For the past year, we have benefited from our exposure to the mining sector. Shares of gold miners, in particular, have been buoyed by rising prices on the precious metal, which are up more than 40% over the past 12 months. We will be the first to admit that our crystal ball for forecasting commodity prices is murky at best.
Since we aren’t experts in forecasting commodity prices, we partner with firms that are. But we recognize they aren’t always right either, which highlights an important point in how we go about constructing our portfolios. It’s about gaining as much perspective as we can from as many angles as possible and using that information to strike the right balance.
Why are we even concerned with commodity prices to begin with, when bottom-up research, driven by our 10 Principles of Value Investing™, defines Heartland’s security selection process? Simple: There are certain stocks, like shares of Energy and Materials companies, that are heavily dependent on the level and direction of commodity prices. If underlying material prices are depressed, for instance, it will be hard for some stocks to appreciate even with sound business strategies and outstanding management teams in place.
That’s why a macro take on commodity prices can help inform our decisions. From that 30,000-ft. perspective, the supply outlook appears more favorable for gold than crude oil. This can help explain why, at the end of the third quarter, we were overweight Materials stocks relative to the Russell 2000® Value Index but underweight Energy.
Top-down assessments of commodity prices, however, represent only one viewpoint that factors in our portfolio decisions. Another perspective comes from what we’re seeing at the company level — among commodity producers themselves. For instance, ExxonMobil produces more than 3 million barrels of crude oil a day and is forecast to increase that production by around 6% next year. By contrast, Newmont, the world’s largest gold miner, is expected to see a slight drop in production this year and next.
This supply snapshots would seem to corroborate the macro views on gold and oil. But this isn’t enough either. Before we determine whether to underweight, equal weight, or overweight a group of stocks, relative to our benchmark, we need to assess those companies through a true bottom-up lens.
To do that, we utilize a Grid Score, which keeps tabs on a list of 10 fundamental attributes for every security we consider. A stock’s grid score, and how it changes over time, will help us determine how it stacks up against peers within its industry, how much our Portfolio should be exposed to that holding, and whether we should consider adding to or reducing our exposure to that position. Here, too, our fundamental work favors the gold group. Currently, the average grid score for our Metal & Mining holdings are positive in more than 8 out of the 10 fundamental attributes that we monitor. That’s slightly higher than the current average grid score of 7 among our Energy holdings.
Also, it should be noted that the “risk/reward” score for our Metals & Miners, denoting the average performance from current levels to our target prices, is better too.
Hopefully, this provides a small window into how we go about constructing our portfolio. Our overweight to mining stocks is not about riding the momentum of rising gold prices. It’s about understanding the opportunities and risks from both a bottom-up and top-down perspective while ensuring that, above all, the fundamentals of each company, guided by our 10 Principles of Value Investing™, drive our decisions.