Portfolio Update: May 2021

After a very quiet Q1, OM made a number of changes to the portfolio during April with the catalyst being an influx of cash into the portfolio, aka OM’s retirement account, after he changed jobs.  Given this, and the portfolio’s strong run over the last ~6mos what better time for a broad update.

In the recent post on Tin, OM mentioned that the largest core theme across the portfolio is things where supply is limited and where there is increasing demand.  This is not a sudden change, and regular readers will know this is a core concept and risk that OM has talked about since the Mid-2020 Portfolio Update.  Today, OM’s exposure to it has increased to over half the portfolio from ~38% in mid-2020, driven by the positions in Uranium, Shipping/Tankers, Tin, and Energy.  This theme is also related to a lesser extent with both  the Equities and Blockchain positions.

Positions (size order, all sizing is as of April 30th)
Dislocation - Uranium: 28.0% NAV
The first few months of 2021 have seen a steady stream of positive news flow and catalysts in the Uranium market.  Most surprisingly, we saw a step shift in attitudes in the West where nuclear power had gone from being on its way out to finding new support as part of a green energy future.  France extended the life of its existing nuclear plants and the EU is poised to declare nuclear as a green investment.  The turnaround in the US was even sharper, with the White House backing subsidies for nuclear power plants to help meet its green goals.  Meanwhile, the developing world continues to build nuclear power plants, most notably in both China  and India.

Two major uranium mines, the Ranger Mine in Australia and the COMINAK mine in Niger have closed in 2021.  Though the closure of these mines had been long flagged, it further reminds investors of the supply issues in uranium.   Supply was also tightened in an unconventional way.  A number of junior mining companies raised capital from the markets with the specific intent to use it to purchase physical uranium! The difficulty that they faced, and the delayed delivery schedules, reflect the paucity of supply especially as the two largest global miners (Cameco and Kazataprom) are also purchasing uranium as a result of reduced production due to COVID-19.
 
Finally, Sprott Asset Management – a large well-known player in commodity circles – announced the acquisition of Uranium Participation Corp and the establishment of the Sprott Physical Uranium Trust (“SPUT”).  Sprott will be listing SPUT in New York, where hit has 4 other listed physical metals trusts, and will be marketing it with the ability to raise capital at market prices to purchase more physical uranium!  Most importantly all of these things are happening as utilities are approaching the time when they need to start contracting to meet their future uranium needs.

Uranium stocks have run strongly over the last 6+ months, and in some cases are comfortably ahead of the fundamentals.  However, OM’s belief is that we’re still in the early stages of this bull market and that the volatility should be weathered.

The majority of OM’s holding is in URNM, a well-constructed uranium ETF.  Additionally, OM holds about 25% of his exposure split between CCJ (the largest western producer) and NXE (which owns the single best uranium asset globally).  The balance is split between four junior miners (PALAF, URG, BNNLF and DNM) who are in various stages of production.


Dislocation – Shipping/Tankers: 12.9% NAV
Not much new to report on tankers; rates are between bad and dreadful but as the world moves towards reopening and normality the demand for oil is increasing.   The order book remains exceptionally low, especially for product tankers, and with steel prices increasing there is added incentive for owners to scrap old tankers.  OM's position is reasonably evenly spread across five shipping names (EURN, STNG, TNK, DHT and INSW, which replaces DSSI as the companies are merging).  This combination gives OM a little more exposure to product tankers (which carry petroleum products, such as gasoline, diesel fuel, etc.) than crude oil tankers.

Theme – Blockchain: 12.2% NAV
The volatility in digital assets over the first four months of the year has seen the two listed closed-end trusts move from trading at premiums to their value to trading at discounts to NAV.  OM took advantage of this by retaining the same direct exposure to digital assets but broadening it by adding a smaller position in ETHE (Grayscale Ethereum Trust) after it fell from trading at a healthy premium to a small discount.  To compensate for his new position, the existing position in GBTC (Grayscale Bitcoin Trust) was reduced.  

