's going to be a lot of defaults. Then obviously the energy sector as well has been hit very hard from this.
Jan van Eck: We know also from the China data, pretty much it will take a while before people start doing certain activities, as long as there's no vaccine. In China, for example, subway traffic during the work week is only 60% of normal, of last year. And weekend subway traffic, which you have to assume relates to entertainment and all that, is still at 50% of last year's level. If China is two months ahead of us, then you know that we're seeing a very uneven recovery, and it'll take a long time to heal from that. But the visibility, if we had lack of visibility in March, we have visibility now, which is why I'm just more comfortable sticking with portfolio allocations.
Jenna Dagenhart: And some people are saying that gold could go above $2,000 [per ounce]. What do you think about that?
Jan van Eck: Merrill Lynch and Morgan Stanley both have said that. The fundamental reason to own gold is because real interest rates are negative, and that's what gold kind of competes with, so that's number one. And number two, the reason people like gold is, if we all agree that the recession will be long, how much more would the central bank have to stimulate to keep things going? And the more they stimulate the better for gold.
Jan van Eck: The one point I would make is that $1,800 an ounce is a really big technical hurdle for gold. It couldn't get above there three times, 10 years ago. So, I'm not a technician. The fundamental reason to own gold is what I just said. But I think as long as gold is below $1,800, which it is right now, then you should be at your maximum gold allocation, which for some people is 5% to 10%. It's not too late to own gold. Let me put it that way. If it breaks through $2,000 and starts really rallying, then I would start taking some gold profits off the table.
Jenna Dagenhart: And with the Fed's (Federal Reserve’s) aggressive bond buying programs and stimulus, do you think that there are opportunities within fixed income?
Jan van Eck: Yeah, I think it's across the spectrum. Again, I'm a little less cautious than some commentators. Investment grade is fine, but there's going to be a lot of corporate issuance in some of those battered sectors. Municipalities as well are going to have to raise a lot of money. The Fed has said, "Hey, we'll be out there buying, directly or indirectly," so it's hard for me to see a big spike in interest rates.
Jan van Eck: You know I like to always talk about China a little bit as well. I'll point out that actually there, interest rates overall have fallen, but what's different is that interest rates with companies have fallen as well. Whereas here, we know that high yield interest rates have spiked a lot, and they're still at elevated levels. So, if things are easier in China almost in a way than they are here, again that should lead to a global recovery from this recession.
Jenna Dagenhart: And Jan, finally, any main market drivers that you'd like to highlight? Any other thoughts on the coronavirus pandemic and how it's impacting the markets?
Jan van Eck: Well, I mean, again, the super high growth sectors are kind of fun to watch. It's amazing how growth stocks have outperformed value again, this year. It's just remarkable, and it shows to me that the market is relatively intelligent, in terms of pricing what this recession will look like. The one wild card is obviously the vaccine. I would say, for the record, I think what the market is pricing in is that we will have a vaccine available by the end of this year. How widely available, we don't know. If it happens a lot faster than that, that will be a positive surprise and obviously a negative surprise if we don't get that. And that will just mean a lot more bankruptcies and credit destruction, I think, for the sectors that need people to get back to work and traveling.
Jenna Dagenhart: Well, Jan, thank you so much for your time and your insights. Really great to have you.
Jan van Eck: Good to see you again, Jenna.
Jenna Dagenhart: In addition to the human toll, the coronavirus pandemic, has had a severe impact on the markets. Here to share his outlook is Jan Van Eck CEO at VanEck. Jan, thanks for being with us.
Jan Van Eck: Thank you.
Jenna Dagenhart: So Jan, what can we learn from China here and what is the latest data telling us?
Jan Van Eck: So we started this period of uncertainty in early March. And I said at the time I thought it would last till mid-April. That seems to be still a good timeframe. And we learned not just about how bad the recession will be because we're going through a global recession, but also the pace of recovery. That's what's really important. We know this is going to affect the US through the summer. The question is, by year end are we going to be back to prior year levels or are we still going to be struggling? China gives us some really early data on that.
Jan Van Eck: We just got the March data. Their PMIs were both solidly over 50, which is great, both services and manufacturing, but their traffic is still at about 90% and their electricity is still at about 90%. So that's not... You would still call that recessionary levels, but that's about a month and a half afterward. So, the early signs are the direction is right, but the uncertainty is still there. And I think that'll still be there for the markets at least through mid-April.
Jenna Dagenhart: And Jan, how are you using commodities as indicators of economic activity?
Jan Van Eck: Well, I do think since this is a global recession, China's 20% of the world economy, which wasn't the case over the long, long time, a 100 years. That commodity prices can be a relatively good indicator just on how basic activity is happening at the industrial level. So, I like to look at copper prices, which fell from about $2.50 down to almost $2 now at $2.22. So that's showing us signs of bottom. Oil is a little bit tougher because of the big OPEC price war that's going on at the same time. But you know, Brent's at 26, so I look at that to be a bottoming indicator as well.
Jenna Dagenhart: And this is the fastest decline ever. How does today's market compared to historical drawdowns?
