Fund Focus March 2012 JPM Global Natural Resources The Fund invests in specialised sectors and themes, primarily in natural resources companies globally, and is therefore subject to diversification, smaller companies, indirect exposure to commodities, natural resources stock, Russia and emerging markets risks. The Fund s price movement may go down or up sharply over a short time span. Investors may be subject to substantial losses. Investors should not solely rely on this document to make any investment decision. 2011 was a difficult year for Global Natural Resources 2011 was characterized by macro concerns and market fears surrounding continual growth and recovery in major economies such as China and the US. The European debt crisis was clearly the biggest unknown for global economies. Such macro factors overwhelmed company fundamentals last year; extreme volatility and elevated stock correlations were particularly evident in the 3Q 2011 panic, leading to the natural resources sector suffering significantly in performance. Similar to the case in 2008 Global Financial Crisis, we observed a strong link between the plunge in risk appetite and an aggressive sell-off in the sector, particularly base metals and mining equities. Although we believe some of these macro headwinds will remain in place for a good part of 2012, we expect a moderate global economic growth environment featuring low inflation in the developed world and an extended period of low interest rates. With monetary reflation a key theme in 2012, various central bank actions could counteract the macro tailwinds. More importantly, we strongly believe that the current macro uncertainties will not derail the structural case for natural resources. Investors should not overlook the brighter spots in the sector from the fundamental point of view, as the demand and supply balance for some commodities remains as tight as ever, lending strong support to commodity prices. In addition, the price correction in commodity equities in 3Q 2011 has resulted in attractive valuations compared to both historical and normalised levels. Commodity prices vs. Commodity equities Gold Spot Price vs. FTSE Gold Miners Index Gold Spot Price FTSE Gold Mines Index Copper Spot Price vs. Freeport McMoran LME 3m Copper Freeport Copper Brent Crude vs. HSBC Global Energy Index Brent Crude HSBC Energy Index China Import Iron Ore vs. Fortescue Metals Group Iron Ore Price Fortescue Metals Group Source: Bloomberg. Data valid as at 31 December 2011 The information contained in this document does not constitute investment advice, or an offer to sell, or a solicitation of an offer to buy any security, investment product or service. Informational sources are considered reliable but you should conduct your own verification of information contained herein. Investment involves risk. Past performance is not indicative of future performance. Please refer to the offering document(s) for details, including the risk factors before investing. This document has not been reviewed by the SFC. Issued by JPMorgan Funds (Asia) Limited. MKT081985 1/6
Global Natural Resources Outlook One view widely held by market bears last year was that commodity demand would be severely impacted by an impending slowdown in economic activity across regions. We continue to believe Emerging Markets remain the key driver for underlying demand, amongst which Chinese demand would be the key price catalyst for base metals prices, as the country consumes close to 4 of the global output total. Although emerging market economies including China have seen some moderation in economic activity, we are far from seeing a collapse in underlying demand as was the case in 2008. We believe the Chinese government will focus on maintaining stable growth in this important political transition year; we continue to see the approval of rail projects with sizable budgets and the construction of social housing continues to receive strong endorsement from the central government. A Chinese economic soft landing has long been our central case and this is becoming a more widely accepted belief. After a slowdown in base metal demand in the first half of 2011, Chinese restocking stepped up after August 2011. Copper imports hit 508,942 tons in December 2011, a 47.7% year-on-year increase. We expect that Chinese restocking patterns of buying at price dips will continue to provide strong price support for the sector. Unlike other sectors, commodities are truly scarce resources they are discovered, explored, extracted, mined out and depleted if no new resources are found. In our view, supply is often the key price driver for many commodities. We continue to see clear distinctions in terms of the fundamentals supporting different commodities, and selectivity remains key. Here is our view on the main commodity groups: Base metals & mining We continue to focus on commodities with the tightest supply constraints, such as copper and iron ore. Despite rising cash operating margins, copper miners struggle to replenish