Franklin Gold and Precious Metals Fund
31 December 2016
Franklin Templeton Investment Funds
Quarterly Commentary KEY POINTS
Investment Team
• Gold and other precious metals traded lower in 2016’s fourth quarter, while most industrial metals rallied.
• Amidst widespread declines for gold-focused holdings, the fund’s negative fourth quarter
returns also underperformed the benchmark FTSE Gold Mines Index, based largely on stock selection in the gold industry and sharp declines for some of our non-goldfocused investments.
Steve Land, CFA
Fred Fromm, CFA
“Growing inflation concerns, global trade tensions and changing political leadership are just a few examples of the challenges facing the global economy. We believe many of these issues will be successfully navigated, but all of them present potential stumbling blocks that could act as a trigger to drive further investment in gold.” Fund Description
The fund seeks capital appreciation by investing at least 80% of its net assets in the securities of companies around the world that mine, process or deal in gold and other precious metals such as platinum, palladium and silver. The fund has a secondary goal of current income. Fund Details
Inception Date Benchmark
30/04/2010
FTSE Gold Mines Index
• Off-index allocations in the copper and diversified metals and mining industries supported relative performance, as did the fund’s small cash position.
PORTFOLIO MANAGER INSIGHT Market Review
After broadly selling off in October, most major commodities, with the exception of precious metals, went on to post fourth-quarter gains despite the substantial drag from an accelerating rally in the trade-weighted US dollar’s value (+7.1% according to the Federal Reserve’s US Dollar Index), which reached a 14-year high.2 Expectations for a Federal Reserve (Fed) rate hike, future US tax cuts and increased infrastructure spending all contributed to the greenback’s sudden surge. Commodities’ upward momentum was most evident in the latter half of the period, following a pact amongst major oil-producing nations to meaningfully address oversupply, a sharp rise in market optimism in the wake of the US presidential election, and a growing consensus amongst economists that global growth will pick up in 2017. Although most commodities traded higher, including industrial metals, gold and other precious metals declined in value.2 The gold market endured its longest streak of weekly losses in more than 12 years in 2016’s fourth quarter, with spot prices declining 12.4% to a 10-month low of US$1,152 per troy ounce.2 Many analysts had called for higher gold prices amidst post-election policy uncertainty in the United States. Speculation over firming US inflation helped keep a floor under gold, as did a wave of physical gold purchases in China. Gold logged an 8.6% gain for all of 2016—its strongest annual return since 2011 and the first increase since 2012—owing to its early-year move.2 The US dollar’s rapid ascent, the Fed’s December interest rate hike, and the spectre of even higher rates in 2017 (the central bank signalled three possible increases for the year) filtered through precious metals markets and were key catalysts to the downside. Gold investors moved into the haven for much of the year, allowing it to reach a 2016 high of US$1,365 per ounce in early July, but they reduced exposure after the US election.2 As a result, the metal finished the year more than 15% below its 2016 peak level.2 During the latter half of the quarter, gold exchange-traded fund (ETF) investors consistently trimmed their gold holdings for the longest stretch since September 2004; overall holdings fell from a peak of roughly 2,000 metric tons (mt) in late October to about 1,787 mt by late December.2 Elsewhere, silver spot prices ebbed 17.0% in the fourth quarter (to US$15.92 an ounce), reducing the 2016 gain to 14.9%; platinum retreated 11.9% (to US$904 per ounce), nearly eliminating its annual advance (+1.2%); and palladium shed 5.5% of its value, though it fared better than all other major precious metals in 2016 with a 21.0% gain.2 Industrial metals performed well after the US presidential election, and as global manufacturing indicators ramped up to a three-year high; the sharp turnaround reflected increased faith in the world economy, rising inflation expectations and dampened demand for perceived “safe haven” assets.2 All major industrial metals tracked by the London Metal Exchange (LME) except lead traded higher, and the LME Index climbed 7.5% on a price-only basis, capping a sizable 2016 gain of 20.7%.3 Benchmark LME copper futures added 13.8% in the quarter (to US$5,536 per mt) and jumped 17% in 2016 after falling for each of the three previous years, which provided considerable relief to many mining companies.3 A drop in inventories aided copper prices, but the metal gave up some of its October and November gains as analysts increasingly deemed it to be
