BlackRock World Mining (BRWM) has released its annual results for the year ended 31 December 2023, during which it provided NAV and share price total returns of -6.2% and -10.4% respectively. In comparison, it says that its reference index, the MSCI ACWI Metals & Mining 30% Buffer 10/40 Index (net total return), returned +2.4%, the All-Share returned +7.9% and the UK Consumer Price Index increased by 4.0%.

After a solid year of performance in 2022, 2023 proved more difficult for the mining sector. The sector performed strongly at the start of 2023, with mined commodity prices up almost across the board, supported by the pace of China’s reopening following COVID-19 and expectations for a pick-up in demand. However, as it subsequently emerged that improvements in Chinese economic data were slower than had been hoped for, the mining sector soon pulled back. Increased geopolitical tensions in the Middle East and expectations that higher interest rates would persist for longer than initially anticipated also contributed to a challenging time for the sector. However, towards the end of 2023, signs that inflation is moderating that allowed interest rate expectations to ease led to positive market sentiment for both the mining sector and broader equity markets.

Dividends and revenue income

BRWM’s revenue return per share for the year amounted to 33.95p, a 16.6% decrease compared with the prior year revenue return per share of 40.68p. Lower commodity prices, higher all in costs and a weakening US dollar (as many commodity company dividends are paid in US dollars) contributed to the reduction in earnings.

Three quarterly interim dividends of 5.50pps were paid during the year (on 5 May 2023, 6 October 2023 and 24 November 2023) and BRWM’s board is proposing a final dividend of 17.00pps, making a total of 33.50pps (2022: 40.00p per share), representing a decrease of 16.3% on the total dividend paid for 2022.

As in past years, all dividends are fully covered by income and, in accordance with the Board’s policy, the total dividends for the year represent substantially all of B|RWM’s available income.

Subject to approval at the Annual General Meeting, the final dividend will be paid on 14 May 2024 to shareholders on the Company’s register on 22 March 2024, the ex-dividend date being 21 March 2024. It remains the Board’s intention to seek to distribute substantially all of the Company’s available income along similar lines in the future.

Gearing

BRWM operates a flexible gearing policy such that it may borrow up to 25% of its net assets depending on the prevailing market conditions. The maximum level of gearing used during the year was 14.6% and the level of gearing at 31 December 2023 was 11.9%. Average gearing over the year to 31 December 2023 was 11.9%.

Discount and premium management

BRWM’s board says that it recognises the importance to investors that the market price of the Company’s shares should not trade at a significant premium or discount to the underlying NAV and it will use the company’s authorities to issue and repurchase shares to manage this.

BRWM started 2023 trading at a premium and was able to reissue 2,430,000 ordinary shares from treasury for a total gross consideration of £15,658,000, at an average price of 644.37p per share and an average 1.4% premium to NAV. BRWM did not buy back any shares and, since the year end, no further shares have been reissued. The discount at the year end was 3.3% and on 5 March 2024 was 6.5%. As usual, resolutions to renew the authorities to issue and buy back shares will be put to shareholders at the forthcoming AGM.

Investment managers’ comments – Overview of the year

“2023 was a year of huge swings in performance for the sector as a whole and markets more broadly. While 2022 as a year finished with strong gains across the sector but much of this came from the rally in the fourth quarter of 2022 on the expectation that the reopening of China, post its zero COVID-19 policy, would drive further growth in 2023. Sadly, this was not to be as momentum stalled as January ended due to the complex array of headwinds that drove moves in 2023. Financial factors such as interest rates and inflation, combined with lower-than-expected growth in China and geo-political events, created uncertainty amongst investors leading to a significant dispersion in returns.

“Commodity price returns were similarly diverse across the suite. These ranged from iron ore prices massively exceeding estimates by failing to move lower, whilst lithium fell sharply finishing the year well below even the most cautious of forecasts. Copper prices, despite tight market conditions, did not react to large production downgrades and surprise disruptions. Precious metals also moved in different directions with gold moving higher, whilst the platinum group metals fell. Mining company share prices generally derated during the year as investors, fearful of China demand weakness, moved out of the sector into either higher yielding cash or to gain exposure to the “magnificent 7” (Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia and Tesla) opportunity. This left the sector trading on multi decade low multiples, presenting an opportunity for the Company.

