The portfolio was up 3.x% for the month. The greatest gains occurred in mining and alternative energy. The biggest winners were two stocks highlighted in previous reports – Linc Energy +56% (underground coal gasification) and Lynas +39% (rare earths).

The portfolio’s most profitable position was in Linc Energy, which is utilising underground coal gasification (UCG) technology to produce hydrogen and methane gases from coal seams deemed uneconomic to mine. The cost of UCG is significantly more competitive than production of coal-bed methane and LNG. However, the catalyst for unlocking value is the negotiation to sell several of its non-core assets, including Australian coal deposits Emerald and Galilee in Queensland, which alone could be worth more than $1.5 billion, a multiple of the current market capitalisation of the entire company. We expect a transaction to close shortly on the sale of the Galilee coal assets to an Indian buyer for a price above what has been expected by the market, while negotiations for the sale of the coking coal asset is on-going. Given the tight supply for coking coal on a global basis, it is quite possible that the asset is sold at a price above what we projected. The portfolio holds a 4.9% weight to the stock and is the largest holding in the portfolio.

Despite considerable recent press coverage on rare earth mineral availability, the United States and Europe have been remarkably insouciant about supplies of rare earth minerals so crucial to frontier technologies, from hybrid engines to mobile phones, superconductors, LED light bulbs, wind turbines and smart bombs. China’s commerce ministry has cut export quotas for these metals by 72% for the second half of this year. The sudden shortage in supply now threatens to choke off the profits of a legion of green and consumer tech groups that depend on them. Lynas is perfectly positioned to benefit from the developing shortage in rare earth minerals and is sitting on a very valuable resource. The firm should start production in the third quarter of next year – offering the first significant source of new supply outside of China. Meanwhile prices for the rare earth composition of its Mount Weld deposit have more than doubled in the last year to pre-recession levels under pinning the unique value of the asset.

The sceptics of global warming suffered a double blow with the “Climategate” scientists cleared of charges by an independent inquiry, and a hot summer, as June was the warmest June on record globally. For those of you who have any remaining doubts, Jeremy Grantham’s (a highly regarded fund manager/market commentator) most recent newsletter “Summer Essays – Everything You Need to Know About Global Warming in 5 Minutes” which should clear any remaining climate change misconceptions.

The problem is political, especially in the US which lacks a clear energy policy. In spite of the political ineptitude, investment in the US is taking place, but at a level considerable below potential. For example, during the second quarter of 2010, investment into venture capital projects reached U$6.5 billion, a 53% increase on the same period last year.

In Europe, renewable generating capacity accounted for 60% of newly installed capacity and more than 50% installed in the US according to UNEP (United Nations Environmental Programe). While in Asia, the region is investing heavily in alternative energy. It is not just China, but Korea, India, Taiwan and Japan. Asia is taking the initiative and in turn its alternative energy companies are beginning to see their investment bearing fruit. It is estimated that solar PV module shipments increased for the fifth consecutive month in 2Q’10 to 3.7 GW generating U$ 7.1 billion in revenues according to IMS Research and are forecast to increase again in 3Q’10 to reach 4.3 GW. Further evidence of strong activity comes from the poli-silicone suppliers. Poli-silicon prices have stabilised at around U$45/kg while activity in the solar sector has remained more buoyant in-spite of the feed-in-tariff cuts in Germany, Spain and Italy (which are the largest single markets). Recently solar cell and module prices have actually increased at the margin during the last two months while poli-silicon suppliers are now pushing solar wafer customers to sigh 3-year supply contracts.

Even Russia, which has spurned clean-energy has recently signed a deal with Siemens to install wind turbines with a total capacity of 1.25 GW by 2015.

According to the IEA, China surpassed the US as the world’s #1 total energy consumer doubling its consumption over a ten year period. China’s ravenous energy demand explains why it passed the US in 2007 as the world’s largest emitter of carbon dioxide and other greenhouse gasses. While most of the world was in a nasty recession, China’s GDP grew 9.1% and oil demand grew 7.8% in 2009. Since then, auto sales have skyrocketed past the US, ensuring Chinese oil demand will remain strong. China will soon announce a new Energy Development Plan that will likely aggressively expand cleaner conventional energy sources such as natural gas and accelerate construction of alternative energy generation projects amounting to an estimated U$738 billion. Part of this plan is to increase its wind and nuclear capacity targets to 124GWs and 82GWs respectively by 2020.

The steady drumbeat of decelerating macro data has continued over the past month with GDP, housing and consumer confidence slumping in the US and economic expansion in the rest of the world is slowing considerably. Although seen somewhat as of a farce by the market, banks in Europe passed the stress tests and new financial legislation was passed in America. Although banks reported decent earnings, loan growth has turned negative in Europe for the 1st time in 50 years. Furthermore, despite Bernanke’s ‘uncertain’ outlook for the US recovery during his congressional testimony, sovereign debt worries temporarily abated and markets trended higher while yields on 2-yr US Treasuries reached a record low.

Clearly the markets have put the risk trade back into portfolios given the rally in July. Yet the macro economic fundamentals in the Western economies remain delicate. However, in China, there has been a growing consensus that the government has achieved the economic slow-down from over 12% GDP growth to around 9% and will begin to relax its austerity policies. This has lead to a sharp increase in base metal prices and also a bottoming in steel prices internationally. For example, the copper price increased during July to U$3.31/lb an increase if 12%.

We are entering what has historically been the period when China restocks its base metal inventories. This has provided a sharp rebound in resource company stock prices during July. The portfolio has remained weighted to copper stocks through Mercator, Lundin and Oz Minerals while also weighted to the large diversified mining companies.

What is worth putting into context is China’s place in the global commodity market place. With an ever-growing and voracious appetite for natural resources, China already consumes 1/3rd of the world’s copper and 40% of its base metals, and produces half of the world’s steel. To satisfy that appetite, companies based in China or Hong Kong participated in $13Bn of mining acquisitions in 2009, 100 times the level of 2005. In 2009, China accounted for 1/3rd of all cross border mining deals, up from less than 8% in 2007 and 1% in 2004. Though demand for commodities has eased a bit as the pace of China’s growth has slowed this year, it is nevertheless expected to stay strong in the long term.

The portfolio has increased the net position during July increasing exposure to the alternative energy sub-sector, adding several new stocks, including Centrotherm Photo-voltaics, Dart Energy and Solutia. In the mining sub-sector, the portfolio has added Invanhoe Australia which has potentially the world’s largest resource of rhenium which is used in the aero-space and gas turbine industry allowing for the highly efficient combustion of fossil fuel and in turn significantly reducing the emission of noxious gases and particulates by burning fuel at much higher temperatures. Rhenium is already being used in jet engines for aircraft such as the A380. However, going forward its use will increase as new aircraft replace older planes as they are taken out of service. We are also looking at the attributes of Alkane a developing zirconia and rare earths in Australia which will compliment the investment in Lynas.

Last month we wrote that the volatility would remain in place. It has. Markets have rallied on the back of the European Banks passing the ‘stress-test’, in-spite of the scepticism that surrounds it. We don’t see volatility going away. While the markets rallied, the portfolio took advantage of taking profit and reducing exposure to stocks that had performed strongly during the rally and in turn reducing stock specific risk.
Looking forward, markets may trend higher in the short term, but we are conscious of a potential consolidation and therefore the net position remains at a moderate level. However, as we have written above, several areas of interest are presenting positive developments and the portfolio has gradually positioned itself toward these.

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