While digital assets have, and will likely continue to be, exceptionally volatile it works in both directions meaning that the management of position sizes really matters.  As a reminder, OM’s approach to digital assets in this portfolio reflects a shorter-term public market view of the investments rather than any longer-term opinion on the digital assets.  To this end, the portfolio construction reflects (i) a broad band of exposure to these assets (currently 6-10%), (ii) that this band will both be reduced and narrowed during 2021, and (iii) OM wants to capture the broad upward trend but also be diligent about taking profits (i.e. think something similar to a trailing stop once the position grows beyond the upper band).  So far, it has worked reasonably well with OM having crystallized so much profit that even if GBTC and ETHE fell to $0 tomorrow, it would still have been a healthily profitable investment.

OM also re-entered his position in OSTK; the broad concept is similar to OM’s original write-up but the changes in management have had  a material impact.  Though the share price is much higher than when OM originally exited, the business prospects for the retail business have improved markedly and there is significantly less uncertainty around the digital assets.  The core online retail business is better managed and took advantage of the shifts due to COVID.  It has grown significantly and unlike many online retail businesses it is profitable!   Overstock’s array of investments in digital portfolio companies is also now being professionally managed after a transaction with Pelion Venture Partners.  The deal allows Overstock to participate in most of the upside, while also retaining direct stakes in certain of the companies (most notably tZERO, a SEC and FINRA regulated trading platform for digital assets!)

Equities - Funds: 12.6% NAV
No changes.

Theme - 4th Industrial Revolution: 8.6% NAV
One of the things that has become apparent over the last year is that the future is arriving quickly; both in terms of technology and biotech.   On the technology side, much of what OM wrote last June still holds true; the thesis for SaaS (part I and part II) is largely unchanged and the pandemic has hastened the transition to cloud services.  However, the median SaaS company trades at 14x its revenues over the next 12M - something that is hard to justify.  As such, the exposure to technology has continued to slowly shrink and is now ~5%.

After five years of not doing a whole lot, biotechnology finally broke out in 2020 and surpassed its 2015 highs.  The genomics revolution began in April 2003 when the Human Genome Project – an international scientific research project seeking to determine the DNA sequence of the entire euchromatic human genome – was declared complete.  It took a leap forwards around 10-years ago with the emergence of CRISPR, and the ability to sequence and edit genomes.  The cost of this sequencing and editing has fallen significantly over the last decade.  While there are many legitimate debates and questions about the mRNA vaccines (Pfizer and Moderna) and their approval process, these vaccines are also clear beneficiaries of much of this work over the last decade and the first of their ilk.  This coupled with the speedier approval process and renewed interest in the space, means OM has taken a small position (~4%) through the biotech etfs.


Themes – Vietnam, India and Brazil: 7.7% NAV
Unsurprisingly, given the very long-term horizon it is unchanged from when OM wrote about it 18 month ago. 

Dislocation - Greece: 4.9% NAV
Following New Democracy’s impressive win in the 2019 Greek elections, things were looking up for Greece.  New Democracy inherited an economy that was rebounding and OM’s expectation was that a business-friendly government would help change the narrative around its recovery and draw investor interest.  The new government started well by persuading the EU to allow Greece to cut taxes and making reforms in order to reduce the primary surplus that the Greek government was mandated to run.   However, the arrival of COVID overshadowed all of Greece’s progress and dealt PM Mitsotakis’ government an abysmal economic hand.  The signs of the new government’s competence remain; it has managed the crisis better than most of Europe, and recently submitted a detailed national recovery plan to the EU that has already drawn positive initial evaluations.


Idiosyncratic - Equities: 3.8%
OM holds a couple of small real estate related positions. 
Texas Pacific Land Corp (TPL) was a publicly traded land trust, with land in the Permian basin that benefits primarily from oil & gas royalties from the drilling/pipelines/etc. on its land and from a smaller but growing water business.  The trust was historically self-liquidating, using its excess cash to buy back shares, but finally converted itself to a C corporation earlier in 2021.

The St. Joe Company (JOE) owns approximately 175K acres in the Florida Panhandle.  The stock was a hedge fund battle ground a half decade ago, with bulls arguing it traded for a fraction of its future value and bears saying the land just wasn’t worth much (and there would be limited future value, as nothing significant would be built).   They were both kinda right but on different time horizons - the bears in the short-term, the bulls in the longer-term – and the stock has gone sideways for much of the last decade.  Today, the population in the Panhandle has hit critical mass and JOE is now benefiting from the broader infrastructure on its land and increased building (at attractive prices).  COVID has further sped up the trend.