Performance Net of Management Fees as at 31/12/2016 (Dividends Reinvested) (%)1 A (acc) USD
FTSE Gold Mines Index
1 Mth
-0,44
3,45
For Professional Investor Use Only / Not For Distribution To Retail Investors
3 Mths
-21,45 -19,06
1 Yr
3 Yrs
60,72
3,13
52,35
2,14
5 Yrs
Since Inception (30/04/2010)
-14,74
-11,05
-14,26
-11,16
Franklin Gold and Precious Metals Fund overbought near year-end. Zinc was a top 2016 outperformer among base metals as it gained 60% (to US$2,576 per mt), driven by tight mine supply and pent-up demand from China, India and the United States.3
Performance Review
Amidst widespread declines for gold-focused holdings, the fund’s negative fourth quarter returns also underperformed the benchmark FTSE Gold Mines Index, based largely on stock selection in the gold industry and sharp declines for some of our non-gold-focused investments. These disappointing quarterly results weakened what was nonetheless a very strong year of absolute returns for 2016.
All of the fund’s holdings in the off-index precious metals and minerals industry shed considerable value during the quarter, as most related companies were contending with lower platinum and palladium prices. Platinum Group Metals (PGM) and Impala Platinum Holdings were the major detractors amongst them. PGM shares lost almost half of their value over the October-December span. In addition to lower metals prices, the company announced a US$40 million secondary stock offering that further weighed on the value of its outstanding shares, following delays with the ramp up at its Maseve mine in South Africa. Though its timeline towards full production has been extended, current mining has broadly delivered on expectations from the feasibility study for the Maseve ore body. In separate encouraging release, PGM published a pre-feasibility study for its Waterberg project that showed it held the potential to be a very large, low-cost operation. Impala, meanwhile, delivered mixed third-quarter results, confirming that the operating environment in South Africa remains quite challenging amidst low platinum and palladium prices. There is some investor concern that Impala might need additional funding if conditions do not improve. Impala also announced a new chief executive officer (CEO) who is a seasoned industry veteran, and we believe he may be able to better address some of the operating issues Impala has been dealing with lately.
Most of the fund’s other major detractors were gold-focused miners, the strongest of which was an off-index position in Perseus Mining as its share-price decline was more than double the index’s. Perseus is a West Africa-focused gold production, development and exploration company. Its guidance for full-year 2016 came in very weak, in our view, including downgrades to second-half 2016 production from 90,000 ounces to 75,000 ounces, due in part to extended mill maintenance downtime and lower-than-expected grade, which pushed up all-in sustaining costs. The mill is now back up and running and management expects better grades and a higher output rate in 2017. With its acquisition of Amara Mining in April of this year, we believe Perseus has built a solid portfolio, comprising the Edikan Gold Mine in Ghana—which has produced approximately 200,000 ounces of gold per year since 2012—as well as the Sissingué and Yaoure projects under development in Côte d’Ivoire. Unfortunately, management also announced a 20% reduction in the reserve profile at Sissingué late in the quarter. Perseus is striving to become West Africa’s next multi-mine gold producer. Even though Perseus’s all-in sustaining costs remained above the recent price of gold, operating results and plant improvements have been supporting our view that the processing of higher-grade ore in 2017 should result in higher production and dramatically lower production costs at Edikan. St. Barbara Limited remained as one of the fund’s higher-conviction overweighted gold holdings for the longer term, but it was a substantial fourth quarter detractor. Aside from the negative impact of lower precious metals prices, we believe the stock might have dipped merely on speculation or profit-taking after a strong run-up in the third quarter. Moreover, its third-quarter results (announced in October) were fairly strong and in line with consensus expectations, delivering strong cash generation and debt repayment. St. Barbara also completed the strategic review of its Simberi mine and sulfide project in Papua New Guinea, deciding to keep the operation as part of the company rather than divest it. They also continued to buy back debt throughout the fall months, and by the end of 2016 the company was net cash positive.