supply to match the margin incentives. This could be explained by the supply constraints; one being sub-trend copper mine production growth and another being the continual decline in the ore head grade of copper mines. On average, global copper supply has fallen short of plan by more than 6% since 2005. Chilean and Peruvian production, which makes up 4 of the global mine supply, saw copper concentrate production in each country fall 3% and 1%, respectively, in 2011. The iron ore sector is also showing supply strains with little signs of easing. New capacity additions continue to see delays due to a combination of high capital costs, regulatory issues and infrastructure constraints in iron ore production countries. Market estimates on new capacity additions have consistently been revised down. Despite rising margins, copper miners struggle to replenish supply Global copper mine output and cash operating margins 25 25% C1 cash margin at 90th %ile 20 15 10 5 LHS: cash margin (12m fwd) RHS: mine supply 2 15% 1 5% Mine supply, 12MMA YoY %ch -5-5% 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Source: CNIA, CRU, ICSG, LME, Wood Mackenzie, Macquarie Resesarch, December 2011 2/6
Iron ore sector continues to be tight, with little signs of easing New capacity additions are already seeing delays Estimated new capacity additions, excluding Big 3 0 0 0 Apr'10 Oct'10 Apr'11 Oct'11 Change in cumulative addition since Apr' 10-258 +211 1227.56 1138.11 1052 1017 0 0 0 200 0 755-330 676 499 569.3-73 496.9 317-53 163 130 222.2 169.4 90.2 108.6 2011 2012 2013 2014 2015+ Source: J.P.Morgan, 2011 Energy the supply/demand situation of thermal and metallurgical coal remains challenging. New expansions have been delayed due to infrastructure constraints in coal mining countries such as Mongolia. On the demand side, China coal imports remain as strong as ever. In the near term, Chinese utilities could start re-invigorating spare capacity as their economy stabilizes. On the other hand, oil s long-term fundamentals are relatively more comfortable, as reflected by the reasonable level of current OPEC spare capacity available and an oil price trading above the marginal cost of production. Nonetheless, we believe that Middle East tensions will be the biggest swing factor for the industry in the near term, with increasing geopolitical risks a key driver for the oil price. China coal import China seaborne thermal coal imports have exploded Chinese seaborne coking coal imports coming back to levels seen in 2009/2010 Source: Chinese Custom, Macquarie Research, December 2011 Gold market fears over the economic outlook for the developed world together with the Eurozone sovereign debt situation are still present. The fear factor in the market could encourage more investors to seek shelter in gold. Also, real interest rates (using 10 year TIPS as benchmark) historically have been highly correlated with the USD gold price. Low real interest rates are expected to remain for an extended period, offering support to 3/6
the gold price. In 2011 we also saw central banks (particularly in emerging markets) turning to become net buyers of gold, accelerating purchases despite persistently rising prices. This trend is expected to continue as gold still represents a much lower proportion of total foreign reserves within the emerging market countries compared to their developed world counterparts. In the chart below we show the consensus estimates for different commodities versus their spot prices. Many of them are presenting meaningful premiums reflecting the market s strong belief in these commodities fundamentals, despite the price downgrades that have been factored in since Q3 2011. 2012 consensus commodity prices vs current spot price 5 45% 4 3 2 1 7% 8% 9% 11% 13% 14% 16% 17% 18% 19% 21% 21% 22% 22% 22% 24% 29% 33% -1-8% -5% -5% -3% -2 WTI Oil Brent Oil Steel - USA Cobalt Zircon Uranium Nickel Thermal Coal Iron ore fines Copper Hard Coking Coal Gold Zinc Aluminium Tin Lead Molybdenum Platinum Steel - Asia Alumina Steel - Europe Palladium Silver Manganese Source: Macquarie, Energy and Metals Concensus Forecast for 2012, data as at 16 January 2012 Commodity equities' underperformance set to reverse Admittedly, commodity equities have seen earnings downgrades along with reductions in market analysts commodity price assumptions since 2H 2011. However, investors should not overlook the fact that commodity equities underperformed spot prices for most of 2011. With underlying support for spot prices still intact and commodity prices having stabilised earlier than equity prices, we could see a reversion play in commodity equities this year. In gold, for instance, FTSE Gold Mines Index significantly underperformed physical gold price in 2011. If history is any guide, in the past 10 years, whenever there was a significant underperformance of gold equities versus physical gold, gold equities have always been able to strongly snap back in the following 12-18 month period. At the company level, miners in general currently have much better fundamentals compared to 2008. Balance sheets have been repaired after the Global Financial Crisis with much-reduced debt levels, yet their share prices are still trading at low historic valuations, even after adjusting for commodity price revisions. This view is confirmed by the company management whom we have met in many company visits. % Net debt/net Debt + Equity 7 6 5 H1 2008 H2 2008 H1 2009 H2 2009 H1 2010 H2 2010 H1 2011 4 3 2 1 BHP Rio Tinto Xstrata Anglo American 8.6x 10.3x 7.3x 11.3x 12.8x 19.3x 8.6x 12.0x Source: Macquarie Research September 2011, Jefferies European Metals & Mining 4/6
