Charts of the Month - April '24

Construction Loves Commodities

A fascinating chart from Tavi Costa of Crescat Capital.

Long-term structural shifts across markets don’t always make themselves immediately apparent, as their movements are tectonic in nature, but slowly and then sometimes all at once, these slow-moving shifts can make a major appearance in the global economy.

This chart portends one of these structure shifts in the commodities market.

From Tavi:

“The chart portrays a predicament that is progressively becoming the centerpiece of the demand argument for commodities. Despite the recent upsurge in construction spending, commodity producers have evidently fallen short of matching this trend. Capital expenditure in natural resource industries has remained near historically low levels, especially when adjusted for GDP.

It is important to bear in mind that changes in the supply curve of commodities typically align with the capital spending behavior of underlying producers, albeit with a significant lag effect. Essentially, it requires time for investments to translate into increased supply. The current scarcity of capex among these producers, juxtaposed with the upsurge in construction expenditure fueling material demand, in our analysis, portends significantly higher commodity prices to balance these markets in the face of these structural supply constraints.

Significantly higher prices, in our view, will be necessary to incentivize new capex investment, and it will take many years before these new supplies come on stream in a significant enough way to alleviate pricing conditions. It has been taking a decade or more on average to bring a new discovery into production in today’s global anti-mining climate given the environmental and social licensing, government permitting, and capital-raising challenges.”

Said a bit more succinctly, construction requires a lot of commodities, from base materials like copper, tin, aluminum, and nickel, to oil & gas, building things like bridges, roads, buildings, and other infrastructure projects all start with these basics.

The U.S. is in the early innings of a manufacturing and construction renaissance, driven in large part by the post-COVID industrial-focused legislative acts (Infrastructure Investment and Jobs Act, Inflation Reduction Act, and the CHIPS and Science Act), and as such, demand for materials is booming.

Given the above and recent history, it’s becoming evident that we’re in the midst of something like a rolling commodity boom cycle, where not all commodities are rallying at the same time, but instead are taking their turns with price spikes.

We covered the Uranium rally a couple of months back which saw prices skyrocket on the back of the COP28 announcement from Western nations to triple their nuclear electricity production coupled with the realization that new supply is far off on the horizon.

Now, over the last 6 months, it looks like we have a new base metals rally on our hands:

Two points to be made here:

First, to Tavi’s chart. The construction boom is likely just getting started as the U.S.–China cold war continues. The CHIPS Act is all about securing the West’s supply chains in the semiconductor arms race and the IRA, if renewable energy is viewed as a domestic energy resource as opposed to a “clean energy” investment, is more about geopolitics than saving the planet.

Second, to industrialize (or in the West’s case, reindustrialize) a nation, you can’t overestimate the quantity of materials required. In any version of this shifting world order, whether that’s deglobalization, nearshoring, friendshoring, or some combination thereof, there’s one constant to stay acutely aware of – the entire world is building out redundant and more secure access to critical supply chains, and redundancy means a step function up in demand for raw materials.

Said more simply, “We’re going to build two of everything, or three of everything”.

China will keep building iPhones, but so will India. Taiwan will keep fabricating semiconductors, but so will the U.S., China, Korea, and Vietnam. Europe will continue to throw money at new natural gas pipeline infrastructure, on top of new LNG import terminals, while the U.S., Australia, and Qatar build LNG export terminals. Most of Eastern Europe, the UK, Australia, India, Korea, and Japan, are all hyper-focused on increasing defense spending for equipment like missiles, tanks, aircraft carriers, and submarines. As the great power competition heats up, the world is going to continue building more of everything on a scale we’ve likely never seen before - that’s the key takeaway.

Commodity investing is not for the faint of heart, but if there was ever a time (at least in our lifetime) to get long the base materials required to rebuild the infrastructure of the modern world, now could be it (or more preferably, 6 months ago…).

Why 3% is Likely the New 2%

Fiscal dominance is here to stay.

To put into context the post-COVID spending spree by the U.S. government, Apollo looked at the five different fiscal plans to rebuild the country after the pandemic vs. the spending required to rebuild Europe after WW2.

The Marshall Plan sent about $13 billion (5.4% of 1947 GDP) of U.S. aid to Western Europe after the war for rebuilding efforts (this also puts into context the aid bills just passed by the U.S. to send $95 billion in aid to Ukraine, Israel, and Taiwan).

The five post-COVID fiscal acts will continue to inject somewhere in the ballpark of $5.5 trillion into the economy.

Let that sink in for a second.

It doesn’t take a PhD in economics to understand why we’re still grappling with above trend inflation. Take the set of commodities charts from above and you see a key driver for Producer Price Inflation (PPI), then couple that with the CARES Act (increased purchasing power for the consumer) and the not-so-obvious fact that we now have the largest share of young adults living with their parents since the great depression (purchasing a home is now out of reach for most) which frees up more discretionary income to spend on goods and services, and you have a key driver for Consumer Price Inflation (CPI).

All this with the Fed Funds rate at 5%.

I’m not sure by how much, but I believe a key driver of inflation (on top of the alarming level of fiscal spending) is the consumption patterns of these young adults living at home. Living without a mortgage or insurance payments or any of the other costs associated with owning a home, frees up a lot of discretionary income, and if you’ve given up on buying a home altogether, your propensity to deploy that discretionary income is much higher.

Yes, the wealth effect is real, and inflated asset prices encourage increased spending, but I’d argue the 57% of young adults who live at home and are employed (which most are) are core to this inflation puzzle.

Feel free to respond to this email and tell me why I’m wrong. Wouldn’t be the first time.

Experts Are Never Wrong

Here’s some context on where we’re at timing-wise in this rate hiking cycle, and why it’s beginning to look more probable that we have a hike before any cuts.

We came into the year with the ‘experts’ expecting a half dozen rate cuts by year-end, some forecasting more.

Now, only four months into the year and with this sticky 3% inflation, most of these ‘experts’ have assured us that a rate cut is a dream now delayed until 2025.

This is after the ‘experts’ consensus was for transitory inflation.

I don’t know why we don’t just listen to the experts?

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