Theme – Tin: 3.1% NAV
OM recently wrote about Tin, and has subsequently continued to add to the position in Alphamin Resources (AFMJF) that makes up the vast majority of the tin exposure.

Theme - Energy: 2.4% NAV
OM has dipped his toe in Energy, through positions in two natural gas plays (AR and SD) who have both managed their businesses well during the turbulent times.  Longer-term, OM remains interested in the offshore oil services sector but has no current positions.

Cash: <5% NAV

Disclaimer:  Nothing above represents a recommendation in any way, shape or form so please don’t even think of trying to take it that way.  For added clarity, while Our Man is invested in all of the securities mentioned that’s a terrible reason for anyone else to do so.  Our Man also holds some cash and a few other securities (of negligible value).  You should not buy any of these securities because Our Man has mentioned them, but should do your own work and decide what’s best for you given your own circumstances/risk tolerance/etc. 

The Adventures of Tin(tin)

The largest core theme across OM’s portfolio is things where supply is limited and where there is increasing demand.  Most obviously, you’re probably sick of hearing OM harp on about the supply deficit in Uranium, while new nuclear power plants are being built in the developing world and existing ones having their lives extended in the developed world.  However, it’s more pervasive than just Uranium – you see it in Shipping/Tanker (record low order books coupled with increasing tonne miles), or in some equities (TPL/JOE own specific plots of land, i.e. supply is fixed and they are seeing increased demand for its use), or even Bitcoin (slowing rate of supply, coupled with increased demand from investors/institutions), etc.

 

COVID-19 has brought many of these situations to the fore as demand is recovering far more quickly than supply can adjust.  This is particularly the case in commodity-related sectors, especially where there have been years (or decades) of under-investment that have led to structurally under supplied markets.  Unsurprisingly, OM has focused his attention on the markets where long-term demand growth is combined with a structural supply issue.  

 

The tin market is one of the clearest examples of this.  Tin is the smallest of the base metals markets and is used across a wide variety of products (i.e. the opposite of uranium, which has one use) and thus typically ignored by investors.  Tin is often also used in tiny quantities in products – there are a couple of grams of tin costing <15c in your iPhone – but typically has no substitutes thus demand is very price inelastic.  Tin also has a crazy history on the supply side with failed CIA stockpiling and a collapsed cartel resulting in oversupply for almost 45-years.  All of the major suppliers are seeing substantial declines in their output, with most of the efficient and cheap to access tin having already been mined.  Finally, though Western investors have limited ways to participate in the tin market, one is the producer with the best global tin deposit!

 

Demand for Tin 

The potential long-term demand growth is the easy part of the equation for Tin. Tin’s primary usage is in solder, especially as the ‘glue’ for semiconductors.  Tin is also used in chemicals (as a stabilizer in plastics), tin plate (tin cans), float glass (i.e. your windows, as tin is vital to the Pilkington process) and in batteries (for EVs), but typically makes up a small but vital component of the overall systems in which it is used.  For example, a ‘tin can’ contains only 1-2% tin or an iPhone contains a couple of grams of tin yet it’s vital for the electronics and touch screen to work.  This means demand for tin is largely price insensitive.

Source: International Tin Association estimates.
 

Tin’s primary use is for solder, especially in semiconductors where the electronic solder (which is 95% tin) joins the components.  Over the last 15-yrs, despite the growth in electronics the demand for solder was constrained by miniaturization, i.e. the semiconductors in your phone became ever smaller requiring less solder.  However, expected demand growth from the increased semiconductor content within electronics (phones, cars, etc.), as well as the growth in electronic technologies (think 5G and the “Internet of Things” or “4th Industrial Revolution”) is an order of magnitude higher than the loss from miniaturization.  Tin is also vital to to new technologies, such as battery technology, robotic and electric vehicles, which was highlighted in an MIT study of key new technologies and the metals required.

Source: MIT study, commissioned by Rio Tinto

Supply 

Tin has been recognized as a strategic metal since it was first combined with copper to create bronze leading to the whole Bronze Age period!  This strategic importance, combined with being the smallest of the metal markets (~300,000 tonnes annual production) has resulted in a crazy history!

