Why consider investing into commodity markets

Our last speaker tonight is Mr. Blair Kirkhope, Head of Sequoia Specialist Investments.

Sequoia Commodities Series 18 is a structured product that provides investors with 100% leverage exposure to a diversified basket of commodities on a limited recourse basis for 18 months.

It provides investors exposure to the commodities asset class without having to outlay significant amount of capital.

Blair has over 22 years of financial markets experience and has been running SSI, one of Australia's leading issuers of structured products and a wholly owned subsidiary of Sequoia Financial Group.

Prior to that, Blair worked in BNP Paribas, ABN Amro and PwC.

Blair's topic tonight is why consider investing into commodity markets.

Welcome Blair.

Thank you.

Thanks very much for the opportunity to be able to present our current offering.

So today what we wanted to do was really talk about why we think commodities as an asset class is an interesting investment for investors to consider.

But before starting, just a quick disclaimer.

So any information provided here is on a general advice basis only and does not take into account anyone's personal circumstances.

So who are we?

So Sequoia Specialists Investments.

We've been in the market for over 10 years.

We've issued over 125 investments, totaling a national currently outstanding of approximately 400 million.

Our main objective here is to be able to offer investments to the Australian market that

that our clients or investors are finding difficult to get access to through traditional RAP platforms or through the ASX.

And if we look just quickly on the commodities asset class, there's actually no listed ETF providing one investor providing diversified exposure to the commodities asset class as a whole.

You can get exposure to gold or oil, but there's nothing in Australia on the market, on the ASX or SIBO, providing investors a diversified commodity exposure through one investment.

And that's part of the reason why we're offering this today.

Say a little bit about why should you listen to SSI or Sequoia.

What we do is we collate and consolidate research across a panel of investment banks, including Goldman Sachs, Barclay, Citigroup and BNP Paribas.

But in conjunction with that, we use the investment banks for fundamental research.

But in addition to that, we rely on a firm renowned as Armstrong Economics.

They built the world's leading artificial intelligence system over 40 years.

It's very much focused on timing and on cycles.

and has a very prominent position in the market.

Just to give a bit of an idea, they ran a conference, Martin Armstrong ran a conference the end of last year with 250,000 virtual attendees at $3,000 US dollars ahead.

His speaking fee for that conference was $750 million.

So this firm carries a lot of clout and we combine it

with the investment banking research in order to formulate our view on the market.

And that's why we're offering, that's the basis of our offering today.

So yeah, what we try and do is offer new diversification opportunities for investors, which they can't otherwise access through the ASX.

So what is our current view on the global markets today?

So, as a result of the big pickup in inflation and interest rates, we've seen government debt securities, for example, 30-year treasuries in the US or 10-year treasuries, or even Australian government bonds really come under massive pressure from a price point of view.

So that particular market, although it's traditionally been viewed as a risk-free asset, we think it's actually carrying the highest risk of any asset class at the moment.

So we look at long-term government debt as being currently in a bearish trend.

We think global equity markets are currently in a bullish market.

We think notwithstanding all the headwinds fundamentally in terms of interest rates and inflation,

If you look at the S&P 500, or even the Dow Jones Industrial Average, that's only 10% from all-time highs, which is quite phenomenal.

And we're seeing basically there's a big shift in capital away from the government bonds sector into equities.

And so those are the two prevailing underlying trends.

But there's a question mark about commodities.

Whilst a lot of investors might get exposure

Two particular commodities through their equity portfolio, it does carry a certain risk associated with it.

And we think that with the high inflationary environment, the commodities asset class is likely to continue its existing bullish trend for many years to come.

So let's talk a little bit more about that.

This is just a chart on the 30-year Treasury.

So government bonds 30 years.

You can see towards the right-hand side there's a big collapse.

It's a big technical breakdown that's showing you that the bond market is bearish.

I'm listening to US Jones Industrial's average to showing you long term, very bullish market structure from that perspective.

But then the question is, OK, what about commodities?

This is a long term chart here going all the way back to 2006.

You can see the peak on the left hand side around 2007, 2008.

That was the last peak.

But since the 2020 lows, the commodity market has just started to turn the other way.

And we think this is just the beginning of a bull market in commodities.

It reached a high on the right hand side.

It reached a high basically in 2022 when the war started, when Russia invaded Ukraine.

It's pulled back for approximately 12 months.

12 to 12 or 13 months and we think it's presenting an excellent opportunity or entry point opportunity right now for investors.

