In the first part of our investment thesis we suggested that we see long term structural deficits in various sectors, offering great investment opportunities, and protection against inflation. In this second part we will look in more detail at each sector we're invested in. We briefly mentioned them in our first post; now we'll expand a bit more. Once again, for the sake of brevity we will only refer to the main points that convince us, going into more detail in future publications.
Energy Metals and Rare Earth Minerals
One of the themes dominating public discourse is a shift towards clean, renewable energy sources, to reduce the world's CO2 emissions, in order to stop the warming of our planet. Some of the most hyped technologies put forward as solutions to global warming are solar panels, wind turbines, electric vehicles and batteries. These however, require tons of lithium, cobalt, nickel, copper, rare earth minerals and others to produce them, and the world's supply is not enough. A letter authored by Natural History Museum Head of Earth Sciences Prof Richard Herrington back in 2019, states:
(...) to meet UK electric car targets for 2050 we would need to produce just under two times the current total annual world cobalt production, nearly the entire world production of neodymium, three quarters the world’s lithium production and 12% of one year’s total annual production of mined copper. (Natural History Museum, "Leading scientists set out resource challenge of meeting net zero emissions in the UK by 2050")
And this only to satisfy the UK demand. We believe the mining companies producing the materials needed for this renewable revolution will benefit from this transition.
Copper
Continuing with the theme of renewable energy, copper's role becomes crucial as it's necessary for wiring and electric motors used in power generation and transmission in a world of increased electrification. In their Q1 Market Commentary Goehring & Rozencwajg write:
Because of increasing depletion issues, the lack of new world class mines coming online, and geological constraints embedded in copper porphyry deposits, our research tells us that copper supply will show little growth this decade. Strong demand is about to collide with severe copper supply problems. Copper prices are heading much, much higher. (Goehring & Rozencwajg, "The Problems with Copper Supply")
Increased copper demand needed to build renewable energy technologies, demand from countries wanting to modernise or build their electric grids, along with structural supply issues makes us believe that companies who produce copper will benefit in the coming years.
Uranium
Globally, around 10% of our electricity comes from nuclear energy (Our World In Data, "Nuclear Energy"), with demand projected to increase in the next years as new nuclear reactors are coming online. Currently there are 445 reactors operating, with another 50 in construction mainly in China and India, and 100 more ordered or planned (World Nuclear, "Plans For New Reactors Worldwide").
Uranium is the most common fuel used in nuclear reactors and it has been in a long bear market since the Fukushima Daiichi Accident (IAEA, "Fukushima Daiichi: The Accident"). The lack of investment towards uranium exploration and production projects has created structural supply deficits, with supply not being enough to cover future demand.
Recently, Uranium spot price has reached $50/lb which is believed to be an incentivising price for new uranium exploration and production projects (Yellow Cake Plc, "Uranium Market"). However not many companies will commit any capital unless they see sustained higher prices.
Contrary to popular belief nuclear energy is one of the safest and cleanest energy sources (Our World In Data, "Modern renewables and nuclear energy are not only safer but also cleaner than fossil fuels"), a fact that many have been noticing recently, highlighting it as an important part of the world's energy mix towards a cleaner, less CO2 emitting future. International Atomic Energy Agency (IAEA) in a recent publication, notices:
Many countries are considering the introduction of nuclear power to boost reliable and clean energy production.
In the high case scenario of its new outlook, the IAEA now expects world nuclear generating capacity to double to 792 gigawatts (net electrical) by 2050 from 393 GW(e) last year. Compared with the previous year’s high case projection of 715 GW(e) by 2050, the estimate has been revised up by just over 10%. (IAEA, "IAEA Increases Projections for Nuclear Power Use in 2050")
We believe uranium is offering one of the best investments in the long term, and despite the recent run of the stock prices of many companies, we're maintaining our positions. For more information on uranium and nuclear energy, we recommend the following interview: Uranium Sector Update - The Cycle Has Turned | Mike Alkin & Tim Chilleri - Sachem Cove Partners.
Oil and Gas
This is a controversial topic, but no matter how much everyone wants to stop using fossil fuels, they still play a crucial part in modern civilization and will probably continue to do so for many years. Currently, fossil fuels account for 80% of the world's energy consumption (Our World in Data, "Energy Mix"), with the energy consumption increasing year after year (Our World in Data, "Energy Production and Consumption").
