Every sub-sector except precious metals lost money during the month, with all sectors seeing increased correlation on the downside. The largest losing positions were in Rio Tinto, Xstrata and BPZ Resources. The largest gain was in Lihir Gold, which was bid by Newcrest.

April saw global markets consolidate gains made during the first quarter of 2010. Investor risk appetite declined during the month in the face of rising sovereign risk in Greece, the other PIIGS and the growing risk of contagion in the Euro area. As illustrated by the CBOE SPX Volatility Index or VIX, which jumped from 15% mid-month to 22% by month end. Greece is a complete financial disaster with a debt-to-GDP level approaching 150% by the end of 2011. At that level, with a 5% real interest rate and no economic growth, it will require an incredible primary budget surplus of nearly 8% just to keep its debt-to-GDP ratio stable. Clearly, Greece has a level of debt that is unsustainable and will end with the country ultimately defaulting; the first in a series of sovereign defaults. This summer could see a sharp rise in social unrest with many Mediterranean countries having a combustible combination of high youth unemployment (~30%) and high temperatures.

The risk to other parts of Euro-land, Portugal, Spain, Ireland and also Italy caused markets to become increasingly concerned with profligate fiscal policies. Ultimately the entire EU faces a difficult choice of either deflationary austerity measures to bring exploding deficits under control or a path of easy monetary policy from the ECB leading to a weak currency and higher inflation. A lack of clear guidance and decisive action from the ECB on how it would handle the Greek situation caused Euro-wide contagion, resulting in sharply higher bond yields for many weaker members. As the Greek tragedy escalated, European equity markets were sold off sharply toward the latter half of the month and contagion also effected the US and Asian markets. (The portfolio has no exposure to European equities.)

Meanwhile, China announced measures to reduce speculation in residential property markets, which caused the resource sector to weaken, as investors became concerned about the level of demand for raw materials in the short term. Although we would agree this is not positive for sentiment short term, demand and prices for iron ore, coking coal and thermal coal remain strong. In the base metals area, where speculators have held long positions, we have seen three-month base metal prices remain relatively steady during the month, with the copper price recording the worst performance, falling 5% to U$3.30/lb. The mining sector is showing good fundamental value with many stocks discounting a much lower implied long term metal price than the corresponding futures.

In Alternative Energy, the portfolio has maintained a cautious investment approach. We have remained concerned about having direct exposure to the European renewable market given our concerns about economic growth in the region. With the fiscal constraints confronting Spain and Portugal, we believe growth capacity over the next several years is likely to be below market expectations as respective governments trim future subsidies to the sector. This in turn may see downward earnings revisions for the major wind operators such as Iberdrola Renovables and EDP Renovaveis, which may struggle to meet guidance. We have maintained exposure to the Chinese solar manufacturers with their cost competitive position. However, even these companies have seen selling pressure as investors developed a more cautious outlook for the sector. Notwithstanding the concerns in Europe, investment in China remains strong. The portfolio has retained several short positions to provide downside protection to the sector, which is likely to continue to remain under pressure in the short term in light of the current environment in Europe.

In the wind sub-sector, both Dongfang Electric and China High Speed Transmissions reported better than expected 2009 earnings. Dongfang Electric benefited from the growth in nuclear generating capacity while China High Speed Transmissions reported better than expected margin growth and an order book which is full for 2010 and into 2011. China has continued to emphasise the importance of increasing its alternative energy generating capacity and both these companies are well positioned to enjoy future growth. In contrast, Vestas, the Danish turbine manufacturer, reported first quarter earnings that were below expectations and poor visibility in the near term outlook. Given the uncertainty that surrounds the outlook for the European economies, we continue to take a defensive approach and have trimmed overall exposure to the sector.

In the Energy Sector, the big news is the BP Deepwater Horizon environmental calamity in the US Gulf and the impact on both market value of the companies involved and the potential impact on future deepwater projects. After peaking at $87/bl in early April, the front end of the curve sold off, while the back end (long dated futures) actually increased following news of BP’s disaster. The portfolio took profit and reduced holdings in Suncor and Pacific Rubiales following strong performance from both stocks. Overall valuations remain attractive in the sector, and while the short term outlook is for volatility to remain, we are carefully viewing opportunities to add to positions.

Whether by monetising debt, quantitative easing or printing money, developed economies are likely to devalue their currencies in an effort to stimulate economic growth. In addition, with many signs pointing to a series of potential sovereign defaults in addition to Greece, it is an investment climate where precious metals are viewed as a safe haven. The portfolio has exposure to gold and platinum equities given the use of the latter in auto-catalysts and China’s continued growth in auto production to over 7 million per annum while we have also seen an increase in auto demand and production from the US, albeit a very low base. Despite the post global financial crisis spectre of deflation, we believe that most indebted developed countries will eventually try to inflate their debts away leading to strong performance in precious metals.

Markets in the alternative energy and natural resource sector have corrected during April, driven by the uncertainties in Europe. This impacted the performance of the portfolio. Valuations have become more attractive during the month however, the timing of when markets will stabilise rests with the actions European Parliament and the European Central Bank and how much markets have confidence in their policies. The portfolio has positioned itself for a rebound in the sector but is not fully invested leaving opportunity to increase exposure to over-sold and cheap stocks.

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