Jan Van Eck: Well, we all know this is the worst stock market fall in history. But to me, it's really thrown up some opportunities that I didn't even think would exist when this period of uncertainty started. In other words, the damage was so great, there was breakage. And so, what are the things that I like to look at as far as buying during this time period? I think obviously the fixed income markets fell apart from Munis to investment grade to high yield.
Jan Van Eck: And there were still, even though the fed buying has caused some price recovery. I think there are still some really good opportunities. There are high yields, interest rates are as high as they've been pretty much over the last 20 years, except for the 08, 09 financial crisis. So that's number one; Number two, financial stocks traded for a while below tangible book value. Now, if people can't pay their bills or their loans, of course there'll be some damage to that book value, but that's kind of, they say they don't ring the bell, that's kind of a bell ringer for me.
Jan Van Eck: And then also, and this is a little bit more controversial, but oil below $30 a barrel, it's just not sustainable for a lot of countries. And so those are the things they're like, wow, maybe those things are worth looking at, even in this period of uncertainty.
Jenna Dagenhart: And Jan, what's your outlook like for Gold?
Jan Van Eck: Well, Gold, our outlook turned positive last summer, in the summer of 2019, because Gold is a monetary asset, and it's driven by interest rates. But sometimes you can look to technicals. And the technicals really broke out, so it said last summer Gold's in a bull market, and Gold Bullion indeed has been up over the last year. We expect a multiyear bull market. I think what's disappointed, some investors is Gold mining shares.
Jan Van Eck: Their shares are Gold mining companies, which fell during this breakage, like I'm calling it. But what we point out like, 08, 09. The recovery of Gold Bullion and Gold mining shares actually was faster than the overall market. So we think that's still a potential. We would definitely say, we're not out of the woods as far as the depression is concerned, even though the risks are low, so it's not a bad time to own a hedge in your portfolio.
Jenna Dagenhart: Yeah. What do you think the biggest risks are moving forward?
Jan Van Eck: Well, obviously one has been taken away, which is the risk of government inaction, even in the depression. What made that so bad is actually the government raised interest rates during that time period instead of lowering them and acting as a backstop. So that risk is kind of taken off the table, but we just don't know the pace of recovery. I mean, the real risk is that all of us change our behavior and that certain businesses are permanently damaged, which means it would take years, not quarters to get back to prior economic growth.
Jan Van Eck: As I said, I think late April, this period of uncertainty will end. And that's when you can have a little bit of a higher conviction. I kind of feel like it's too late to sell. And that is one thing I've been saying. So if you think this is only going to be a recession, definitely start adding to your exposures now.
Jenna Dagenhart: Well, Jan, thank you so much for your time and your insight.
Jan Van Eck: Thank you. And you know, one thing I want to remind people is we update the China's statistics on our website every month, as they said, as this sort of saga continues. So vaneck.com is good place to look out for subscribing to updates.
Jenna Dagenhart: This afternoon, I'm joined by David Semple. He's the VanEck emerging markets, equity strategies, portfolio manager. David and the team believe that the growth potential for emerging markets should be viewed with the longer timeframe in mind, beyond the coronavirus and other headlines. Today we'll discuss emerging markets equities and the COVID-19 impact, strategy highlights and investment opportunities in the EM space. David, thanks for being with us.
David Semple: Thank you very much for having me.
Jenna Dagenhart: Yeah. Great to have you. So, David, in light of the current pandemic, how has this impacted investing in emerging markets?
David Semple: I think there's a lot of change going on in emerging markets, but I would like to focus on two different things. Hang your hat on two different words here. One is acceleration, and one is divergent. So, acceleration is important because on a macro sense the countries that came into this with issue have seen those issues accelerate and be exacerbated. I think that's very relevant for countries.
David Semple: The likes of let's say Brazil or South Africa, for instance. So, I think that's one element of it in a macro sense, but I think even more interesting in terms of acceleration is by sector. So, what we've seen, I mean, we're all working from home, right? So, we can see what happens in terms of acceleration for telecommuting acceleration for the use of data centers for instance, but for us very relevantly, it's eCommerce and certain parts of eCommerce.
David Semple: It's about cashless societies for instance, but it's also about things like Chinese pharmaceuticals. So, as we develop vaccines, we're becoming unfortunately much more nationalistic everywhere. And so, development of the vaccine is taking place everywhere, but certainly provide an impetus to the Chinese pharmaceutical sector, which was in any event, an area of a lot of interest to us, including telemedicine as well. I mean, that's another area. I myself, I have an appointment with my doctor on video on Monday, and one of our companies we own in China is one of the largest telemedicine providers in the world.
David Semple: So you're seeing an acceleration of some of these trends that were already happening buying stuff online and so forth, but also a divergence as well. A divergence in terms of how countries deal with this. China, obviously first in first out. Increasing control surveillance on what's going on and we might not philosophically like that, but it's been very effective. And I think it's hard how to deny that. I'm on the other hand for poorer emerging markets, economies, their way of dealing with it. I mean, unfortunately they have a very Hobbesian choice about whether people stop or whether people... If you're locked down or whether you let the virus.