31 December 2016
Acacia Mining was overweighted in the portfolio and lost nearly a third of its share value. In the absence of any major setbacks, Acacia may have suffered from speculative trading to the downside; Barrick Gold (also a fund holding) owns a 64% stake in Acacia, and there was some speculation that it may become more aggressive in divesting some of its interest in Acacia. The company has, however, been driving stronger performance at its North Mara operations in Tanzania, and it increased full-year guidance by 5% while all-in sustaining costs were lowered to the bottom of its stated range. Acacia also continued to make headway on its exploration properties in Kenya. The stock of South Africa-based AngloGold, in which we held an overweighting versus the index, also declined by roughly one-third after it reported higher cost guidance, lower full-year 2016 production guidance and somewhat disappointing earnings results for the third quarter. As an overall higher-cost producer, AngloGold is quite sensitive to lower gold prices. We believe AngloGold continues to operate a world-class portfolio of operations and projects— the company has 17 gold mines in nine countries, as well as several exploration programmes in both established and new gold-producing regions. Additionally, a December update on its Tropicana gold mine in Australia revealed a 45% increase in the mine’s forward reserve estimate. Elsewhere, the fund’s off-index stake in Primero Mining declined more than 50%. The company recently lowered its full-year production guidance for the third time this year as mine results were negatively impacted by lower grades at San Dimas (Mexico) and Black Fox (Canada). Primero’s guidance is now targeting 170,000 to 190,000 ounces of gold equivalent versus 195,000 to 215,000 previously and an early-2016 projection of 230,000 to 250,000. High costs were placing additional pressure on the company as it has been eying a total cash cost of US$1,350 to US$1,400 per ounce of gold. Some of our other key detractors stemmed from our substantial underweightings of largecapitalisation gold miners that declined less than the FTSE Gold Mines index, namely Barrick Gold and Newmont Mining.
On the upside, the fund’s off-index allocations in the diversified metals and mining; and copper industries supported relative performance, as did our small cash position amidst the broad-based selloff. Underweightings in several stocks that declined well in excess of the index also proved beneficial, as was the case with key relative contributors such as Gold Fields (gold industry) and Fresnillo (silver industry). In the same vein, the fund benefitted from our avoidance of several index stocks that suffered notable three-month declines, including Sibanye Gold, Yamana Gold, Kinross Gold and Harmony Gold Mining. We actively exited the fund’s positions in Yamana and Kinross earlier in the year, ahead of these precipitous declines.
Relative performance gains in the diversified metals and mining industry relied on several key contributors, the best of which were Ivanhoe Mines and Nevsun Resources. Ivanhoe is in the process of building the Platreef platinum/palladium mine in South Africa, as well as two other development projects in the Democratic Republic of Congo (DRC) that are focused on copper and zinc, and its shares rallied during the autumn months. Higher copper and zinc prices were primary catalysts for its share-price increase even though the company is still in the preproduction phase. Ivanhoe announced continued success at a copper discovery in the DRC called Kakula, following some high-grade drill intercepts in a separate ore body not far from its Kamoa project. Ivanhoe released a preliminary economic assessment of Kakula, and included combined mining scenarios with nearby Kamoa (they are separated by about 15 kilometres), but as the ore body continues to grow from drilling success there are likely further optimisation gains to be realized in the region. Our stake in mid-tier miner Nevsun Resources also increased in value as it benefitted from higher zinc prices and enjoyed a solid November gain. The company recently began to produce and ship zinc from its Bisha open pit mine in Eritrea, having worked through the ore body’s gold and copper layers. Furthermore, initial drilling results at its Timok copper/gold project in Serbia confirmed the high-grade nature of that ore body.