“However, overall the year was disappointing for the Company as a number of key holdings failed to generate returns for a variety of factors. Examples include: First Quantum Minerals where the Panama Government enforced the closure of the company’s largest asset due to a populist agenda; Chalice Mining set unrealistic project parameters; weakness in lithium prices impacted valuations of holdings in the Company, but the opposite for South Korean steel company POSCO with shares rerated on their exposure; and mid-sized copper growth holdings heavily derated during the year. The cumulative impact of this caused the Company’s NAV to underperform the reference index (MSCI ACWI Metals & Mining 30% Buffer 10/40 Index (net total return)) for only the second time in the last 9 years.

“For the year as a whole, the NAV of the Company was down by 6.2% with income reinvested and share price total return was -10.4% as the discount widened slightly over the year. This compares to the FTSE 100 rising by 7.7%, Consumer Price Index (CPI) up by 4.0% and the reference index up by 2.4% (all numbers based in Sterling terms). Despite this poor one-year performance the Company’s track record over three and five years remains firmly intact.”

Investment managers’ comments – Seismic shifts

“2023 arrived with a huge spread of expectations. How much further would interest rates rise? Would inflation be sticky or start to fade? Would companies be able to manage margins? These questions were then mixed in with slower growth, bank rescues (Silicon Valley Bank, First Republic and Credit Suisse), conflict in the Middle East and a far slower reopening trade in China. Given the above, it is amazing to have finished the year with such positive returns for equity markets (S&P 500 Index up 18.6% in Sterling terms) and without widespread recession across the world.

“For the mining sector the fundamentals of the medium term have remained firmly in place. Energy transition related commodity demand growth remains robust. Sales of electric vehicles (EVs) broke new records in both total numbers and market share levels. Installation of renewable power infrastructure also broke records with huge amounts built during the year and an industry sales pipeline for future projects as full as can be expected.

“On the supply side, copper production numbers both for 2023 and beyond look to be less than expected as mines have been unable to ramp-up on time or to expected levels. Capital expenditure for new projects continues to exceed expectations, making project development less likely. Metal inventories generally declined during the year leaving them at multi year lows, again keeping markets tight. Resource nationalism remains an ever-present threat with risks in many countries around the world and some mines have been forced to close, including Cobre de Panama. With supply looking increasingly price inelastic in the near to medium term there seems little room to manoeuvre should disruptions escalate in 2024.

“Despite these supportive factors the sector was unable to generate enough momentum to create widespread investor interest and the alternative, such as money market deposits at 5%, captured much of the flow of savings. Mining shares significantly underperformed the broader markets as valuations moved to multi decade lows. This is in stark contrast to 2022 when the sector, alongside oil, was one of the best places to be exposed.

“Merger and acquisition (M&A) activity was elevated versus recent years, but most was characterised by failing to complete. Lithium companies in Australia were the focus of deals during the year. Despite a number of suitors being able to announce terms the deals were eventually thwarted by domestic interest, for example Liontown and Azure. In Canada, Teck Resources (Teck) announced plans to separate into an energy metals company by divesting its metallurgical coal mines. Soon after being announced, Teck received a bid from Glencore for the whole company which was rebuffed by management. Eventually Teck announced a joint plan to sell the coal business to Glencore for cash.

“In the United States (US), Newmont Corporation agreed terms to buy Newcrest Mining and this deal was completed in the final quarter of the year. Also, US Steel announced terms of a deal that could see it sold to Nippon Steel if the deal is approved by US regulators, the unions and of course shareholders.

Investment managers’ comments – ESG and the social license to operate

“ESG (Environmental, Social and Governance) issues are highly relevant to the mining sector and we seek to understand the ESG risks and possible related opportunities facing companies and industries in the portfolio. As an extractive industry, the mining sector naturally faces a number of ESG challenges given its dependence on water, carbon emissions and geographical location of assets. However, we consider that the sector can provide critical infrastructure, taxes and employment to local communities, as well as materials essential to technological development, enabling the carbon transition through the production of the metals required for the technology underpinning that transition.

“We consider ESG insights and data, including sustainability risks, within the total set of information in our research process and make a determination as to the materiality of such information as part of the investment process used to build and manage the portfolio. ESG insights are not the sole consideration when making investment decisions but, in most cases, the Company will not invest in companies which have high ESG risks (risks that affect a company’s financial position or operating performance) and which have no plans to address existing deficiencies or controversies in an appropriate way.

• We take a long-term approach, focused on engaging with portfolio company boards and executive leadership to understand the drivers of risk and financial value creation in companies’ business models, including material sustainability-related risks and opportunities, as appropriate.
• There will be cases where a serious event has occurred, for example an accident at mine site and, in that case, we will assess whether the relevant portfolio company is taking appropriate action to resolve matters before deciding what to do.
• There will be companies which have derated (the downward adjustment of multiples) as a result of an adverse ESG event or generally due to poor ESG practices where there may be opportunities to invest at a discounted price. However, the Company will only invest in these value-based opportunities if we are satisfied that there is real evidence that the relevant company’s culture has changed and that better operating practices have been put in place.