David Semple: The huge advantage for a lot of those countries is a very young population. So, if I clear the fatality rate would likely be less. But also, within sectors as well. There's been a big divergence. So, we've long been shareholders, I mean, high active share in the healthcare sector. In healthcare sector, hospitals are struggling a bit simply because there's not as my elective procedures, medical tourism is not as viable as borders are closed.
David Semple: On the other hand as I mentioned, the pharmaceutical side is doing well. Telemedicine's doing well. And also, for consumption, if you distinguish here between social consumption and remote consumption. Social consumption is where you have to be with other people to consume. In other words, restaurants, the towels, travel, tourism, casinos, those sort of things. They're clearly going to take some time to come back. On the other hand, the remote consumption, which is things like eCommerce things like video games, things like telemedicine as I talked about earlier, they are clearly benefiting from this.
Jenna Dagenhart: Yeah. Building off of that, can you give some more examples of companies or industries that are hurt or benefiting from the current market environment?
David Semple: Yeah, we started the Academy. We think and talk about this all the time. So, there's many, many examples to this. So, for instance, I talked about telemedicine. One of the holdings that we have is a company called Ping An Good Doctor, listed in Hong Kong. It is, I believe, the largest telemedicine provider by user base in the world. Now in China, typically you go to hospitals to see doctors, rather than a family practitioner. In this environment, I mean, even before this environment, it was not necessarily a pleasant experience because of wait times and the crowdedness of a lot of these hospitals.
David Semple: If you can see your medical provider for relatively routine things through a video call on your phone, clearly that's preferable, and the government clearly understands as well that the cost of medical care going forward, is something they have to address given that doctors in this environment can see many more patients have many more consultations in a day and much more cost effectively. This is clearly had some tailwinds behind it, which have only accelerated in this case.
Jenna Dagenhart: And finally, how do you see the evolution of the asset class longer term, and specifically what role will China play?
David Semple: Well, it's an interesting question. I mean, I've said for a long time that the clearance of emerging markets becomes less violent going forward. In other words, it is a grab bag of countries in many different places. And what we've seen come out of this is an acceleration of nationalism and acceleration, particularly in the US of a narrative about China which is disapproving. And we'll see increasing sort of balkanization of capital going forward.
David Semple: And that really comes out in terms of particularly the tech bifurcation that we're starting to see where US companies won't deal with Chinese companies, Chinese companies won't deal with US companies and they develop on their own. So, we're going to see more of that, more splinter net as they call it. I think it's going to be harmful, particularly for the smaller poorer countries the less educated countries where they depended upon cheap labor as their methodology for climbing up the volume audit chain.
David Semple: That's going to be less relevant. There's going to be more reassuring. And it certainly tends to advantage those countries that have scale, that are large so-called continental economies, and that have that educational background and it's hard to get away from China here, that China has a lot of these attributes in this respect. So, like it or not in terms of how they run the economy, they run the society. It's going to be an increasingly large part of the emerging markets landscape. It's already almost 40% of our benchmark. I can only see that getting bigger.
Jenna Dagenhart: Well, David, thank you so much for your time and your insight. It's really great to have you.
David Semple: Thank you very much.
Jenna Dagenhart: The coronavirus health crisis has led to historic sell offs and a flight to safety. Joining us today to discuss Gold is Joe Foster portfolio manager at VanEck. Joe. Thanks for being with us.
Joe Foster: Hello, Jenna. It's nice to be here.
Jenna Dagenhart:Yeah. So Joe, despite being recognized as a safe haven investment. Gold and Gold stocks were caught up in the broad market sell off in February and March. What happened here? And was this something that you anticipated?
Joe Foster: Well, I've always told investors that in a crash, Gold and Gold stocks will sell off with the rest of the market. And that situation people are raising cash. They've got redemptions, margin calls, funds are positioning for a risk off environment.
Joe Foster: So there's just a flight to cash and everything goes down at the same time. We've been using the 2008 crash as a template. And if you look at that crash Gold and Gold stocks again, they went down with the market. But they bounced back very quickly in a strong V-shaped recovery. And we've seen this time the market went down in March, but by April 13th, Gold and Gold stocks had returned to their pre-crash levels. And in fact, Gold had made a new longterm high of over $1,700 an ounce.
Jenna Dagenhart: Yeah. The highest price in seven years.
Joe Foster: Yeah, it's doing very well.
Jenna Dagenhart: And what have been some of the most notable changes to Gold price fundamentals during this latest market crisis? And have they impacted your near or longterm outlook for Gold at all?
Joe Foster: We have adjusted our outlook for sure. We turned very bullish on Gold last year when Gold broke through the $1,365 level. When the fed reverse course and started cutting rates, that brought on a falling real rate environment and Gold historically has always done very well when real rates are falling. So now later on that this deflationary pandemic shock and you've got rates falling further, we're going into a recession.
Joe Foster: We don't know how deep it will be or how long it will be, debt is increasing, companies are increasing their debt levels to cope with this, governments are having massive increases in debt to raise the funds to get through this crisis. So there's an awful lot of uncertainty in the market going forward. And we think that that can propel Gold up to $2,000 an ounce over the next 12 months. And in certain scenarios, we could see Gold go much higher than that.