A 2017 report from the World Economic Forum expects fossil fuels to still dominate energy for the next 20 years, for various reasons including increased demand from developing nations:
But even though the use of renewables is expected to grow faster than fossil fuels, the US Energy Information Administration (EIA) says coal, oil and natural gas will still account for 77% of our energy in 2040.
This is particularly true for developing nations such as Nigeria, Malawi and Niger. (...) These up-and-coming nations - along with India, which has a young population of almost 28% - will be looking to literally fuel their economies with growth industries so they can cash in on their “youth dividend”. Their businesses will, in turn, literally need energy to run. (World Economic Forum, "Fossil fuels will still dominate energy in 20 years despite green power rising")
In addition, many industries depend on oil and gas and their by-products and it will take a long time to find viable, cost-effective alternatives. From plastic and fibres to fertilizers, our modern civilization depends on oil. The machines mining the materials needed for the green transition and the energy the factories use to produce renewable technologies, all currently require the use of fossil fuels. We think renewable energy has an important part in the energy mix but it's not realistic to believe it will completely replace fossil fuels.
These, coupled with the narrative that fossil fuels are irrelevant (The Guardian, "On the horizon: the end of oil and the beginnings of a low-carbon planet"), and the ESG pressures on major oil companies to disinvest from fossil fuels, cause structural deficits which make us bullish on this sector. The recent Q2 commentary from Goehring & Rozencwajg (Goehring & Rozencwajg, "The IEA Ushers in the Coming Oil Crisis") provides an in-depth look into Oil and Gas demand and supply deficits.
Coal
A similar situation is forming in coal: due to ESG pressures (Investopedia, "Environmental, Social, and Governance"), investors are heavily disinvesting from it. However metallurgical (cocking) coal is necessary for the production of steel, and steel is crucial for infrastructure including the construction of wind turbines (WCM factsheet, "Cocking Coal"). Disinvestment increases the supply deficit while demand, even if it's not increasing, remains the same or doesn't decrease as fast.
In addition, thermal coal is still used to produce electricity, with countries such as China still building Coal powered electricity plants. We don't like coal as on top of the CO2 emissions, it results in poor air quality linked with various respiratory illnesses (J. Lelieveld et al., "Effects of fossil fuel and total anthropogenic emission removal on public health and climate"), however we believe that the world will keep using it, not only for steel production but also for electricity.
Shipping
So far we have focused mostly on energy and the commodities required for the green transition. We will now shift our focus on a sector that is not producing any commodities but is required to transport them, offering some interesting investment opportunities: the shipping sector. There are different types of ships for different types of goods: Containerships for transporting containers, dry cargo for commodities such as coal, iron ore and grains, tankers for oil and oil products and LNG vessels to transport liquefied natural gas (Opensea Blog, "An overview of the types and sizes of dry cargo and tanker ships").
Due to long term underinvestment there is a shortage of new ships getting built, with shortages in containerships more pronounced. The following excerpts paint a picture of such shortages (emphasis ours):
(…) while IMO 2020 is poised to push out those older vessels, the current orderbook is at near all-time lows for nearly every segment of shipping except for LNG. (J. Mintzmyer, "IMO 2020 Impacts To Shipping")
Due to trade war concerns 2018 and 2019 and Covid in 2020, the industry just didn't order many ships for delivery in 2021 and 2022. With about 24 months needed to crank out a ship, it is now too late to add for 2022 delivery and the supply shortage is likely to get much worse. (Nick First, "Welcome To The New Container Shipping Supercycle")
There are more reasons for shortages of new ships, for example retiring older vessels as a result of IMO 2020 (IMO, "Global limit on sulphur in ships' fuel oil reduced from 01 January 2020."). At the same time global demand is increasing, while trade and border restrictions make it more challenging to transport goods. This increases the rates shipping companies charge to transport goods, increasing their earnings. Shipping stocks can be characterised as value stocks; their fundamentals have been improving, but the stock prices have been lagging:
(…) shipping stocks have recently traded less in-line with actual fundamentals (i.e. market rates, contract durations, commodity markets) and moreso in-line with small cap indices and 10y Treasury yields. (J. Mintzmyer, "Has Momentum Returned For Shipping?")