“Given the activities that mining companies undertake, it is no surprise that there are always events that unfold during any calendar year. 2023 was a year where there were fewer events for the Company and this meant that engagement once again focused mainly on our holdings’ approach to the energy transition and how they plan to not only benefit from the opportunities, but also how they are planning to decarbonise their own operations.

“During the year the main areas of focus were prior ESG issues relating to Vale and governance in relation to the board’s fiduciary responsibilities. Vale has continued to make further progress on its journey to raise its ESG profile following the tragic tailings related events from the last decade. The company paid US$55.9 million in March 2023 to settle charges related to misleading disclosures in relation to the Brumadinho dam. On the governance front, changes have been made to the board with new international independent directors being added. Vale also announced plans to separate its base metals division and raised capital to support this process. Analysts from BlackRock visited Brazil to review restoration work done around the tailings failures and engaged with local communities impacted by these initiatives. It was pleasing to see ESG ratings agencies reflect the work the company has done in improved rating scores.”

Investment managers’ comments – General price weakness

“Similar to last year, average prices were generally lower across the suite aside from gold and silver. This, however, hides the intra year volatility which was more elevated than in recent times. For example, the price of copper over the year was basically flat but this hides the fact that at one point it had fallen 17% from peak to trough. This pattern played out across the metals universe and, were it not for the year end rally, most would have finished 2023 well below levels seen at the start of the year.

“Despite the overall negative tone to price moves, the standout performer was iron ore which over the year was up by 20.3%. Even more importantly, the average price was flat which might not sound like a win but with estimates forecasting it to decline sharply the impact on margins of it being flat was significant.”

Commodity price moves

Investment managers’ comments – Income

“As highlighted in last year’s report, income received by the Company has exceeded expectations for several years in a row. This has been driven by higher absolute pay out levels for ordinary dividends, a greater number of holdings in the portfolio paying dividends, improved capital discipline by companies and generally stronger balance sheets. Looking back, the peak seems to have been in 2021 with last year a close second.

“This year has seen income fall due to lower commodity prices and higher all in costs reducing profitability, meaning less to return to shareholders. In addition, as highlighted in last year’s report, companies allocated more surplus cash to share buy backs which bodes well for the future but in the short term further reduced dividend payments. It is noticeable just how rapidly share counts have declined on the back of these buy backs. For example, the shares in issue for ArcelorMittal and Glencore have declined by 8% and 5% respectively with a combined total of US$2.9 billion used to buy the shares back.

“Looking forward, we see no reason for companies not to honour their capital allocation plans and as such with commodity prices lower than in 2023 payments could in turn be below that of last year. However, at the time of writing, the commodity most important for dividends, iron ore, is well in excess of market forecasts meaning there is room for upgrades to dividend estimates.”

Investment managers’ comments – The energy transition

“As alluded to earlier, the energy transition continues to gather pace. EVs are taking market share away from combustion engine vehicles at levels well in excess of expectations. The roll out of renewable power projects and related infrastructure is happening far quicker than planned. This has, in part, been driven by a desire by European countries to diversify away from Russian supplied fossil fuels and the fact that with fossil fuel prices so high, renewable power is substantially more cost effective, not to mention helping countries/companies to meet their net zero commitments.

“It is clear that we remain very close to the start of the energy transition cycle given the enormous scale of investment that is going to be needed over the coming decades. Looking at the data for renewable power, it is increasingly obvious how much more resource intensive it is. On top of this there will also be commodity demand from battery storage needs and the buildout of the hydrogen economy.

“It is also essential for mining companies to embrace the need to decarbonise their own operations as future demand is likely to seek out supply from companies that do not just meet quality but also have green credentials. This move from “Brown to Green” presents a range of investment opportunities for the Company both in trying to reduce the heavy discount rates applied to carbon intensive production techniques, as well as new technologies that could solve some of the more damaging historical processes.”

Investment managers’ comments – Base metals

“It was a difficult year for the base metals with average prices down across the board as concerns around global growth, higher interest rates and China’s property sector saw significant destocking of metals which depressed prices. With prices moving lower and costs increasing (albeit at a slower rate than in 2022) margins for the producers also declined reducing cash generation and dividends. Encouragingly, as we approached the end of the year, expectations of US interest rate cuts and signs of demand stabilisation and stimulus in China buoyed prices.