Jenna Dagenhart: Yeah. Joe, with interest rates as low as they are, as you mentioned, that definitely reduces the opportunity cost of holding Gold.
Joe Foster: Oh, definitely. So obviously Gold doesn't pay any interest, but with interest rates at zero or even negative in Europe and Japan, Gold is now competitive with interest bearing instruments
Jenna Dagenhart: And Gold prices seem to be supporting the case for owning Gold stocks now, too. Is there anything other than Gold prices backing your bullish view?
Joe Foster: Well, the Gold companies are very well positioned both financially and in terms of cash flow. So looking first at their balance sheets, we look at net debt-to-EBITDA, which is the debt ratio that many banks use. On average, the net debt-to-EBITDA of the Gold industry is about one fifth of the debt ratios of the S&P 500. So these companies are very strong financially and in fact, many Gold companies have negative net debt, which means they have more cash than debt on their balance sheet.
Joe Foster: Also these companies are generating a lot of cash when you consider that it costs about $925 an ounce on average to produce Gold. You have to add in other non-cash costs like exploration, capital needs, overhead, when you throw it all in, it costs about $1,200 an ounce to run a strong Gold company, compare that with current Gold prices, these companies are cash flying 400, $500 an ounce in free cash flow. So very, very strong financially.
Jenna Dagenhart: Certainly. And finally, how do you think that the coronavirus pandemic is impacting Gold stocks?
Joe Foster: That's had a limited impact on the miners. Looking back at March, roughly 12% of Gold mining globally was offline due to the lockdowns and the mitigation efforts. Since then, we've seen back Argentina, South Africa allow the miners to go back to work. So currently we're looking at probably roughly 8% of the industry is offline due to the virus. And we expect that to decrease over the next several weeks.
Joe Foster: So these companies are seeing a limited impact and in fact, I think governments are finding, they're very well suited to combat this type of a health crisis. Many companies have operations in Africa whether they've got malaria, they've been through the AIDS epidemic, the Ebola epidemic. They know the protocols and the procedures. And so they're implementing those obviously globally now, but they're very well positioned to take on a health crisis like this.
Jenna Dagenhart: And what about valuations?
Joe Foster: Valuations, another aspect, I'm glad you brought that up, is stocks are very cheap historically. So they're trading at about eight times cash flow right now. Compare that with a longer term average of around 11 times cash flow. In a stronger bull market, you get up to 20 times cash flow. So these stocks are very cheap financially. They're strong, they're generating a lot of cash. They're paying dividends.
Joe Foster: We've seen two companies increase their dividends in the midst of this crisis. And we expect more companies to continue increasing dividends once all the mines are back online. So this industry is very strong contrast that with many other industries that are struggling and will continue to struggle for the foreseeable future. We think gold stocks are an outstanding value right now.
Jenna Dagenhart: Yeah. A lot of companies cutting dividends.
Joe Foster: Yeah. Cutting dividends, adding debt to their balance sheet. Gold is one of the few industries with a rising commodity price, rising price for its product. So that's a very unique situation for these gold miners.
Jenna Dagenhart: Yes. Very unique indeed. Well, Joe, thank you so much for joining us.
Joe Foster: Yes, it's good to be here and stay well.
Jenna Dagenhart:Joining us to discuss OPEC's historic production cut, the energy sector and more is Shawn Reynolds. He's portfolio manager for the natural resources, equity strategies team at VanEck. Shawn, thanks for being with us.
Shawn Reynolds:Thanks for having me.
Jenna Dagenhart: So Shawn, walk us through the recent OPEC plus resolution. What do you believe to be the short term as well as the longterm ramifications on a wheel?
Shawn Reynolds: Well, I guess that really depends on your perspective. I mean, if you're taking it from the OPEC really slash Saudi side, they've done two things. In the short term, they've stopped Armageddon, complete hemorrhaging of the oil price, and they needed to do that because they were getting to a level where prices were hurting everyone, not just those who they were focused on. Longer term, I think they've gotten what they wanted in that prices are going to settle in the twenties, thirties over the next three to six, seven months.
Shawn Reynolds: And that's a price that continues to put stress on the high cost producers around the world, whether it be shale or off shore and they want that. They want those high cost producers to exit the market and for them, for Saudi and other OPEC members to continue to gain market share. So they've pretty much accomplished what they're looking for. For the actual producers on that end, it's too little too late. You are basically getting to a point where inventories are going to get full in the United States and North America all around the world.
Shawn Reynolds: And that is obviously pressuring near term prices. You know, there's quite a bit of contango in the market right now, meaning that prices in the outer months and outer years are much higher than the near months. But that doesn't matter when you're producing today and looking for cash flow today. So many of these companies here in the US as well as around the world are really struggling with regards to the cash flow they're generating.
Jenna Dagenhart: And Shawn, how has the pandemic impacted operations of US E&P companies and their recent initiatives to focus on returns.
Shawn Reynolds: Operationally. It really hasn't hit the industry very hard at all. In many other resource industries, we hear about mine closures or even pork producing closures or whatever. In the oil industry so far you're not seeing pandemic related closures. You are seeing the rig count and frat crews being cut dramatically, but that's really related to the operations associated with price and restriction of capital.