In the copper industry, Sandfire Resources was the main contributor. Pricing fundamentals were the primary catalyst, with the stock logging a modest three-month gain as it tracked copper prices higher.
For Professional Investor Use Only / Not For Distribution To Retail Investors franklintempletonnordic.com
2
Franklin Gold and Precious Metals Fund In the gold industry, only a handful of contributors enjoyed what turned out to be a rare combination of positive returns and outperformance versus the benchmark index, led by advance-stage gold explorer and developer Continental Gold, the shares of which climbed nearly 8%. The company took a step forward when it received the long-awaited environmental permit for its Buriticá project in Colombia, clearing a major hurdle on the way towards construction. The site feasibility study indicates that the Buriticá project will be a lowest-quartile cost producer and an economically robust gold mine.
Most other gold industry contributors were overweighted or off-index holdings that declined less than the index. For example, OceanaGold’s much shallower-than-index decline was highly supportive of relative performance. Heightened political scrutiny over mining rights and inspections in the Philippines had been pressuring OceanaGold’s shares in recent months as the new administration, under President Rodrigo Duterte, initiated a countrywide audit of all mining operations. OceanaGold operates the Didipio mine, a high-grade gold/copper mine located on the Philippine island of Luzon, along with mines in New Zealand and the soon-to-be-completed Haile gold mine in South Carolina in the United States. Overall investor sentiment towards OceanaGold improved in November, with growing confidence that Didipio would not be closed and that the company could work with the government to resolve any issues. We visited Didipio earlier this year and believe it is a well-run and environmentally sound operation. In November Didipio won the country’s Presidential Mineral Industry Environmental Award for the second year in a row, recognising its exemplary effort towards responsible mining, which lent further credence to the idea that the mine was unlikely to be shut down. The stock received an additional boost in December when management announced that the Haile gold mine had commenced milling, onschedule for the planned ramp up to full commercial production in the first half of 2017.
Our overweighted position in B2Gold declined roughly half as much as the index. B2Gold announced record gold production and revenue for the third quarter and first nine months of 2016, and it lifted annual production guidance for several mines, while operating and all-in sustaining costs were expected to be below or near the low end of the company’s annual cost guidance range. Adding to B2Gold’s rally was an update showing construction of its Fekola mine (located in Mali) was progressing well, on schedule and on budget, and is expected to commence production in 2017’s fourth quarter. We visited the mine site in October and met with B2Gold management to confirm the company’s progress. We held an overweighted position in Centamin, which delivered a smaller-than-average share-price decline for several reasons. Centamin, which operates the Sukari gold mine in Egypt, reported solid third-quarter earnings that were well above consensus estimates and prior guidance. The company is producing more gold at a lower cost than previously forecast, and although it maintained its fullyear 2016 production guidance, many analysts felt the company could exceed guidance given the strong results so far this year. Centamin’s management also highlighted interesting exploration potential near a new underground decline ramp that, if successful, could further improve Sukari’s production profile.
Portfolio Positioning
The fund’s strategy is to seek capital appreciation by investing at least 80% of its net assets in the securities of companies around the world that mine, process or deal in gold and other precious metals such as silver, platinum and palladium.
Outlook & Strategy
US election headlines and subsequent market reactions seemed to dominate gold trading for much of 2016’s fourth quarter. Gold initially spiked by more than US$60 per ounce on election night (8 November) as it became clear that Donald Trump was the likely winner. Market sentiment towards gold quickly reversed as many investors took the view that a Republican controlled government would be positive for US growth and corporate profitability. As general markets moved higher,
31 December 2016
gold exchange-traded fund (ETF) holdings headed lower with 6.5 million ounces divested out these products globally in the fourth quarter.2 Similar to what we saw in previous months, gold equities demonstrated high beta (a measure of the volatility, or systematic risk, of a security or a portfolio in comparison to the market as a whole) to moves in the spot gold price during the quarter. Regardless of the direction, we continue to expect gold-mining stocks to show high gearing to movements in physical gold prices, which at year-end 2016 were close to the total costper-ounce for many producers, indicating that even a small price move in physical gold can drive a significant change in cash flows and outlook for a company.
