Week 02. 19th of June 2022
Market crash, interest rate hikes, Rare earths made in Canada?, Russian McDonald's, Food crisis, China reopening, Buying the dip in commodities
News
Interest Rates
Central banks have been raising interest rates this month to fight inflation.
CBS News, "Federal Reserve raises key interest rate 0.75 percentage points as it tries to calm inflation"
Yahoo! finance, "Bank of England raises UK interest rates to 13-year high of 1.25%"
Chances are that the recent hikes won't go long way to fight inflation as we're mainly dealing with a cost-push (supply side) inflation. Central banks act on the monetary fallacy that changing interest rates allows them to control inflation, however we believe inflation is a far more complex equation.
Controlling interest rates affects money supply, and cost of capital. In today's debt addicted economies we can see how increasing interest rates will pop a few bubbles (tech stocks, crypto, housing) ending an era of cheap capital, and potentially bring economies into a recession. A recession in turn would affect the demand side of the equation (less demand, lower prices), but it won't do much to address the fundamental structural problems that exist on the supply side, including but not limited to the lack of investment and capital expenditure.
The only way to address the supply side of the equation is with more investment to bring more supply to the market, however higher cost of capital and ESG pressures deter capital from wanting to be invested in these industries. Eventually, we believe, that prolonged higher prices will affect the sentiment of the public towards energy and materials (oil and gas, coal, uranium). This change of sentiment will in turn affect on how capital gets allocated and invested and eventually we'll see more production (of various commodities) coming online.
But we're not there yet. We're still extremely optimistic on energy and commodities and we see any short term dips, corrections and a potential recession as great buying opportunities.
Energy and Commodities
The Assay, "Ready to Supply the World"
According to the International Energy Agency’s net-zero pathway, the total market size of the critical minerals needed for the green energy transition could grow almost sevenfold between 2020 and 2030.
Aside from the $3.8B investment in critical minerals, the Budget commits to expanding low-carbon energy generation, advancing Canada’s nuclear capabilities, and seizing the opportunity presented by a growing global market for hydrogen.
That's an interesting development, and we'll probably see more of that as the West needs to diversify away from Russia, China and other commodity producing nations.
Food Crisis
A few people and organizations are now warning about a coming food crisis. We think this is probable, especially in emerging economies. We are bullish on fertilizer stocks as we think they'll benefit from this.
Our World in Data, "How could the war in Ukraine impact global food supplies?"
Random
On a different note, these cheeky Russians...
Forbes, "‘Tasty And That’s It’: Former McDonald’s Restaurants Reopen In Russia Under New Name (In Photos)"
And a little view into our dystopian future.
The Counter Signal, "Alibaba is creating a digital ID carbon footprint tracker":
We can imagine how tech like this can go wrong in many ways. Reminds us of the proverb:
"The road to hell is paved with good intentions"
Last but not least, looking through our archives we found this interesting article from November 21, 2021. This was way before the Russian-Ukraine invasion.
Asia Times, "Arc of encirclement appearing around Russia":
Britain and Ukraine also recently finalized a treaty that will enable Kiev to seek loans from London to buy British warships and missiles. Sky News reported that “on Ukraine’s £1.7 billion [US$2.3 billion] shopping list are two minehunters, the joint production of eight missile ships and a frigate, as well as the purchase of weapons for existing vessels.”
As well, Britain will build two naval bases for Ukraine in the Black Sea.
Traditionally, the UK acts in tandem with the US. In fact, on November 10, US Secretary of State Antony Blinken and Ukrainian Foreign Minister Dmytro Kuleba signed a major document titled the US-Ukraine Charter on Strategic Partnership in Washington, DC, affirming America’s commitment that “Bolstering Ukraine’s ability to defend itself against threats to its territorial integrity and deepening Ukraine’s integration into Euro-Atlantic institutions [read NATO] are concurrent priorities.”
The Western capitals and Moscow have diametrically opposite interpretations of what is unfolding.
There could always be spoilers who might exacerbate tensions with Russia for their own dissenting agenda – be they the UK, Ukraine or Poland – but neither the Kremlin nor the White House seeks confrontation.
Seems like they were wrong on that last point, though they still offer some very interesting observations...
Podcasts
Evergreen Exchange, "What Does China's Reopening Mean"
Louis-Vincent Gave, CEO of GaveKal Research
China has been an area of bad news for a long time
Shenghai lockdowns basically ended
Xi president for life or will he get his wings clipped in the Chinese Communist party congress?
As China reopens, what happens to oil and energy?
Very few people are exposed to energy in their portfolios for various reasons
You'll see a lot more coal used in EM (China, Brazil, India, etc). By far the cheapest way to produce electricity
Reading
Louis-Vincent Gave, Evergreen Gavekal, "Looking For Silver Linings"
Elaborating on similar points as in the podcast above:
Catalyst #1: China winds down its COVID lockdown strategy.
Catalyst #2: China moves on from “common prosperity.”
Catalyst #3: China attempts to support equities.
Catalyst #4: Chinese easing kicks into higher gear.
However, should the coming months see China turning its back on lockdowns, one-man rule and tech crackdowns, choosing instead to stimulate its domestic economy while also benefiting from increased commodity trade with Russia, then a lot of a conditions would have come together to push Chinese equity markets—and optimism on the broader emerging market space—much higher.
Cornerstone Futures, Brynne Kelly, "OIL: Tensions Between Supply and Demand Have Never Been Higher"
Everyone wants to buy a pullback when they are rallying, but is afraid of pullbacks when they appear.
If we were looking for confirmation bias, we couldn't have found anything better to fully confirm most of our beliefs other than the following article from "Crescat Capital". it's definitely worth a read!
Crescat Capital, "May Research Letter – Too Soon"
Too Soon to Buy the Dip, Unless It’s Commodities
The Fed’s main policy tool for fighting inflation is to hike interest rates. This reduces the demand side of the economy by tightening credit conditions and causing financial asset prices to decline which crimps investor savings and consumer demand and increases unemployment. But raising interest rates does not stimulate commodity supplies, the core inflationary problem today. In fact, raising interest rates could have the opposite effect because it makes the cost of capital for investment in new commodity production higher.
In our analysis, the overwhelming best deep value, high medium-term growth, and high appreciation potential macro investment opportunities in the market today are in commodity exploration and production equities. As a result, we believe smart money investors will increasingly seek both inflation protection and outsized real returns in fundamentally sound businesses that produce valuable scarce resources. Along with energy, base metals, agriculture, and forest products, precious metals miners are where some of the deepest value and appreciation potential lies in the market today.
Some Random Thoughts
Energy companies have high free cash flow, so what are they going to do with it?
Hoard it: possible but how will they justify it to the shareholders?
CapEx, R&D: probably won't happen anytime soon because of ESG pressures and because companies will be waiting for the commodity and energy prices to stabilize somewhere in order to incentivise production. Last thing a company wants to do is commit loads of capital to then see the commodity's price drop dramatically.
M&A: acquire other companies, probable scenario.
Distribute it back to the shareholders either with share buy backs or dividends: probable scenario as well.
Pay off debt: probable as well, and it makes sense in an environment where debt servicing is becoming more expensive.
Stocks
Seeking Alpha, Dividend Sensei, "Profit From Soaring Oil Prices With These 6+% Yielding Blue-Chips"
EPD, ENB, MMP, and MPLX
We like MMP and EPD. We'll have to look at them more closely and we might add one or both to “The Haptón Portfolio”
Until next week!
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