Shawn Reynolds:So from that front, you haven't seen a lot of impact. With regards to the emerging and growing strategy and business model of returning capital in the forms of dividends and perhaps share repurchases yet to be seen. There are some companies like Chevron who have said absolutely our first priority is to maintain and grow that dividend. Many of the shale companies who understand that they've spent 10 years investing on the behalf of shareholders and now have to return some of that capital.
Shawn Reynolds: You know, many of them have committed to doing that. In fact, when we talk to them, quite often you hear, "here are our priorities, make our employees safe, take care of our balance sheet, pay our employees and return capital to shareholders, at the expense of production." And that's the key point there is that when we hear that from companies, we say, well, what does that mean?
Shawn Reynolds: A year from now your production could be down 10 or 20%, and we basically get a nodding of the head, or saying, yes, that's exactly what it could be. Not, that's what we want to be. Not that's what we're planning for, but if that's what it turns out to be, we can do that. And many of them are forecasting and modeling around very low prices, $15 a barrel. And several are saying that we can deliver on those priorities that I just outlined if we hit that, not if we stay there for years, but if we hit that for a period of time, we can deliver on those priorities.
Jenna Dagenhart: Shawn, despite this challenging environment, what opportunities are you seeing in alternative energy?
Shawn Reynolds: Well, alternative energy is a space that we've been adding exposure to for quite some time and really for two reasons, first of all, it fits into the overall strategies, philosophy of trying to leverage global growth and provide some inflation protection. Also importantly, it really provides some diversification benefits that we've seen a lot of help from in terms of the performance over the last few years actually.
Shawn Reynolds: The second reason is that this portfolio that we run has always kind of tried to be forward looking and think about themes and trends in the future, and clearly alternative energy and sustainability is a gigantic theme. The areas that we've been exposed to most is solar, solar components, geothermal, financing in the solar and alternative area as well as most recently into renewable diesel. Obviously quite a spectrum there quite a lot of different things and that's true to the entire area that we've seen for quite some time.
Shawn Reynolds: There's a lot of companies involved in alternative energy. There are not a lot of good investment opportunities and alternative energy. And we spend a lot of time focusing on what we always say, sustainability demands, sustainability. I.e Sustainable financial results need to be there to deliver sustainable environmental results. So we looked for, just like we look for every company, great management team that can actually execute good assets, good business models and a strong balance sheet. Those are few and far between and the alternative energy space, but we've had a lot of success in identifying those over the last few years.
Jenna Dagenhart: So looking for those strong points, but you're still well-diversified within the alternative energy space?
Shawn Reynolds: Yes. As I said, solar, geothermal, renewable diesel, quite a lot of different areas and there's more to come, I would not be surprised and I would even say expect, more alternative energy over the years in this strategy.
Jenna Dagenhart:Shawn, thanks so much for joining us.
Shawn Reynolds: Thanks for having me
Jenna Dagenhart: As people around the world are staying home. The COVID-19 pandemic is having a huge impact on all asset classes, including commodities. OPEC-Plus just reach a deal for the biggest oil production cut ever. But the question is. Will it be enough to offset the dramatic drop in demand? Joining us now is Roland Morris. He's a portfolio manager and strategist for the commodity index strategy team at VanEck. Roland, thanks for being with us.
Roland Morris: Happy to be here.
Jenna Dagenhart: So Roland, how are commodities being impact on the supply and the demand side with coronavirus?
Roland Morris: Sure. Well, this has been a historic shock to the whole global economy. At the very beginning of this crisis, there was some concern that there was going to be some supply problems. Really, because we thought globally that the pandemic or the virus was just striking China, but as it spread across the world and we had to shut down global economies in virtually every country, the demand side really collapsed dramatically.
Roland Morris: In fact, it's probably the sharpest demand collapse we've ever seen really in history. So all commodities, all of a sudden with a lot of other asset classes declined in response to the demand shock. Some commodities were worse than others oil in particular. But all commodities fell roughly 20, 25% in the first quarter. And it was all really related to fears around how long economies are going to be shut down and how severely demand will be impacted.
Jenna Dagenhart: Yeah. Digging deeper into the curve for oil. What are you seeing? Are we seeing contango with the flood of supply? You bring up a storage costs.
Roland Morris: But when you think about it, we really had a historic mismatch of demand and supply of anything I've ever seen in commodities. And since we are close to storage, all storage is booked or essentially tankers are all full we're coming close to the top of tanks, transportation, pipes, everything is sort of booked. So there's no real place to put the oil. And if you can find a spot it's very expensive.
Roland Morris: So we've driven the market into steep contango, the front markets portraying deep discounts in the forward curve, and really at its most extreme, which some people refer to as super contango, it was almost a 50% premium one year out, which is a dramatic shift in the curve. In fact, we'd never seen the curve that's steep in contango. We saw briefly in 08. Sometimes that can actually mark an extreme in a market where prices just get completely disjointed.
Roland Morris: And the pressure on the front of the curve was so pronounced relative to the back end. I will say that the agreement over the weekend has improved the situation, but only modestly the curve is still steep in contango. There's just those front contracts are lower price than the forward curve.
Jenna Dagenhart: It takes a little while to get out of that historic contango.