“Copper, our favoured base metal, finished the year flat as macro concerns offset improving fundamentals particularly on the supply side. Despite headwinds from China’s property market, China’s copper demand was healthy with apparent demand +12% year-on-year. China’s focus on “green” related investments in renewables, EVs and the grid, offset the drag on copper demand from the property sector.

“The most interesting feature in the copper market this year has been the escalation in copper supply disruptions as we approached the end of the year. It was widely expected that 2024 would see notable supply growth as assets recovered post COVID-19 and new assets such as Anglo American’s Quelleveco mine and Teck’s Quebrada Blanca Phase 2 (QB2) project in Chile began ramping-up. However, we now expect copper concentrate supply to be lower in 2024 versus 2023.

“The most impactful supply shock is the closure of First Quantum Minerals’ Cobre Panama mine, which is now on care and maintenance. Cobre Panama has capacity to produce about 400ktpa of copper and there is a high degree of uncertainty when this mine will be restarted. We have also seen meaningful production downgrades from Anglo American, which lowered its copper production guidance by 180-210kt in 2024; Southern Copper, Vale and Rio Tinto all lowered their copper supply forecast in 2024 and we see ramp-up risk for Teck QB2 in 2024. Given the low level of copper inventories, the lack of investment in new mine capacity and structural operating challenges for many copper mines, prices are poised to rebase higher once the demand outlook improves.

“With the long-term fundamentals of the copper market remaining robust, in particular copper’s role in enabling the energy transition, we continue to remain positively exposed to copper producers within the Company. It was a mixed performance result among the companies with strong share price performance, including Foran Mining (0.9% of the portfolio). Foran Mining also delivered exciting exploration results at McIlvenna Bay and its Tesla Discovery site in Canada which has potential to increase production rates in the future. Lundin Mining (1.2% of the portfolio) also performed well, delivering improved operational performance and acquiring a 51% stake in the Casserone’s copper mine in Chile. Ivanhoe Mines (1.9% of the portfolio) continues to deliver as their Komoa-Kakula asset in the Democratic Republic of the Congo ramps-up and they also announced exciting exploration results at their earlier stage Western Forelands land package. The key disappointment during the year was the performance of First Quantum Minerals (1.5% of the portfolio) which saw its share price decline by approximately 60% as the government of Panama requested the closure of the Cobre Panama mine.

“The aluminium price finished the year flat compared with 2022. However, this masks the 17% decline in average prices year-on-year. Aluminium prices have declined significantly over the last two years as energy prices have fallen which is the largest cost component of producing aluminium. China’s demand for aluminium has been strongly boosted by its solar rollout, but so too has its production levels which has left the Chinese market largely balanced. Demand ex-China declined by circa 1% in 2023 largely due to inventory de-stocking with limited new supply coming into the market ex-China. Longer term we see upside to aluminium prices as carbon costs begin to be incorporated into prices. The demand for “green” or “low-carbon” aluminium continues to grow with these products sold at a premium to traditional London Metals Exchange grade aluminium. The Company’s largest exposure to aluminium is via Hydro (2.6% of the portfolio) which is one of the lowest-carbon producers of aluminium by virtue of its access to hydro power in Norway. Hydro continues to pursue its strategy of growing its low-carbon product mix via recycling and investing into renewable energy, with the company announcing an investment into its renewable energy company Hydro Rein by Macquarie Asset Management which acquired a 49.9% stake for US$332 million during the year.

“The nickel market was particularly challenging in 2023 with the nickel price finishing the year down 45% and average prices declining 18% year-on-year. Significant growth in Indonesian nickel supply has structurally changed the nickel market in recent years and with nickel pig iron (NPI) producers rapidly growing production and adapting their facilities to allow the production of nickel matte and other intermediary products. This allows them to sell into the market for class 1 battery grade nickel which is expected to see increasing demand alongside the growth in EVs. A key question for the nickel market is whether or not we see differential pricing for nickel based on the carbon intensity of production which is significant for many of the Indonesian producers given their reliance on thermal coal. The Company has two pure play exposures to nickel – the first Nickel Industries (0.5% of the portfolio) today a NPI producer which is transitioning towards LME grade nickel production which will improve earnings and margins. The second investment was done via a “PIPE” deal in 2022 into Lifezone Metals which has traded as a public company since the end of June 2023. Lifezone Metals, in conjunction with BHP, owns the Kabanga project in Tanzania which is one of the world’s largest undeveloped nickel sulphide deposits.”