And let's talk a little bit about that.

Why is that?

This is an unusual looking chart.

It's an output from the artificial intelligence system called Socrates of Armstrong Economics.

And it is suggesting from a cyclical standpoint that inflation should peak in 2026.

So what we're looking to do from a commodity standpoint is play that trend, playing the trend of inflation going over the next few years.

So what is really driving that?

Let's think about it fundamentally.

OK, from a cyclical standpoint, we think inflation will peak 2026.

That's based on an artificial intelligence system forecast from a timing standpoint.

But fundamentally, what's driving this?

So we know, obviously, it all started with the COVID lockdown, supply chain disruptions.

A lot of those actually have not been fully addressed, have not been fully fixed.

So there are still a number of essential materials that are stuck in supply chain.

But I would say the most overriding and most important driver of inflation right now is the war in Ukraine.

Historical international war has always been the most important factor driving inflation.

And that situation is far from getting resolved and is likely, in our view, to continue for many years to come.

In addition to that, we have obviously the climate change policies.

There's a lot of divestment away from fossil fuels.

We have increasing protectionism and also cuts coming from OPEC, et cetera.

So there are a lot of fundamental factors at play which are driving this going forward.

We look fundamentally again in terms of fossil fuels.

We really like what's happening with clean energy, but we have to be realistic about the fact that fossil fuels is by far and large the major energy source driving the global economy currently, and it's going to take a long time for that transition to occur.

So we think it's important to take note of that, especially during a high inflation environment.

When we look at what is the Goldman's forecast, so the Goldman Sachs, we rely on their fundamental forecasts.

They're very bullish over the next 12 months, especially in relation to the energy sector and the precious metal sector.

So they're looking at a 58 per cent rally in the energy sector and almost a 25 per cent rally in industrial metals over the next 12 months.

Looking at why is that from their perspective, they think that we've got some supply and demand imbalance in terms of energy over the next three to six months during 2023.

So that's on the right hand side.

Deficits are expected across oil.

The same is picking up in terms of, the same is occurring in copper.

So deficits expected in copper over the next few years.

And in natural gas we can see they're expecting some price uplift in terms of natural gas prices going forward.

That is the yellow line there compared to the dotted line which is the current price.

So they think a pick up in natural gas prices.

So these are just a few slides showing fundamentally why they're bullish in this sector.

And so this is the reason we think from a typical standpoint, commodities are showing an excellent entry point in terms of the pullback over the last four months, fundamentally looking forward.

A lot of the banks are very bullish.

And so we think it's a right time right now to consider making an allocation into commodities.

And that's why we've launched Sequoia Commodities Series 18.

So let's talk a little bit about the terms of this investment.

So this is a fixed

This is a structured product where the terms and conditions are fixed up front in the terms of products.

So it runs for 18 months.

What we do is we lend investors 100% of the investment amount.

So there's no initial margin.

We lend 100% of the investment amount on a limited recourse basis.

So what that means is if the investment goes down by maturity, you simply walk away from the loan.

We are not required to, or there's no recourse that we have back to you in the event that that occurs.

So we lend 100% on a limited recourse basis at only 5.9%.

So when you look at the current mortgage rate, it's a full recourse mortgage.

You're at risk if you can't repay the loan and the property falls.

That's not the case here.

But our interest rate is pretty similar.

So we think it's a very attractive funding rate for something that is 100% lending and limited recourse combined.

We charge a 1.1% application fee, so in total when you say 1.5 years times 5.9% plus 1.1%, the total investment cost is 9.95%.

So if we think of an example, $100,000 loan, if you wanted $100,000 of exposure to the commodities asset class, it would cost you $9,950.

And that is your absolute worst case risk.

In the worst case scenario, that's what you can lose.

You do get a tax deduction for your interest, which is spread over the term of the loan, so that can also reduce the worst case, potential worst case after tax risk, especially if you're in the top marginal rate.

And then at maturity, what we do is we measure the performance of the underlying commodities index, and we pay that through in the form of a performance coupon of maturity.

And we calculate that by reference to the $100,000 investment amount.

So if the index is up, say, 10%, you would break even.

We'd be paying a coupon of $10,000.

You would recoup your original investment cost.

If it's up 20% you would be basically doubling your money at the end of the 18 month period.

We offer daily liquidity so investors can exit at any point in time.

So there's absolutely no lock in.

You can take profits off the table early before maturity if you like to do so.