Roland Morris: Really in this situation, we really need to understand how bad demand is and how quickly it will come back. We're clearly oversupplied even with the production cuts over the weekend in the near term. The real question for the market is how quickly that demand will come back. And that's something we're just not going to know for a while.
Jenna Dagenhart: And turning away from oil and looking at Gold, which FANUC is known for, how you Gold in the world of commodities because it has a very different role as a safe haven asset and we're seeing a very different performance there.
Roland Morris: We have central banks responding aggressively, which at some point might lead to some inflationary pressures. So you have all those question marks out there. And Gold has benefited as a flight to safety asset. It's obviously performing well, it's making new highs for this move. And most other asset classes around the world are down severely on the year. I will say that it is interesting, we've had a little bit of an issue between the futures and the spot price.
Roland Morris: The future has been trading at a pretty steep premium to the spot price of about $45 over the last week. There's a lot of theories as to why that's happening. Part of it probably is just the difficulty of actually moving the physical Gold to make delivery to the exchange. So there's a mismatch between the dealer's positions and the futures exchange. We haven't seen that kind of premium in the market to sit in a sustaining way. It has happened in brief periods, but that is something interesting. And I'm not sure anybody's entirely sure why that has happened.
Roland Morris: But futures have been very strong relative to the spot price, but any rate Gold's acting well, I will say one other thing about commodities broadly speaking, if you look at some other sectors, you are seeing some production being shut down and over time, you'll see production shutdown everywhere, including in energy, just because of the price, but we're seeing actually related to the virus, some shutdowns and other sectors. In Gold, for instance, about 11% of production is shut in. Now that's not as important to the price of Gold because what really matters is investor demand.
Roland Morris: But if you take an important commodity like copper, almost 30% of current production is shut due to the virus. And so those mines, depending on how long they're shut. They will severely impact those commodities. So we may end up with a situation where when we come out of this, we actually get some pretty strong price movement in commodities because we will have destroyed some supply. And when demand comes back, particularly in some of the industrial metals, we're likely to be short on supply. And copper would be one that I would highlight. So it is sort of the virus is having an effect on both sides. Clearly now we're more worried about demand, but as we go forward with some of these mines being shut for health concerns, you're going to have concerns about actual supply. So there's two sides to the forces here.
Jenna Dagenhart: Yeah, really interesting point Roland and definitely something to keep in mind. Well, thanks so much for your time.
Roland Morris: Thank you for having me.
Brandon Rakszaw...: After a brief stint of tightening. The fed is now back in easing mode interest rates have declined, which add to what has been a decade plus search for yield for investors. I think that need for income paired with some apprehension in the markets in 2019, led to ETF fixed income flows, surpassing all time highs in terms of net new inflow in 2019. It nearly kept pace with equity ETFs in terms of total net flows for the year despite equity markets posting returns of 30 plus percent here in the US.
Brandon Rakszaw...: So certainly a demand for income producing assets, longer term we've seen what used to be previously obscure asset classes become far more prominent in many investors portfolios. So certain asset classes focused on income such as MLPs, Master Limited Partnership, mutual funds and ETFs in the US, investing in that space have grown over 800% in the last decade, infrastructure funds, mutual funds and ETFs 700%, preferred securities 300%, real estate 200% in the last decade.
Brandon Rakszaw...: So clearly trends toward income producing assets, dividend, focused ETFs strategies are no exception. ETFs that allocate to dividend paying stocks have grown from a very small $12 billion segment of the ETF market prior to the financial crisis of 2008, to about 230 billion today. So clearly long and short term trends toward income bearing assets.
Brandon Rakszaw...: The VanEck Vectors Morningstar durable dividend ETF, ticker D-U-R-A or DURA seeks to leverage Morningstar's equity research process, their forward-looking equity research process to assemble a portfolio of high yielding companies that are financially healthy and also focus on valuations. The underlying index of the ETF, the Morningstar US dividend valuation index uses a three pronged approach. It starts with the obvious, target companies with high dividend yield, and then it ensures that a company is financially healthy, which is very important.
Brandon Rakszaw...: And third, it allocates to those high yielding, financially healthy companies that also display attractive valuations. The strategy assessed financial health using Morningstar's distance to default score. Distance to default is a quantitative measure, that's used to assess the probability that a company may default or go into bankruptcy. Distance to default considers both financial statement information such as asset values and total liabilities, but also recent equity market data, namely equity price volatility associated with a company.
Brandon Rakszaw...: The reason that the model considers equity market data is that, equity markets tend to be, or can be a leading indicator of financial distress, sometimes indicating financial distress in a company far before any financial statements may reflect that stress or even credit rating agencies may reflect financial distress in a credit rating.
Brandon Rakszaw...: So the distance of default score is not only a quantitative measure of financial health is important because it's predictive and a forward-looking way. Morningstar has found that distance to default is a strong indicator of the potential for future dividend cuts from a company. In other words, a company with better financial health or a longer or larger distance to default, historically had less of a chance of cutting future distributions. A great case study on how this has played out.
