OM was starting to write a short note on the current market environment, but finds those notes dull to consume and OM has little original to say. Broadly, OM’s market view can be summarized as - things aren’t as good as we’d like but not as bad as people think, though inflation is likelier stickier than the Fed would care to admit.
However, Our Man has made several meaningful changes to the portfolio over the last few 6 months, largely reflecting opportunities that he’s been watching for a while. As such, it’s probably a good time for a portfolio update – in two parts, so it doesn’t become too long and unwieldy.
Portfolio Update – Part I – There’s a Supply Deficit
The broadest theme across OM’s portfolio is that of a supply deficit; primarily where an under-investment in supply coupled with a slight growth in demand has resulted in the supply deficit. The theme is most obviously seen across numerous commodity markets, which represent about 1/3 of OM’s exposure. More generally, this is something that impacts physical markets (commodities, goods, etc) and because of the rise of digital/software driven business models over the last decade+ OM think investors are poor at truly understanding the impacts. One of attractions of digital/software business models is that marginal cost is (almost) zero and supply is (almost) unlimited. For example, if I want to use Microsoft Office on my computer, the cost is almost nothing to Microsoft and my usage has no negative impact on your use of Office on your computer. However, this doesn’t hold true in the physical world – if I use this barrel of oil then you cannot, and if there is a supply deficit we are effectively competing to use that barrel of oil leading to a very different impacts on price.
Uranium (24.3%) remains OM’s largest position as it is the purest expression of the supply deficit. Given the 7-year plus time horizon to successfully permit, build and begin to operate a uranium mine, the supply side is relatively easy to project. Uranium’s sole end use is as they key component in fuel for nuclear power plants, who purchase it under long-term contracts. Over the last few years, OM has noted the sharp turnaround in sentiment towards nuclear power. This has seen nuclear power become accepted as part of the clean energy solution (including within the EU’s green taxonomy/bond program), increased uranium demand through life extensions for nuclear plants (even in the US!) and plans for new plants globally. This imbalance of projectable supply and increasing demand has not gone unnoticed by the markets with both the Uranium price and the mining stocks up multiples over the last few years. Despite this, OM retains a sizable position believing that while we’ve reached the ‘end of the beginning phase’ there remains further to go. Why? The largest miners keep missing production targets, the best assets keep extending their timelines to start production, the US is determined to wean itself from Russian uranium fuel, the continued nuclear plant extensions and starts bolster demand, and finally the largest banks are only now starting to cover the sector.
OM sees similar dynamics are playing out across Commodities/Mining (1.3%), and in particular in the smaller Tin (7.8%) market. The supply deficit in the Tin market continues to edge closer as supply in Indonesia & Myanmar – major tin producers – run into problems. The demand-side case continues to strengthen; as a reminder, ~50% of Tin demand is as solder, primarily as the ‘glue’ to make semiconductors – it is a direct beneficiary of the emergence in AI, and the subsequent demand for AI chips and increasing computing power. Furthermore, Tin has no substitutes in the production of semiconductors, and has a no impact on the price of the end goods – the iPhone contains <25c worth of Tin, but wouldn’t work without out it. If the tin price increased by multiples, it has almost no impact on end demand. Finally, while commodities aren’t a core driver of the Brazil (4.7%) thesis, they are a meaningful contributor given the country (and its companies) are a major supplier of many commodities. OM suspects that we’re seeing the impact of supply deficits in Uranium ahead of in other markets given the simplicity of its story. As such, it’s likely that as OM’s exposure to uranium decreases over time, much of that capital will find its way into other commodity-related themes that are only starting to recognize the supply deficits in their markets.
Outside of commodities, the impact of limited new supply and increased demand is also clearly visible in Shipping/Tankers (12.1%), where positions have rallied strongly over the last 3-years. This originally began due to the IMO 2020 changes but has been supercharged as a result of the Russia/Ukraine war. We’ve previously discussed its impact on the demand side, but the sanctioning of tankers has also reduced supply. The Russia/Ukraine war has had the effect of highlighting and exacerbating the imbalances in the tanker market, pulling some of the performance forwards and OM expects the position to continue to shrink over the short-to-medium term.
Elements of the supply deficit dynamic also help underpin some other positions including Idiosyncratic Equities (5.7%), Carbon Credits (2.3%) and Blockchain/Crypto (3.8%). Both idiosyncratic equity companies (TPL and JOE) own real estate where there is increased demand for its usage be it through oil/gas drilling in the Permian (TPL), or increasing population and build out in Northwest Florida (JOE). California Carbon Allowances are a man-made ‘environmental commodity’ where regulation specifically targets reducing supply over time to drive the price higher. Finally, OM has added to the Blockchain/Crypto position – while the Bitcoin halving slows future supply, OM suspects that this 12-month post-halving cycle will be driven by Institutional FOMO (vs. prior halvings’ retail FOMO) now that exposure can be more easily obtained via ETFs.
Part II will look over the rest of the portfolio...
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.
