Charts of the Month - April '23
Base Metals, Freeport McMoRan Overview, and Higher Rates are Beginning to Crack the Foundations
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Big Shovel is the new Big Oil
Underappreciated, underinvested, not fully adopted by the broader investment community for fear of the ESG tribe’s wrath, and irreplaceable in our everyday modern world.
Base Metals (Copper, Nickel, Zinc, and Lead), make up the backbone of just about everything we hold dear… from iPhones to buildings, to electrical grids and batteries - the availability of these metals will very literally dictate how quickly (or slowly) the world is able to make the ‘energy transition’ (I’ll stay as apolitical as I can on this topic and will, for this section, accept the fact that the Western world has collectively decided to transition their energy sources to be lead primarily by renewables, dominated by wind and solar).
In another excellent piece of commentary by the folks at GoRozen, ‘Base Metals: A Decade of Shortages Ahead’, is a highlight of the supply side issues facing the mining industry, and this chart showcases just how low inventories of these critical metals already are:
From the piece:
- “Although the global mining industry, over the last decade, has been able to side-step most of the negative publicity that has engulfed the world oil and gas industry, ESG pressures have placed substantial downward pressures on global mining industry capital expenditures in the last ten years. Environmental and related permitting issues have made both greenfield and brownfield mine development projects extremely difficult to bring into production.
- Given the vast ESG–related restrictions put on mining projects today, it is not uncommon that significant, economically robust discoveries made over 20 years ago are still not in production today.
- In a world where metal demand is already beginning to see substantial accelerations—ironically because of ESG-inspired environmental pressure - mine supply has, for many years, started to fall behind demand.
- In global base metals markets, we are well past the former tightness levels experienced in 2005 and 2006. Given the strength of worldwide demand and supply constraints, we believe it’s only a matter of time before shortages in various metals reach detectable levels, with potentially tremendous resulting upward price pressure.
- Last summer, S&P Global’s Commodity Insights paper “The Future of Copper: Will the looming supply gap short-circuit the energy transition?” received significant press attention. The study warned of an “unprecedented and untenable” copper shortfall of 10 mm tonnes as suppliers grapple with copper demand that will double by 2035. We believe even S&P’s “pessimistic” copper supply outlook is still too optimistic.”
The next chart illustrates just how demanding renewables are for a metal like copper, which “is necessary for transforming and transmitting sustainable energy sources to a useful final state. Copper's qualities make it the most cost-effective material for a variety of sustainable energy systems, including cables, batteries, transistors, and inverters”.
This is the future we’re moving towards – one where we will need vast amounts of these metals and one where supply will likely fall far short.
Again, this is the path the Western world has chosen, so instead of complaining about it, why not try to get on the profitable side of this shift?
Where’s copper produced?
What makes the metals and mining conversation even more interesting, is just how geopolitically exposed the industry is, on the same level as Oil & Gas.
Not only are country production, imports, and exports highly concentrated, but the leaders of these countries know it and are beginning to make moves to ensure their countries are protected.
Two big stories from this last month showcase just this:
Paraphrasing some commentary on the Indo story, “A reminder that while wind and solar are renewable, solar panels, wind turbines, batteries, and EVs are products of a strategically competitive, capital intensive, extractive, and industrial process.”
Jacob’s views on Chile and Indonesia were showcased in last month’s Research piece, with excerpts here (be sure to go read the piece to get the full context):
“Want to use geopolitics as a compass? This is where I’d start looking:
- Chile: Think renewables (because of its lithium and copper resources, as well as location) and data economy. Chile is building the first submarine cable to connect South America to Asia, positioning itself to capture the benefit from not only traditional commodities but also of data-as-a-commodity as well (5G, the cloud, regional data centers, etc.).