Brandon Rakszaw...:And the underlying strategy would be Kraft Heinz. In 2018, the company was a member of the Morningstar US dividend valuation index. In September of that year, the company was removed from the index because it failed the index's distance to default screen. Subsequently, in February of 2019, Kraft Heinz cut its distribution significantly, and its market price sold off to a pretty large degree.
Brandon Rakszaw...: So the distance to default screen allowed this strategy to flag potential for future dividend cut and remove that company from the index and avoid holding Kraft Heinz at the time of its dividend cut. Tremendous asset flow into dividend paying stocks paired with equity markets, reaching all time highs seemingly every week, elevates the importance of focusing on valuations when accessing the equity markets, Morningstar's rigorous forward-looking valuation process.
Brandon Rakszaw...: Forecasts, future free cash flows decades into the future, discounting them back and arriving at a current intrinsic value. The underlying index can then leverage that research to ensure that the strategy on a regular basis at each review is avoiding overpaying for dividend paying stocks. This is what truly sets DURA apart from other indexed dividend strategies.
Fran Rodilosso: There are several key drivers of fallen angels out performance. First and most significantly when bonds crossover from investment grade to high yield. There's naturally a change in ownership from investment grade based, investment portfolios to high yield and more opportunities to investors. But during that period, that crossover from triple-B to double-B, there tends to be a lot of for selling, in fact, overselling. In the six months prior to a bond being downgraded from investment grade to high yield.
Fran Rodilosso: In fact, historically they've lost between 7 and 8% in price terms. The hypothesis that is actually overselling has been proven historically, at least so far, as on average, those bonds have recovered most of that price loss in the six months post downgrade. So that pricing anomaly is the most important aspect of a fallen angel index in terms of its performance versus a broad high yield index, but there are two others.
Fran Rodilosso: One is sector differentiation. In simple terms, fallen angel index is not adding bonds at the top of a cycle when there's a lot of new issuance in the sector, it tends to add bonds after cycles bottomed out when there are a lot of downgrades it's contrarian, but that also leads to very different sector exposures. That also historically has worked in favor of fallen angel indexes. Finally, quality. The majority of fallen angel stay in the double-B category in recent years, between 70 and 80% of a broad fallen angel index has stayed in the double-B category versus an average a little less than 50% in a broad high yield market. And that has provided some downside protection when spreads move wider.
Fran Rodilosso: Because fallen angels were originally issued as investment grade. There tends to be longer maturities. That is part of why fallen angels often remain in the double-B category. They've longer debt profiles, more financial flexibility, that also does mean they'll have longer duration on average than broad high yield. Historically that duration difference has been about one to two years also because of the higher quality, fallen angels have tended to have a lower yield than the broad high yield market. The recently that yield gap has been very narrow relative to its historical levels.
Fran Rodilosso: We've seen investors use fallen angels in a variety of ways in a portfolio as either a compliment or substitute versus active or passive high yield alternatives. We think the most common use has probably more as a compliment adding more fallen angels with a different risk return profile than broad high yield to a portfolio that may actually contain some active and passive options but on absolute basis and risk adjusted basis, fallen angels warrant use in a variety of ways, including as a substitute for active.
Fran Rodilosso: This late in the credit cycle investors in considering their positioning in high yield. I mean, if they're tactical in terms of their high yield allocations, they may be looking to stay away or wait till a cycle turns, given current central bank policy growth outlook even a mid declining earnings credit cycle could last for quite a while, still. And high yield still offers attractive yields versus a lot of other asset classes, even considering the risks.
Fran Rodilosso: So the way I look at fallen angels though, is a good alternative through the credit cycle. The high double-B component can offer some downside protection. When spreads start widening again, the differentiated sector exposure may or may not help, but historically has helped in terms of which sectors have performed worse when the credit cycle turned hardest.
Fran Rodilosso: But also because fallen angel indexes tend to be very dynamic as the credit cycle turns, especially as it bottoms out. And adds a lot of those credits and the underperforming sectors, a lot of formerly triple-Bs that are now double-Bs that have lost significant value it's tended to snap back faster than the broad high yield market. So we think fallen angels are an interesting way to play high yield through the cycle historically that's been true.
William Sokol: A green bond is like any other bond, except that the proceeds only are used to finance environmentally friendly projects. In the vast majority of cases, a green bond is backed by the full balance sheet of the issuer and ranks equally with other debt of the same seniority. So all else equal, the risk and return profile of a green bond is the same as a conventional non-green counterpart. The market only began around 2007 and remain fairly small until 2013, when we saw growth turn parabolic.
William Sokol: That growth has first and foremost been driven by investor demand, from the very start this has been an investor driven market, and it's grown to where it is organically without explicit incentives from regulators. We expect that demand will only increase particularly as there's greater awareness that investing doesn't mean sacrificing return. And in fact, there's mounting evidence to suggest that it can lead to better investment outcomes.
William Sokol: Policy makers have also taken interest in this space and want to see the market grow. There's a growing recognition that public finance is not going to be sufficient to fund the transition towards a low carbon economy. And we see greater interest from issuers as well as they better understand the benefits of issuing green bonds.
