China’s long march to net zero
Salman Siddiqui, Fund Manager, Global Emerging Markets Focus, discusses China’s move toward carbon neutrality and the investment opportunities it provides.
It was widely noted that China’s President Xi Jinping did not attend COP26, the climate change conference held in Glasgow, at which more than 100 world leaders were present. What received less attention was China’s publication of its net zero framework, which sets out a step-by-step plan to achieve peak carbon emissions by 2030 and net zero emissions by 2060.
China is responsible for the largest annual amount of carbon emissions of any country, followed by the US and then India. Yet China is the world’s most populous country, with four times as many people as the US, and so on a per capita basis, the US is the world’s largest carbon emitter. In fact, the US emits three times as much carbon per capita as China and almost 10 times as much as India.
Today, more than 80% of China’s energy mix comes from fossil fuels – mostly coal – and only 20% from renewables (hydropower, wind and solar). China’s target for 2060 is to swap those around: 20% is to come from fossil fuels and 80% from renewables.
China has introduced strict capacity curbs on carbon-intensive industries like steel making and cement: from now on, no new capacity can be built, and all replacement capacity must be more energy efficient. China plans that its overall carbon intensity – carbon emissions per unit of GDP – will fall 30% by 2030.
To be sure, the international community had hoped for more aggressive targets from China – and that certainly would have boosted the mood in Glasgow. China, like other emerging market countries (notably India), argues that setting the same net zero targets as developed countries would be unfair: it started to industrialise a century and a half later than the West, and has far lower income levels.
China’s commitment to carbon neutrality by 2060 represents the largest and most rapid emissions reduction by any country. There is likely to be strong growth in China’s green and low carbon industries such as wind, solar, and electric cars (EV). China targets EV penetration of 40% by 2030.
While we see plenty of growth potential, a danger for investors is that companies in these sectors often swallow up lots of capital and their products are often undifferentiated from competitors’. High capex and a commoditised product do not easily translate into the high and sustainable profitability that we look for from the companies we invest in. We find that companies with long-term sustainable business models tend to score highly on all Environmental, Social, and Governance (ESG) metrics.
A tale of two monetary metals
Chris Mahoney, Fund Manager, Gold & Silver, says the recent price action seen in gold shows that that the bull market is still intact, adding the use of silver to make solar panels may boost demand for the metal.
The Federal Reserve (Fed) has managed to avoid a taper tantrum like that seen in 2013, as the US central bank did a very good job of preparing the market for the gradual withdrawal of stimulus introduced to underpin the economy during Covid.
Now the focus is on when it may start raising interest rates. The Fed has said that, whilst lift off won’t happen until the tapering is complete, the end of tapering won’t trigger lift off in a mechanical fashion.
The decision may hinge on two key factors: full employment and price stability. The Fed acknowledges that inflation is high, but it has expressed its dissatisfaction with where the US economy is, in terms of full employment. Extrapolating the jobs growth seen since the start of the year, the US will take until the second half of next year to reach full employment.
We may see a lift off in rates in the second half of next year. So what would that mean for gold and silver? What would a hiking cycle mean for the monetary metals?
It depends on the extent to which the hikes in question were expected by the market, one way or the other. It will also depend on the inflation picture at the time. After all, gold and silver are mainly driven by real interest rates. And it’s worth making clear that rising nominal yields, in and of themselves, aren’t necessarily bad news for gold and silver. Indeed, if we look back at the last hiking cycle that began at the end of 2015, gold and silver actually rose during that period.
It was good to see gold recapture the key level of $1800 recently. And it’s looking more and more as though the price action that we’ve seen in the gold price since it hit an all-time high in August 2020 was a breather and that the bull market is still very much intact.
Silver too holds a lot of promise, particularly given the need to reduce greenhouse gas (GHG) emissions, a topic that took centre stage at the COP26 meeting in Glasgow recently. Solar photo voltaic will be a key part of reducing such emissions and by 2050 and may account for about a fifth of the world’s energy mix, according to the International Energy Agency.
All commercially viable solar panels contain silver. The International Energy Agency estimates that in order to achieve net zero by 2050 the world’s solar photo voltaic capacity is going to have to increase twenty-fold. That is a lot of solar panels, a lot of silver, and silver is already a very tight market. Although producing silver does itself entail GHG emissions, this needs to be understood in the context of silver’s role in various green technologies and its other important uses.
What a robust recovery, higher valuations and inflation means for UK Small Caps
Dan Nickols, Co-Head of Strategy, UK Small & Mid Cap, discusses how his view on UK small caps has evolved this year in light of the strong economy, rising inflation, higher valuations and a busy IPO market.
With the end of the year in sight, I’d like to look back to the views we held at the start of the year that led to our positive outlook on UK small caps and to review how things have evolved since then.
At that time, we thought the vaccine rollout would lead to a rapid recovery in economic growth, we were sanguine about inflation and viewed it as transitory, and we thought the Brexit resolution would be an opportunity for marginal and overseas buyers to look again at UK equities. We also noted the cheapness of the UK market, which was trading then at around 20% and 40% discounts, respectively, to Europe and the US. Finally, we viewed the IPO market as an opportunity to generate above-market returns.
The economic recovery and growth have surprised to the upside. Forecasts from the Bank of England (BoE) and others suggest around 7% growth this year and 5% next year. The UK is very much in the pack with the rest of the developed world.
Inflation is more persistent than we expected. The BoE is signalling 5% inflation in the early part of next year, but what’s not clear is how embedded it is in wages and prices, and whether there is an absolute requirement for the BoE to try to control it. We are at the beginning of the process of monetary policy normalisation, and that has clear implications for markets.
On Brexit, the impact is largely obscured for the time being by the economic recovery from the pandemic. There is no tangible net positive accruing from Brexit for now. The sabre-rattling happening around Article 16 of the Northern Ireland Protocol and the threat of retaliation from the EU, if that would come to pass, would be unhelpful. It would probably lead to incremental sterling weakness and another period of risk aversion.
The FTSE 250 Index is trading on a valuation equal to 16 times next year’s earnings, pretty much exactly where eurozone equities are trading. It’s quite difficult now to say the UK is cheap on a relative basis.
Finally, on IPOs, it’s been quite a decent year, with 91 IPOS so far this year raising 15 billion pounds, the best year since 2014. Performance of these new stocks has been good, with 60% trading at premiums and 40% at discounts to their IPO price. There is a more nervous feel to the market, however, with a greater incidence of IPOs being pulled.
In response to all this, our view has evolved over Q2 and Q3 in favour of reducing exposure to faster growing, or growth, stocks and raising exposure to undervalued, or value, shares.
The value of active minds: independent thinking
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