RAB Special Situations : Final Results

The Company's sole investment is in the RAB Special Situations (Master) Fund Limited (the 'Master Fund') and the review that follows refers to the portfolio of the Master Fund.

Commodities saw their worst losses in 2015 since the 2008 financial crisis, with the Bloomberg World Mining Index falling 35.3% over the period. Nearly a decade of overinvestment in production, supported by high prices and demand growth in Emerging Economies, gave way to a vicious cycle of price deterioration and cost deflation as global supplies soared and demand expectations were tempered on the back of a China-led Emerging Markets slow-down. Precipitous price declines in the petroleum complex acted as a catalyst, but the sell-off was broad based with every sector from metals, to bulks, to agriculture seeing sharp losses in 2015.

Compared with the previous year, base metal prices were down 24.4% on average (London Metal Exchange Index) in 2015 with molybdenum (-42.8%) and nickel (-41.8%, at a 12-year low) demonstrating the most significant declines. Copper, the primary revenue driver for the base metal sector, was down 26.1% as moderating global GDP growth and the continued slowdown of the Chinese economy continued to weigh on all commodities throughout the year. Even gold languished at multi-year lows, down 10.6%, unable to attract buyers despite bouts of intense stock market volatility, geopolitical shocks, counterintuitive bond market behaviour, unusually fluid and unpredictable asset class correlations and changing views about central bank policies. Steep appreciation in the US dollar further weighed on dollar-denominated commodity prices amidst the bearish fundamental environment.

Many commodity markets were beginning to tighten in the latter half of the year though as the impact of lower prices started to filter through in the production side. For oil and gas, sharp declines in US rig counts should begin to make meaningful impacts on production growth in 2016. Meanwhile, mining supply cuts could support a rebound for some metals. A slower pace of US dollar appreciation should also give the complex some breathing room in 2016.

On the back of this poor sector performance and one legal ruling (Oxus Gold), the Master Fund suffered, falling 41.7% (on the Sterling Share Class) in 2015.

During 2015 the Master Fund remained almost fully invested and continued to pursue the sale of private positions in line with the aim of reducing the portfolio's exposure to private asset classes. As of 31 December 2015 the Master Fund had 16% in net cash (including contracts for difference borrowings), with publicly listed investments or positions where the underlying security is listed (including contracts for difference exposure) representing 70% of the net asset value of the Master Fund. Of these listed investments 17% were illiquid (i.e. they cannot be liquidated in less than 180 days using 25% of the year end 90 day average daily traded volume of the stock). Unlisted investments at the year end represented 14% of the net asset value of the Master Fund.

There follows an update on the top 5 holdings by value, and their prospects going forward.

Falkland Oil and Gas Ltd: After the disappointment of the Humpback well in October 2015, the result of the Isobel well and the approval of the merger with Rockhopper Exploration plc ('Rockhopper') have been two positive events to start 2016. Looking forward, the rig will move to drill the Chatham prospect in which Rockhopper holds 40% and estimate a Pmean resource of 51 million barrels. In addition, with their partners Premier, they will look to move forward with the FEED process on their Sea Lion field. In terms of risks, clearly the oil price will affect general sentiment towards this space as well as directly impacting the economics of their projects.

Royal Nickel Corporation ('Royal Nickel'): Royal Nickel is a stock that is highly leveraged to the nickel price and requires the economies of scale (i.e. high initial capital expenditure) to maximise economic return. The company announced in 2015 that it had received the certificate of authorisation for its Dumont project, positioning it to proceed to construction upon completion of financing. This is arguably a long term holding for the Master Fund given the project is uneconomic at the current nickel price (US$8,780 per tonne).

Victoria Gold Corporation ('Victoria Gold'): Victoria Gold is a stock that is highly leveraged to the gold price, with significant scale and method of mining (open pit, heap leach operation) conducive to the low operating cost theme sought by investors. Since completing the feasibility study for its flagship Eagle Gold project in Yukon in 2012, the company has been focusing on project financing and aims to have this completed in 2016. The permitting of the project is now complete and the final piece of financing would render the project ready to progress towards its theoretical value.

Trevali Mining Corporation ('Trevali'): Trevali performed poorly in 2015 on the back of a sharp fall in zinc prices (-26.5%). With its Santander mine performing very well and Caribou mine and mill commissioning advancing in New Brunswick, the company should have two operating zinc mines on line by the time positive zinc supply and demand fundamentals take hold, which may yet occur in 2016. With the demonstrated strong support of its lenders and its strategic partner Glencore plc, we believe Trevali remains in good condition to take advantage of improving zinc fundamentals.

Brasoil do Brasil: The Manati gas field offshore of Brazil, in which the company holds a 10% interest (Petrobras act as operator), continues to produce well after compression equipment was installed. Looking forward, clearly the macro economic situation in Brazil and the prevailing market for oil will be particular points of risk for this company.

2015 witnessed a much sharper slowdown in China's commodity demand than was generally expected. Combined with ongoing supply growth - the result of a 30-year high in capital investment over 2009 to 2013 - this has led to commodity prices falling materially in 2015, and the mining sector underperforming for an unprecedented fifth consecutive year, making it the worst period for the sector since at least 1966.

We do think 2016 will see a steady acceleration of the supply cuts in the commodities sector. However, we do not expect to see any material impact of these cuts in the short term. In past cycles we would have seen more producers going out of business completely, but the availability of cheap capital in the current financial environment has buffered against this.

Supply cuts in themselves are generally a reaction to current market conditions, and it is rare to see 'too much' supply cut - they may stabilise cycles, but they rarely lead sustained recoveries if demand does not play ball. Unfortunately, the prospect for an upside demand-shock looks limited with the Purchasing Managers Indices in China and the US in contraction territory. Aside from the structural transition away from fixed asset investment intensive growth in China, we worry about deteriorating demographics and a multi-year slowdown in property investment.

While the above points to further short term difficulties, for those with longer term horizons, we are starting to see the capital raises, dividend cuts and, crucially, capacity withdrawals, which are a necessary prerequisite for a cyclical turning point, as is an increase in merger and acquisitions activity. Unfortunately they do not in themselves signify a bottoming of the market which may well be yet to come.

Philip Richards and Team

28 January 2016