William Sokol: Green bonds can be an excellent way to fund sustainability initiatives and can be a very visible demonstration to the marketplace that an issuer is taking its sustainability issues seriously. So we have this ecosystem of issuers, policy makers, and investors who all want to see this marketplace grow. We need to see more growth to get to where we need to be, but that need translates into investment opportunity as well.
William Sokol: The green bond market was really started by super nationals and development banks. So issuers like the world bank, the European investment bank and others, because green bonds are really a natural extension of the work they do. And they continue to have a very large role in the market and have played a very important part in developing the market. But over the past few years, we've seen new types of issuers come into the market, and it's really evolved into a very diverse opportunity set.
William Sokol: On the corporate side, we see utilities and power companies issuing green bonds to fund new renewable energy capacity. Here in the US, companies like Southern Power and Duke Energy have been active in the space. But it's not just utilities. Apple is actually the largest corporate issuer in the US to date. They've issued green bonds to fund renewable energy and energy efficiency projects in their facilities, as well as throughout their supply chain and their green bonds are also financing new technology that helps them capture recycle and reuse scarce, natural resources in their products. Fannie Mae is also a very large issuer in the US. In fact, it's the largest issue of green bonds globally.
William Sokol: Those bonds are financing efficiency, upgrades in multifamily, apartment buildings across the country which directly translates into savings for tenants. And we see sovereign issuance taking off as well in a very big way. The Republic of Chile just issued its first green bond, and that is going to finance solar infrastructure and transportation projects in the country. So they can meet their commitments under the Paris agreement, including a target of becoming a net zero emitter of greenhouse gas emissions by 2050. So the universe has evolved into a very diverse opportunity set that in many ways resembles a US aggregate bond benchmark. It's diversified multi-sector and high credit quality exposure. So from that perspective can fit very nicely and seamlessly into a core bond allocation.
William Sokol: It's important to remember that green bonds are like any other bond, except they only finance environmentally friendly projects, all else equal from a risk return perspective. A green bond is the same as a conventional non-green bond. So from a portfolio construction perspective, we can set aside for a second. The fact that we're talking about green bonds, and just look at the fixed income exposure, you're getting.
William Sokol: The US dollar denominated green bond market has many similarities to a US aggregate bond benchmark, both are high quality and provide diversified and multi-sector exposure. We have a government corporate financial and agency issuers all active in the green bond space. From a yield and duration standpoint. Green bonds are inline with the US Ag. So you can allocate a portion of your core bond exposure into green bonds with very little impact from that perspective, and without adding currency risk, and also increasing sector diversification.
William Sokol: And that's an extremely attractive value proposition for fixed income investors who are looking to build sustainable bond portfolios. Another way we see investors using green bond is as a risk mitigator. And I'm talking specifically about climate risk. Climate risk is complex, and we find that it's not really priced by the market as opposed to your traditional bond risks like interest rate risk or credit risk. An example of climate risks could be an oil company whose assets are held mostly in underground fossil fuel reserves, or a municipality who has infrastructure assets that are vulnerable to rising sea levels.
William Sokol: When the market does begin to price in climate risk, you might expect those issuers to underperform issuers who have addressed climate risk. And with the green bond strategy, you're getting diversified exposure to a set of issuers who are proactively addressing climate risk. Because you're not giving up yield, you can think of it as a cheap or free hedge against climate risk in your bond portfolio.
William Sokol: The global green bond market is about 70% Euro denominated. That market has been characterized by extremely low and even negative interest rates in recent years, which makes it difficult for a US dollar based investor to take that currency risk in their portfolio, even if they find the green aspect attractive. Fortunately, the US dollar segment of the market has grown significantly in recent years, and we can now build diversified and liquid investment strategies without the currency risk.
William Sokol: We believe that a US dollar based green bond strategy can allow more investors to build sustainable fixed income portfolios without the currency risk, without giving up yield and without the costs complexity, and sometimes unanticipated tax consequences associated with currency hedging. Projects like solar and wind are unambiguously green for the most part. But it gets more complicated when we talk about projects like clean coal or projects that are seemingly green, but may have unintended environmental consequences.
William Sokol: When we launched the VanEck Vectors Green Bond ETF or GRNB, we knew it was crucial that we have an objective consistent and science-based framework in place to select the bonds, so that investors can be confident that they are investing in bonds that are truly green. To do that we partnered with an organization called the Climate Bonds Initiative or CBI. The CBI is the leading voice globally in the green bond market, helping to mobilize debt markets to fund climate solutions.
William Sokol: And their framework has really become a de facto standard in the marketplace. They've developed a taxonomy, which is an extensive list of vetted project types that are all aligned with the Paris agreement. That's the overarching principle of their taxonomy. Specifically, it's to limit global warming to well within two degrees above pre-industrial levels, through a rapid and dramatic decline in greenhouse gas emissions.
William Sokol: So what the CBI does is, it reviews all of the information around a green bond issuance to confirm that the projects being financed align with their taxonomy. If it does, the bond is then eligible for GRNB's index. If there's not enough information to make that determination, or if the projects are not aligned the bond is not eligible. The CBI also reviews ongoing reporting from the issuer to ensure there's no new information that would affect the bond's eligibility. The result is that investors can have confidence that the bonds they're investing in are truly green, thanks to this independent review.