Investment managers’ comments – Bulks and steel

“The iron ore market was an area of strength in 2023 with the price finishing 20% higher and average prices flat year-on-year. Given the depressed outlook for China’s property sector, the broad expectation from commodity analysts was for prices to decline in 2023 alongside falling steel production in China. The iron ore market benefited from better-than-expected Chinese steel production in 2023, rising blast furnace production at the expense of lower scrap-fed electric arc furnace production and higher steel exports from China which were up 40% year-on-year. With steel margins in China under pressure, the premium for higher grade material declined. However, we remain positive on the outlook for higher grade iron ore longer term, particularly as the steel industry looks to reduce its carbon intensity.

“The iron ore market remains highly concentrated with the four largest producers accounting for circa 70% of the seaborne market. We have seen the industry remain disciplined from a supply perspective with limited supply growth from the major producers, despite strong cash generation from their existing iron ore assets. We expect this to remain the case over the next few years as producers continue to focus on value over volume and decarbonising their operations.

“The Company’s exposure to iron ore is primarily via the diversified majors BHP, Vale and Rio Tinto. These companies tend to generate strong margins and free cash flow from the iron ore businesses which underpins the attractive dividend yield they trade on. Given better than expected iron ore prices in 2023, we see scope for dividends from the iron ore producers to surprise to the upside. In addition, the Company has exposure to two pure play high grade iron ore producers, Champion Iron and Labrador Iron. Champion Iron is ramping-up its Bloom Lake operation in Canada and targeting the production of high grade (69% Fe) iron ore which is a key component of low carbon steel production.

“During 2023 we saw notable differences in the performance of steel margins and equity prices for each of the key steel producing regions. The US has remained an area of strength in the global steel market, supported by higher infrastructure and re-shoring investment, alongside supply discipline from the producers. In Europe, steel prices and margins have been under pressure as industrial production in areas such as Germany have remained depressed and higher Chinese exports have weakened prices. Steel margins in China have remained around breakeven levels for much of the year, with steel prices largely tracking moves in its key cost inputs iron ore and coking coal. Our expectation was for steel production in China to moderate in the second half of 2023 in line with the government’s target of reducing steel production year-on-year. However, this did not eventuate supporting iron ore prices.

“From an equity perspective, the Asian (ex-China) steel producers outperformed in 2023, a detraction from relative performance for the Company given its lack of exposure. Korean listed POSCO performed strongly in 2023 on the announcement of its battery material plans, with Japanese listed Nippon Steel also performing well with renewed interest in Japanese listed equities. The Company’s exposure to steel is focused on companies with a track record of capital returns through share buybacks and dividends, as well as disciplined growth and an industry leading approach to decarbonisation. Our preference in the Company is to have exposure to low carbon producers such as the US Electric Arc Furnace producers Nucor and Steel Dynamics, or to be invested in those producers which might be carbon intensive today but have credible plans to decarbonise their production as is the case with Arcelor Mittal.

“Stronger than expected steel demand and rising blast furnace utilisation also benefited coking coal prices which averaged US$295.5/tonne during the year. China’s coking coal imports remained healthy with domestic supply impacted by accidents and rising safety inspections. India, the world’s fastest growing steel market, continued to increase its imports of coking coal and is set to increase its coking coal demand by circa 50Mt by the end of the decade, equivalent in size to Japan’s coking coal demand today. Combined with limited supply growth we expect a “stronger for longer” price environment over the medium term to persist. During the year we saw M&A in the space with Glencore acquiring a 77% interest in Teck’s coking coal business for US$6.9 billion with the deal expected to complete in Q3 of 2024. BHP sold its Blackwater and Daunia coking coal mines in Queensland to Whitehaven for a cash consideration of up to US$4.1 billion. The Company’s exposure to metallurgical coal remains in the two leading producers, BHP and Teck Resources, which have been able to generate very strong levels of free cash flow from their coking coal businesses to support returns to shareholders in recent years.

“After record-high thermal coal prices in 2022 following the European energy crisis, prices declined meaningfully in 2023 but finished modestly above market expectations. China has dominated coal demand growth in 2023 with thermal power generation higher in 2023, with both coal imports and domestic coal production in China higher year-on-year. This higher level of demand was largely met by rising Indonesian coal exports, along with higher Australian supply which has been hampered in recent years by heavy rainfall. We have seen less supply disruption in Australia during 2023 which has helped stabilise demand.