So they're a quick summary of the terms.

Examples of investment costs, so $100,000 investment amount would cost $9,950.

$500,000 of exposure would cost $49,750 or $1 million of exposure.

to the commodities asset class will cost you $99,500.

So what is included within the underlying commodities index?

There are 13 commodities in total including cash across industrial metals, copper, zinc, aluminium, nickel, lead.

It includes gold and silver.

So many of the benchmark commodities within the energy sector, especially including WTI and Brent crude oil, natural gas, diesel, gasoline, and low sulphur gas oil.

These are the benchmark commodities included for the energy sector.

So when we look at the actual performance of this index itself, this is published by BNP Paribas.

So when we look at, okay, since the 2020 low up into April, May last year, there was a 67% rally from the trough to the peak, and it's pulled back since then at approximately 13%.

So we think this is still indicative of a strong bullish market as a slight pullback.

And we think the entry point right now is very attractive for investors to take advantage of that pullback.

The reason we say that oil has pulled back from 130 or 140 back to 70 or 75 right now

When you look at natural gas, it's pulled back from $10 back to about $2, $2.50.

That's a huge pullback and a lot of upside in terms of natural gas.

And when we look at the gold, we think we're on the verge of breaking out at $2,100 in terms of gold.

We've had a pullback into June, and we think this is about to break out during Q3, potential Q4.

So positioned quite nicely for gold as well.

So that's it for me, just a quick summary.

This is a high risk investment with the potential to generate a higher return.

Investors can lose 100% of their initial cash out.

Labor can never lose more than that.

So they have no risk in relation to the loan amount.

And if investors are, this is open to both retail and wholesale investors.

If you are a retail investor, we have to ensure that you fall within the target market.

and Hamish McCathy at Sequoia Worth Management is the advisor here and will take any inquiries for investors.

His details are shown here.

This investment closes on the 8th of September, so there's a bit of time left to consider and will start on the 15th of September.

So that's it for me.

Thanks, Blair.

I've got some questions for you.

Can you explain the limited week course loan again, please?

So yeah that's a very good question.

So as I mentioned we lend 100% of the investment amount.

So if we talk about that example where an investor wanted $100,000 of investment exposure to the commodities market, we will lend $100,000 to the client.

on a limited-recourse basis, but however, if that commodities basket or commodities underlying actually falls by the maturity date, 50%, so in a normal full-recourse loan, an investor would be required to repay that difference on the loan of $50,000.

However, in this particular case that's not required.

There's absolutely no recourse that we have back to the client in relation to that and investors would simply walk away.

And the reason for that is because we've actually built into the interest rate effectively a cost of protection on that portfolio.

So the underlying hedge provider here takes the risk in relation to that loan amount.

So that's why it's limited recourse.

Sorry.

you lend investors 100% of the investment amount, but the investors don't have to repay this if the underlying index falls.

Absolutely.

Have I understood this correctly?

What's the catch?

That's absolutely the case.

So yeah, we lend 100% and if it goes down, investors do not have to repay all the loans.

So they take no risk in relation to the loan and they get all the upside in relation to the leverage investment exposure.

However, they are, of course, there's no magic involved here.

So of course they are at risk in relation to their initial cash outlay.

So it costs them 9,950.

That's an interest cost plus the cost of the application fee.

So if the index does fall, they do not get their 9,950 back.

So they are at risk in relation to the $9,950.

And in order for investors to break even, the index has to be up.

10% at maturity in order for clients to actually receive a performance coupon of $10,000.

If that occurs, then they are broken even.

So anything above that, so if the commodity index performance at maturity is above 10%, that is when investors start generating a net profit from this investment.

Right, and is the prepaid interest tax deductible?

A good question again, yes it is tax deductible, fully tax deductible.

The reason for that is because it is incurred for the purpose of generating assessable income.

So the performance coupon of maturity that investors hope to achieve if the index is positive in maturity is actually assessable income for investors.

Because that's the case and the expectation is that that performance coupon should be greater than the interest cost that's incurred, then it is actually tax deductible.

However, it's not deductible at the time of payment.

It is something that is accrued and amortized over the term of the loan.

So what that means is that clients would effectively be claiming 9.5 months worth of interest during the tax year ending 30 June 2024 and then the balance of the prepaid interest would be claimed in the tax year ending 30 June 2025.

Right, that makes sense.

Well thank you Blair, good to see you and have a good night.

Great, thanks very much for the opportunity to present.