 

After WWII, the CIA identified tin as a strategic metal that was required for artillery and naval guns, and early electronics, and which the Soviet Union was entirely reliant upon imports.   This led to the US Defense and Logistics Agency (“DLA”) aggressively procuring tin until 1960, such that in thirteen years it had acquired over 350,000 tonnes of tin, or three-years of global annual production at the time!  The DLA eventually gave up as its purchases had squeezed supply, causing price to rise and pushing the Soviets into major exploration, production and eventual self-sufficiency.  The DLA subsequently liquidated this tin inventory and it took them until 2006 to do so.  This huge forty-five year (!!!) secondary supply overhang limited the need for new tin exploration and production during this period.  

 

While this was all happening the International Tin Council was created in the late 1950s.  Over the course of twenty-five years, six separate International Tin Agreements were signed by thirty countries to limit production.  While a key aim was to reduce fluctuations in the tin price, the majority of the members were producers and so the agreements contained increases in the targeted tin price.  However, by 1985 the ITC ran into soft demand (damn aluminium cans!) and new tin discoveries in non-member countries (primarily Indonesia and Peru).  This coupled with quota busting by ITC members led to a vastly oversupplied market and the ITC collapsed into bankruptcy in 1985.  In its attempts to hold the tin price up, the ITC had run up liabilities of just under $1.5 billion (in 1985 dollars!!!) and held over 120,000 tonnes (or eight month’s global supply) of physical tin, as well as additional derivative purchases.

 

During the 1990s and 2000s while the DLA and ITC were slowly liquidating their tin inventory and China and Indonesia were ramping up their tin production the market was in surplus.  This meant that the tin price was depressed and there was no incentive for producers to look for tin.  After the secondary liquidations finally finished in the mid-2000s, the tin price rose only for Myanmar to plug the under-investment gap after ramping up production in the 2010s.  China and Indonesia are the two largest producers in the market today, each representing 25% of supply, though production is down significantly from its highs.  Myanmar represents 17% of global tin production and will have run out of tin in 2023!!  

 

Finally, there’s a wrinkle in the way that tin is mined.  The cheapest and most efficient way of mining  tin is alluvial mining, where a river or stream bed is mined for deposits.  This can be done artisanally in a similar way to gold pan-handlers and on a more commercial basis through dredging.  However, the best alluvial mining sites (e.g. Myanmar, Malaysia, and Indonesia) have all seen significant production declines as they have mined most of their resource.  This means future tin production will come from underground (hard rock) mining, which is more expensive, difficult and capital intensive and requires a significantly higher tin price.

 

In summary, you have a potential perfect storm for a non-linear rise in the tin price.   On the supply side you have a market where massive secondary supply has limited exploration over the last 50+ years, existing suppliers are running out of material, and where the only viable method of mining is vastly more expensive and less efficient.  At the same time, you have a material that is a tiny but key and not substitutable component of almost its entire end demand, and where technological changes are driving material demand growth in the coming years.

 

How is OM expressing it? 

For Western investors there are currently only 2 investable producers; Alphamin Resources (AFMJF) and Metal X Limted (MLXEF).  The difference between the two companies is stark!  

 

The majority of OM’s exposure is to Alphamin Resources (AFMJF) who own ~80% of the Bisie tin mine in the Democratic Republic of Congo (“DRC”).  Bisie is THE premier tin asset globally.  It has the highest grade resource of major mines globally, is a lowest quartile producer, and currently produces about 4% of global supply (it is 8% of global reserves), with near term ability to expand production. 

Alphamin is significantly cash generative at today's tin prices and is using its free cash flow to pay off its external debt (OM’s back of the envelope model suggests it’ll be debt free before year-end) and then potentially pay a dividend.   The company has benefited from upgrading management at both the corporate and mine levels, and at today's tin prices will be generating close to  a fifth of its current market cap in free cash flow this year.  However, the single mine and DRC-related risks limit OM’s position size, though it should be noted that the DRC Government has a 5% stake in the mine.

 

Metal X (MLXEF) is Australia’s largest tin miner but is a marginal producer that expects to mine 10K tonnes of tin by 2025 and can barely make money even at today’s rising tin price.  It is thus riskier and far more levered to a higher tin price, and as such a tiny position for OM. 

 

 

 

 

Disclaimer:  Nothing above represents a recommendation in any way, shape or form so please don’t even think of trying to take it that way.  For added clarity, while Our Man is invested in all of the securities mentioned that’s a terrible reason for anyone else to do so.