Capital spending across the metals and mining sector pulled back meaningfully in 2015, and, based on the third quarter results, further cuts were implemented in 2016. We believe the lack of investment and limited exploration is apt to foster lower gold production in the coming years. Mine production for the third quarter of 2016 was down 1% when compared to the same quarter in 2015, but recycled gold supply was up 30% over the comparable timeframe in response to higher prices and stronger demand.4 Even if gold prices move higher, we think high debt levels for many of the world’s largest gold miners make it unlikely that they will aggressively pursue new projects as they may focus first on repairing their balance sheets. Despite this trend, we continue to see opportunity for high-quality, moderate capital-cost projects to move forward.
Structurally, many of the major mining companies have been underinvesting in long-lead projects to maintain their current production profiles. Mergers and acquisitions (M&A) offer the potential to rebuild their asset bases while reducing overhead and driving efficiencies of scale. Volatility in the gold market led to no notable deals being announced in the fourth quarter. Notable M&A transactions in 2016, however, included Tahoe Resources’ (also a fund holding) acquisition of Lake Shore Gold (not a fund holding) in April, which further diversified the company via access to gold production in Canada; Perseus Gold’s acquisition of Amara Mining; and Nevsun Resources’ acquisition of Reservoir Resources (not a fund holding), which helped strengthen Nevsun’s development pipelines with quality projects while bringing increased visibility to its future growth. In July, Goldcorp (also a fund holding) closed its acquisition of Kaminak Gold (not a fund holding), adding Kaminak’s gold project in the Canadian Yukon to its development pipeline. Centerra Gold (also a fund holding) closed the acquisition of Thompson Creek Metals (not a fund holding) in October successfully diversifying the company’s production base.
Growing inflation concerns, global trade tensions and changing political leadership are just a few examples of some of the challenges facing the global economy as we head into 2017. We believe many of these issues will be successfully navigated, but all of them present potential stumbling blocks that could act as a trigger to drive further investment in gold. The world’s financial system is increasingly complex and seems to be moving into untested waters given the unprecedented amount of fiscal stimulus over the past decade, combined with very low or negative interest-rate policies and growing trade tensions. An investment in the gold industry is based, in part, on the fundamental belief that exogenous events such as Brexit, subdued global economic growth and accommodative monetary policies by key central banks should support gold. Over the past 20 years, gold has shown a low correlation with global stock markets, which we believe makes it a compelling diversification tool and potential store of value. We continue to see attractive investment opportunities in gold and precious metals equities, with many companies trading with enterprise values below what it would cost to build their existing mines today. We also believe many gold companies are well positioned to survive another downturn in prices if it should occur, and yet they offer significant upside potential if the market begins to attribute value to their resources if and when prices resume an uptrend. Furthermore, mining companies have continued to focus on improving the cost structure of their operations, debt repayment and asset rationalisation, which we believe should result in improved performance potential and is conducive to equity-price appreciation, especially in a rising gold-price environment. Gold and gold equities
For Professional Investor Use Only / Not For Distribution To Retail Investors franklintempletonnordic.com
3
Franklin Gold and Precious Metals Fund
31 December 2016
remain valuable tools for portfolio diversification, in our view, as they generally do not correlate significantly with the prices of non-gold equities, bonds or other commodities, and serve as a potential hedge against geopolitical instability, inflation, US-dollar depreciation and stock market volatility.
One-Month Performance Review
The fund’s slightly negative return underperformed the benchmark as stock selection hindered our outcome in the gold industry. To a lesser extent, the fund’s was also negatively impacted by declines for its offindex investments in the precious metals and minerals industry, as well as for its diversified metals and mining holdings. A combination of overweighting and stock selection in the silver industry also proved to be a minor hindrance versus the index. Several of our off-index or overweighted holdings did, however, received considerable positive investor attention for company-specific reasons, allowing them to rally well ahead of the FTSE Gold Mines Index average, namely Continental Gold, Guyana Goldfields, Eldorado Gold, Alamos Gold and Rubicon Minerals.