“The Company’s thermal coal exposure is via our 8.3% position in Glencore which has used elevated thermal coal prices in recent years to deleverage the business and buyback shares. During the year, Glencore made a proposal to Teck to merge their two businesses and subsequently demerger the combined coal business to create two separate companies – a metals business and a coal business. This proposal was not accepted by the Teck board and instead they chose to sell their coking coal business which Glencore acquired. Glencore has indicated that it will separate coal from the rest of the business over time. As a reminder, the Company has no exposure to pure play thermal coal producers.”

Investment managers’ comments – Precious metals

“Precious metals were an area of strength during 2023 with the gold price up by 14% and the average price 8% higher year-on-year. The gold price benefited from elevated geopolitical issues during the year, strong central bank purchases and as we approached the end of the year and the expectation of Federal Reserve interest rate cuts which would see real yields fall. Central bank net purchases of gold in 2023 of 1,037 tonnes almost matched the 2022 record, falling just 45 tonnes short. Central bank purchases have been dominated by China which continues to build gold reserves.

“Another interesting feature of the gold market in recent years has been the disconnect between the gold price and real yields. Historically, gold has performed well in an environment of low real yields, as gold is a non-yielding asset. Conversely, in an environment of rising real yields, the attractiveness of other “safe haven” assets such as cash and government bonds improves, which typically acts as a headwind to gold. Rising physical demand for gold from central banks alongside elevated geopolitical risk partly explains the strong performance of gold despite elevated real yields in 2023. As we approached the end of 2023 and the market began to price in rate cuts, we did see the gold price rally, more in line with the traditional correlation between gold and rates.

“The silver price has modestly underperformed gold when looking at average prices during 2023 versus the same period last year. Industrial demand for silver was strong during 2023 with solar installations globally exceeding expectations. With silver inventories declining over the last two years and supply challenges in the world’s largest producer of silver, Mexico, the physical market for silver is set to tighten further particularly if solar installations continue to supply to the upside.

“The Company has increased its exposure to gold producers during the year given the improved gold price outlook. However, we have maintained our strategy of focusing on high quality producers which have an attractive operating margin and solid production profile and resource base. Typically, gold royalty companies offer a higher quality and lower risk exposure to gold as they do not face operating and capital cost inflation. Disappointingly, Franco-Nevada’s (1.4% of the portfolio) exposure to First Quantum Minerals’ Cobre Panama mine which was placed into care and maintenance towards the end of the year saw the shares finish the year down by 19% in US Dollar terms. 2023 marked another year of consolidation in the gold industry with Newmont Corporation (3.6% of the portfolio) successfully acquiring Australian listed Newcrest Mining to create the world’s largest gold producer.”

Investment managers’ comments – Energy transition metals

“Battery electric vehicles (BEVs) sales continued to grow in 2023, with estimates that sales would reach over 14 million battery electric vehicle units. This growth has been mainly driven by China, where BEV sales totalled 8.8 million units, +38% year-on-year according to the China Passenger Car Association. Globally, competition has resulted in EV price declines supporting volumes. However, this has cost profitability and led to weakening investor sentiment as some large equipment manufacturers, particularly in the US, have slowed investment plans as they prioritise returns.

“Legislation continued to evolve and of particular note was the US looking to exclude Foreign Entity of Concern (FEOC) owned companies from qualifying for EV incentives under the Inflation Reduction Act. Beginning in 2024, an eligible clean vehicle may not contain any battery components that are manufactured by an FEOC and beginning in 2025 an eligible clean vehicle may not contain any critical minerals that were extracted, processed or recycled by a FEOC. This is disruptive as it will exclude many Chinese companies from the US supply chain.

“The Company has exposure to the raw materials that go into EV batteries and the e-motor. Lithium is a critical component of an EV battery and, although demand for lithium has been strong this year, prices have been weak falling by 43% as the sector saw both destocking and increased supply. The Company’s holdings in lithium producers such as Albemarle and SQM cost performance. The holding in Sigma Lithium was an exception, up a modest 6.6% over the year. The company started producing lithium concentrate from its Brazilian project during the year, as well as announcing a Strategic Review was underway.

“A critical component of the electric car is also the e-motor, which most commonly uses a Praseodymium-Neodymium (NdPr) magnet, an alloy of two rare earth elements (REEs). REEs are commonly mined and processed in China and have been deemed of strategic importance by both Europe and the US. The Company has exposure to REEs through Lynas Rare Earths (Lynas), a REE miner and processor crucially based in Malaysia and Australia. In 2023 Lynas equity fell by 13.4% during a period of weaker Rare Earth Mineral pricing. This year the company successful commissioned their cracking and leaching plant in Australia, as well as progressing their US plant securing a site in Texas.