Investment Strategy: JPM Global Natural Resources 2011 was a difficult year for the global natural resources sector and for our Fund. Our bias towards small and mid cap companies hurt performance as these companies got sold off indiscriminately amidst increased risk aversion, although this market segment offers the strongest growth profile over the medium to long term. We continue to focus on identifying junior companies with the best resource deposits. Our in-depth knowledge across the market cap spectrum and a long-term investment approach allows us to identify tomorrow s leading projects. The Fund is unconstrained as we build a best-idea portfolio with diversified exposure to commodities. Our Fund has a neutral allocation to base metals & diversified mining (3), gold and precious metals (3), energy (3), as well as other commodity sectors such as soft commodities (1). In terms of current strategy, we continue the overweight in gold and precious metals, within which we are positive on gold. We believe investors will keep a close eye on central bank purchases; any reflationary policies would support the outlook for gold versus paper assets. Our gold position also serves as a defensive position against any significant deterioration in the global economic outlook. We currently hold a neutral position in base metals and diversified mining overall and continue to be selective in commodities with a tight supply situation such as copper, iron ore and mineral sands. For energy, we have been moving to a neutral position in view of the geopolitical risks in the Middle East situation despite the oil supply/demand balance remaining comfortable in the near term. Coal remains one of our high conviction plays. The prevailing uncertainties in the Eurozone, with the Greek sovereign refinancing schedule being the key focus in recent months, are likely to remain a source of volatility this year. But as noted above, we continue to invest in many superior stock opportunities in our portfolio, given the appealing valuations levels. We believe our Fund is poised to outperform again once market sentiment improves. More importantly, should global growth deteriorate much further from this point, there will be significant delays to mining capital expenditure, accentuating the longterm supply constraints that we seek to exploit within the Fund. As always, we focus on identifying world-class exploration projects that offer the greatest investment return potential. Fund performance JPM Global Natural Resources (EUR) A (dist)^ 2007 2008 2009 2010 2011 2012 YTD Calendar year return (%) +45.5-67.4 +118.4 +.1-29.9 +20.1 1 year 2 years 3 years 5 years Since inception* Cumulative return (%) -15.6 +23.5 +148.1 +18.3 +92.1 JPM Global Natural Resources (USD) A (acc)^ 2007 2008 2009 2010 2011 2012 YTD Calendar year return (%) +45.4-67.1 +117.4 +39.7-29.8 +20.8 1 year 2 years 3 years 5 years Since inception** Cumulative return (%) -15.3 +24.7 +151.0 +18.9 +44.6 ^ JPM share class of JPMorgan Funds. Source: JPMAM (NAV to NAV in USD with income reinvested). Data valid as at 29 February 2012. * The launch date was 14 March 2005. ** The launch date was 12 September 2006. 5/6
JPM Global Natural Resources: A broad exposure with a flexible and diversified approach is key Sector Allocation Commodity Allocation Gold And Precious Metals 34.9% Soft Commodities 1.2% Cash 1. Base Metal And Diversified 29.4% Silver 3.1% Rare Earth 1.1% Platinum/ Palladium 1.4% Oil And Gas 22.9% Tin 0.4% Palm Oil 0.9% Uranium 0.4% Zinc 0.9% Cash 1. Agriculture 0.3% Alternative Energy Aluminium 0.1% 0.3% Chrome 0.7% Coal 3.4% Cobalt 0.4% Copper 6.3% Diamonds 2.2% Energy 27.1% Diamonds And Other 6.4% Nickel 1.7% Molybdenum 0.3% Mineral Sands 2.7% Lead 0.1% Iron Ore 5.3% Gold 30.7% Diversified 13.6% Regional Allocation Market Capitalisation Cash 1. Australia 11.8% Central and South America 12.7% EUR 20bn or above 22. Below EUR 250mn 10. Russia 3.2% North America 13.6% Africa 20.8% EUR 250mn to 1bn 22.8% Middle East 0.2% Global 17. Asia and Far East 9.2% China 3. Europe 7.5% EUR 5bn to 20bn 16.2% EUR 1bn to 5bn 29. Source: JPMAM, data valid as at 31 January 2012 For more information, please call us or visit J.P. Morgan Investment Centre at: 1/F, Jardine House, Central, Hong Kong G62, E Plaza, Legend Tower, 7 Shing Yip Street, Kwun Tong, Hong Kong Tel: (852) 2265 1188 Fax: (852) 2868 5013 www.jpmorganam.com.hk 6/6