For Professional Investor Use Only / Not For Distribution To Retail Investors franklintempletonnordic.com
4
Franklin Gold and Precious Metals Fund IMPORTANT LEGAL INFORMATION
This document does not constitute legal or tax advice nor is it investment advice or an offer for shares of Franklin Templeton Investment Funds (the “Fund”). Subscriptions to shares of the Fund can only be made on the basis of the current prospectus and, where available, the relevant Key Investor Information Document, accompanied by the latest available audited annual report and the latest semi-annual report. These documents can be obtained, free of charge from Franklin Templeton Investment Management Limited (FTIML), Swedish Branch, Blasieholmsgatan 5, SE-111 48 Stockholm, Sweden. Phone: +46 (0) 8 545 01230, Fax: +46 (0) 8 545 01239, E-mail:
[email protected] or can be found on our website www.franklintempletonnordic.com or www.ftidocuments.com.
Issued by Franklin Templeton Investment Management Limited (FTIML), Swedish Branch, Blasieholmsgatan 5, SE-111 48 Stockholm, Sweden. Phone: +46 (0) 8 545 01230, Fax: +46 (0) 8 545 01239. FTIML is authorised and regulated in the United Kingdom by the Financial Conduct Authority and is authorised to conduct certain investment services in Denmark, in Sweden, in Norway and in Finland.
Past performance is not an indicator or a guarantee of future performance. The value of shares in the Fund and income received from it can go down as well as up, and investors may not get back the full amount invested. Investment in the Fund entails risks which are described in the Fund’s prospectus and, where available, in the relevant Key Investor Information Document. Special risks may be associated with a Fund’s investment in certain types of securities, asset classes, sectors, markets, currencies or countries and in the Fund’s possible use of derivatives. References to particular industries, sectors or companies are for general information and are not necessarily indicative of a fund’s holdings at any one time. Currency fluctuations may affect the value of overseas investments. When investing in a fund denominated in a foreign currency, your performance may also be affected by currency fluctuations. No shares of the Fund may be directly
31 December 2016
or indirectly offered or sold to residents of the United States of America. Shares of the Fund are not available for distribution in all jurisdictions and prospective investors should confirm availability with their local Franklin Templeton Investments representative before making any plans to invest.
The information provided is not a complete analysis of every material fact regarding any country, market, industry, security or fund. Because market and economic conditions are subject to change, comments, opinions and analyses are rendered as of the date of this posting and may change without notice. A portfolio manager’s assessment of a particular security, investment or strategy is not intended as individual investment advice or a recommendation or solicitation to buy, sell or hold any security or to adopt any investment strategy; it is intended only to provide insight into the fund’s portfolio selection process. Holdings are subject to change.
References to indexes are made for comparative purposes only and are provided to represent the investment environment existing during the time periods shown.
An index is unmanaged and one cannot invest directly in an index. The performance of the index does not include the deduction of expenses and does not represent the performance of any Franklin Templeton fund.
CFA® and Chartered Financial Analyst® are trademarks owned by CFA Institute. 1. Source for all information is Franklin Templeton Investments. Benchmark related data provided by FactSet. Past performance is not an indicator or a guarantee of future performance. Portfolio holdings are subject to change. Periods greater than one year are shown as average annual total returns. Sales charges and other commissions, taxes and other relevant costs paid by investor are not included. 2. Source: Bloomberg, L.P. 3. Source: London Metal Exchange. 4. Source: World Gold Council.
Franklin Templeton Investment Management Limited Blasieholmsgatan 5, SE-111 48, Stockholm, Sweden franklintempletonnordic.com
For Professional Investor Use Only / Not For Distribution To Retail Investors © 2017 Franklin Templeton Investments. All rights reserved.