“2023 saw a rapid rise in interest around uranium cumulating at the 28th United Nations Climate Change Conference (COP28), which recognised the key role of nuclear energy in reaching Net Zero with a declaration to triple nuclear energy capacity by 2050. The uranium price rose sharply during the year with the Ux Consulting weekly spot price up by 82.3%. The Company’s holding in uranium producer Cameco rose by 81% in the year, benefiting from rising prices. They also completed an acquisition of 49% of Westinghouse, a nuclear reactor technology original equipment manufacturer and service provider, further integrating them into the nuclear power supply chain.”

Royalty and unquoted investments

“During the year the Company evaluated several new private investment deals but in the end declined to participate for a variety of reasons. As mentioned in previous reports, the focus of the unquoted investments is to aim to generate both capital growth and income to deliver the superior total return goal for the portfolio.

“We continue to actively look for opportunities to grow royalty exposure given it is a key differentiator of the Company and an effective mechanism to lock-in long-term income which further diversifies the Company’s revenues.

“2023 saw several of the recently listed shares deliver further progress at their projects. Bravo Mining reported excellent drilling results, an updated resource for their Luanga project and completed a financing which covers them for the next couple of years. Ivanhoe Electric reported strong drill results and completed a significant capital raise during the period.

“As at the end of 2023, the unquoted investments in the portfolio amounted to 6.7% of the portfolio and consist of the BHP Brazil Royalty, the Vale Debentures, Jetti Resources and MCC Mining. These, and any future investments, will be managed in line with the guidelines set by the Board as outlined to shareholders in the Strategic Report of this Annual Report.”

Investment managers’ comments – BHP Brazil Royalty Contract (1.4% of the portfolio)

“In July 2014 the Company signed a binding royalty agreement with Avanco Minerals (Avanco). The Company provided US$12 million in return for a Net Smelter Return royalty payments (net revenue after deductions for freight, smelter and refining charges) comprising 2% on copper, 25% on gold and 2% on all other metals produced from mines built on Avanco’s Antas North and Pedra Branca licences. In addition, there is a flat 2% royalty over all metals produced from any other discoveries within Avanco’s licence area as at the time of the agreement.

“In 2018 we were delighted to report that Avanco Minerals was acquired by OZ Minerals, an Australian based copper and gold producer for A$418 million. We were equally pleased to report that in early 2023 OZ Minerals was acquired by BHP, the world’s largest mining company and which now operates the assets underlying the royalty. Since our initial US$12 million investment was made, we have received US$27.4 million in royalty payments with the royalty achieving full payback on the initial investment in 3½ years. As at the end of December 2023, the royalty was valued at £18.4 million (1.4% of the portfolio) which equates to a 329.6% cash return on the initial US$12 million invested.

“In August, the Pedra Branca mine experienced a geotechnical event which suspended operations in line with BHP’s global safety standards. The mine recommenced operations in October and is targeting normal production levels in early 2024. This has reduced 2023 production levels and associated royalty payments, but it is not expected to impact overall reserves and resources or long-term production rates. BHP has implemented changes to the mine design and mining method, along with additional monitoring systems to reduce the risk of future events.

Investment managers’ comments – Vale debentures (2.8% of the portfolio)

“At the beginning of 2019 the Company completed a significant transaction to increase its holding in Vale debentures. The debentures consist of a 1.8% net revenue royalty over Vale’s Northern System and Southeastern System iron ore assets in Brazil, as well as a 1.25% royalty over the Sossego copper mine. The iron ore assets are world class given their grade, cost position, infrastructure and resource life which is well in excess of 50 years.

“Dividend payments are expected to grow once royalty payments commence on the Southeastern System in 2025 and volumes from S11D and Serra Norte improve. At Vale’s Capital Markets Day in December, the company outlined 50Mt of iron ore growth to 2026 of which S11D is the largest component and an improved quality mix which the royalty will benefit from.

“The debentures offer a yield in excess of 10% based on the 1H-2023 annualised dividend. This is an attractive yield for a royalty investment, with this value opportunity recognised by other listed royalty producers, Franco-Nevada and Sandstorm Gold Royalties, which have both acquired stakes in the debentures in 2021.

“Whilst the Vale debentures are a royalty, they are also a listed security on the Brazilian National Debentures System. As we have highlighted in previous reports, shareholders should be aware that historically there has been a low level of liquidity in the debentures and price volatility is to be expected, although this is improving following the sell-down in April 2021.”