A compelling argument on how shipping companies can offer a hedge to inflation is offered by J. Mintzmyer; these companies own steel vessels, of tangible value, commodities by themselves (they can be sold for scrap), and they have fixed debt associated with them. In an inflationary environment asset prices usually go up while the fixed cost of the debt (the real value of it) goes down.
For all these reasons we're bullish on the shipping sector, but looking at a shorter investment horizon (3 years). For those who want to learn more on shipping check the following videos: J. Mintzmyer, "Maritime Shipping: Riding the Global Economic Recovery", J. Mintzmyer, "Maritime Shipping: The Hottest Sector for 2021-2022".
Agriculture
One of the consequences of the lockdowns enforced by governments globally, to tackle the COVID-19 pandemic, is supply disruptions in food and agriculture. We're already witnessing not only higher food prices, but also scarcity of goods in many places:
Covid-19 has been the most disruptive global event in a generation. In addition to its direct health effects (...), the economic burden that it created has also resulted in reductions in agricultural production, supply chain disruptions, and trade restrictions.
Although there has not been a global food shortage or widespread price spikes, global food prices have increased 38% since January 2020. (John Drake, "The Effects Of Covid-19 On Global Food Security")
Border restrictions meant migrant workers couldn't get to the countries when needed in key times for sowing or harvesting seasons. Supply chain disruptions, among others, meant that farmers couldn't sell their products and often ended up destroying them, resulting to future shortages:
And around the world, COVID-19 has brought food supply chains to a standstill, as farmers in China have been unable to sell their produce at closed wet markets and unable to access animal feed; in the U.K. and Germany, there has been a shortage of workers to help with the spring harvest due to lockdown and self-isolation measures.
(...) Earlier this week, the U.N.’s World Food Program’s Chief Economist Arif Husain told TIME that the world is facing an “unprecedented” food crisis due to the COVID-19 pandemic, with an estimated 265 million people projected to go hungry in 2020, adding a global dimension to the contrasting actions of farmers who are having to destroy their stocks. (Suyin Haynes, Time, "'The Saddest, Bitterest Thing of All.’ From the Great Depression to Today, a Long History of Food Destruction in the Face of Hunger")
On top of those shorter term issues, we believe the next decade will be characterized by further disruptions due to de-globalisation (eg.: Brexit, China - US trade wars under the Trump administration). With the past couple of years being highly disruptive for agricultural markets, we see great investment opportunities in some companies in the space that have been in long bear markets.
For more information on this thesis we recommend Goehring & Rozencwajg, "The Problems with Copper Supply" (p18-21) and Capitalist Exploits, "Inside Our Agriculture Investment Thesis".
Precious Metals
Gold historically has been seen as a good store of value, protecting against fiat currency debasement while hedging against inflation, playing an important part in a diversified portfolio. We believe in the next decade, increased fiscal stimulus coupled with expansionary monetary policies will make investors more cautious and uncertain of governments' actions, leading them to allocate some capital to gold, as an insurance. In addition, gold equities offer good value after being in long bear markets.
Lyn Alden has a great guide on investing in gold and silver Lyn Alden, "How to Invest in Gold and Silver: Precious Metals Investing Guide" and Christopher Cole from Artemis Capital Management offers some research on how gold can protect a portfolio in Christopher Cole, "The Allegory of the Hawk and Serpent".
Eastern Europe and Asia
Finally, we see a lot more value in companies in Eastern Europe and Asia than in Western ones. China has emerged as the world's major trading partner and we believe countries in its periphery along with those that provide China with the goods and services it needs, will benefit in the coming years (CNN Business, "China signs huge Asia Pacific trade deal with 14 countries"). China is the world's largest energy consumer and Russia supplies much of the energy needed in forms of Coal, natural gas and petrochemicals (NIKKEI Asia, "Russia deepens China ties with expanded energy exports").
How China Overtook the U.S. As the World’s Trade Partner
East European and Asian companies offer great value in the sectors we're invested in, and they seem less affected by ESG pressures. We have some investments in these regions but we're doing more research on finding companies or ETFs in Freetrade.io that better represent our thesis.