Investment managers’ comments – Jetti Resources (2.1% of the portfolio)

“In early 2022, the Company made an investment into mining technology company Jetti Resources (Jetti) which has developed a new catalyst that improves copper recovery from primary copper sulphides (specifically copper contained in chalcopyrite which is often uneconomic) under conventional leach conditions. Jetti is currently trialling their technology across a number of mines where they will look to integrate their catalyst into existing heap leach SX-EW mines to improve recoveries at a low capital cost. The technology has been demonstrated to work at scale at Capstone’s Pinto Valley copper mine, as well as Freeport-McMoRan’s Bagdad and El Abra operations. If Jetti’s technology continues to work at scale, we see valuation upside with Jetti sharing in the economics of additional copper volumes recovered through the application of their catalyst.

“During the second half of 2022 we were pleased to report that Jetti completed its Series D financing to raise US$100 million at a substantially higher valuation than when our investment was made at the beginning of 2022. This sees the company fully financed to execute on their expected growth plans in the years ahead.”

Investment managers’ comments – MCC Mining (0.4% of the portfolio)

“MCC Mining is a private company exploring for copper in Columbia. It is undertaking early-stage greenfield exploration and has strong geological potential to host multiple world class porphyry deposits. Shareholders include other mid- to large-cap copper miners, which is another indication of the strategic value of the company. Following new regulations in Colombia which allowed for the exploration drilling in the forestry reserve, the company commenced drilling at its Comita and Pantanos deposits in 2023. Initial drilling results were very encouraging, which confirmed two porphyry deposits at Comita and Pantanos. The valuation of the Company is based on the US$170.7 million equity value implied by the April 2022 equity raise. The focus for the company is to continue exploration into 2024.”

Investment managers’ comments – Derivatives activity

“The Company from time to time enters into derivatives contracts, mostly involving the sale of “puts” and “calls”. These are taken to revenue and are subject to strict Board guidelines which limit their magnitude to an aggregate 10% of the portfolio. In 2023 income generated from options was £6.0 million, in line with contributions from prior periods. During the year implied volatility was generally lower than in prior years making the opportunity set less attractive. In addition, the cost of the trades had to be looked at in the context of higher interest rates, given that the borrowing capacity is generally used for such transactions. Despite these, enough opportunities were found to generate revenues almost in line with previous years without having to take too much risk. At the end of the year the Company had 0.1% of the net assets exposed to derivatives and the average exposure to derivatives during the year was less than 5% of net assets.”

Investment managers’ comments – Gearing

“At 31 December 2023, the Company had £149.8 million of net debt, with a gearing level of 11.9%. The debt is held principally in US Dollar rolling short-term loans and managed against the value of the debt securities and the high yielding royalty positions in the Company. As in recent years, the Company sought to maximise the use of gearing against the equity holdings rather than debt securities. This was driven by the risk adjusted relative value available in shares where dividend yields were mostly in excess of the coupons being paid on the bonds. Since the companies also have strong balance sheets, it was opportune to gear up the equity portfolio of the Company since we were not adding debt to holdings that were already heavily leveraged themselves. However, in 2023 the debt came with a higher cost and this meant absolute gearing was kept below that of prior years to minimise the interest cost.”

Investment managers’ comments – Outlook

“The dominant story for 2023 was that of interest rates versus inflation. The transition to higher rates was far from smooth as short-term expectations gyrated markets creating a bumpy ride for investors. However, it now looks likely that inflationary pressures have more than peaked and there is an increasing consensus that rates are not moving higher. It is worth remembering that the post global financial crisis and Covid period of zero rates are an outlier versus history and as such the new norm should be anchored around current levels rather than a return to such extreme lows.

“At the time of writing it appears we are seeing a change in China’s demand for commodities, with investment into renewable infrastructure, manufacturing and EV’s growing significantly, against more traditional areas of commodity demand such as property declining. Energy transition spending globally continues to drive commodities demand growth and with supply growth across a number of commodities increasingly constrained markets look set to tighten further over the next few years which bodes well for prices.

“For mining companies whose balance sheets remain strong and management teams are anchored to disciplined capital allocation frameworks, the challenge will be balancing the desire to invest either for decarbonisation or growth, versus returning capital to shareholders. Given the high level of capital intensity attached to building new capacity, those with the flexibility to repurchase shares should take advantage of the current low equity valuations given that it generally remains cheaper to buy existing capacity than to build it.

“In summary, the near term as always remains volatile, but with medium-term demand and supply fundamentals strong, the Company is well positioned to capture returns from this imbalance. In the meantime dividend payments, whilst lower than the peak of a few years ago, remain competitive with alternatives such as bonds and cash meaning shareholders are paid to wait for the positive outlook to be reflected in share prices.”