- Indonesia: Think about the sectors that are poised to take advantage of the exodus from China (i.e., lower-end manufacturing or battery production). Indonesia is taking a very different path than Chile, Brazil, or even Mexico. Indonesia, like India, is trying to vertically integrate. The difference is that Indonesia has resources that many countries and companies want (like, for example, nickel, which is a critical input for the batteries that go into electric vehicles and other purportedly green technologies), and it has a coherent government policy to restrict exports and require technology transfer and foreign investment for countries that want to operate within the country.”
We’re beginning to see a wave of resource nationalism, where critical materials are quickly becoming the next battleground – the difference this time around (juxtaposed to the early days of oil exploration and land appropriation in the Middle East) is that we’re existing in a multipolar world, and regions from South America to Southeast Asia, are going into this resource war with eyes wide open.
So, what should we do about this? Not to oversimplify, but I want exposure to these metals and to place my bet on GoRozen’s view that “it’s only a matter of time before shortages in various metals reach detectable levels, with potentially tremendous resulting upward price pressure.”
Where to look? We can start with the world’s largest producer of copper, Freeport-McMoRan (FCX) (which is also the world’s largest producer of Molybdenum, used in most alloys, including steel, to increase strength, hardness, electrical conductivity, and resistance to corrosion and wear.)
Channeling my past research analyst days, a few interesting snippets from the FCX 10K:
- “In general, demand for copper reflects the rate of underlying world economic growth, particularly in industrial production and construction. According to Wood Mackenzie… copper’s end-use markets (and their estimated shares of total consumption) are electrical applications (28%), construction (27%), consumer products (22%), transportation (12%), and industrial machinery (11%).
- We [FCX] believe copper will continue to be essential in these basic uses as well as contribute significantly to new technologies for clean energy, to advance communications and to enhance public health. Examples of areas we believe will require additional copper in the future include: (i) high efficiency motors, which consume up to 75% more copper than a standard motor; (ii) electric vehicles, which consume up to four times the amount of copper in terms of weight compared to vehicles of similar size with an internal combustion engine, and require copper-intensive charging station infrastructure to refuel; and (iii) renewable energy such as wind and solar, which consume four to five times the amount of copper compared to traditional fossil fuel generated power.
- The top 10 producers of copper comprise approximately 42% of total worldwide mined copper production. For the year 2022, we ranked first among those producers, with approximately 7% of estimated total worldwide mined copper production.”
The ‘Risks’ section reads like a Lykeion dream (Geopolitical and Macro considerations everywhere)
- “Geopolitical events, social and economic instability, bribery, extortion, corruption, civil unrest, blockades, acts of war, guerrilla activities, insurrection, and terrorism, certain of which may result in, among other things, an inability to access our property or transport our commodities.
- Changes in U.S. trade, tariff, tax, immigration or other policies that may impact relations with foreign countries or result in retaliatory policies.
- Foreign exchange controls and fluctuations in foreign currency exchange rates.
- Because our mining operations in Indonesia are a significant operating asset, our business may be adversely affected by political, economic and social uncertainties in Indonesia.”
The be clear, this isn’t trading advice. I won’t pretend to have done sufficient analyst work, I’m not a financial adviser, and there are simply too many variables to consider that are far out of the purview of where I sit.
What this is, however, is the way I’m thinking through some of the big-picture frameworks that the team here at Lykeion is discussing. Meaningful geopolitical shifts, generational changes in the macro landscape, a focus on investing in companies that produce ‘needs’ as opposed to ‘wants’, and building a portfolio for the long-term.
So the case is pretty straightforward: the world needs A LOT more copper and current prices don’t support investment in new mining and exploration. The likely sequence is that we slip further into an inventory deficit, the market eventually wakes up to this imbalance, prices surge then stabilize higher. At that point, new investment in mines and exploration from firms like FCX can then take place. But seeing as new mines take 10+ years to come online and demand is continuing up and to the right, a re-racking of prices higher seems like the most likely path in the years to come. This is just an educated guess though.
Not. Investment. Advice
Higher Rates are Causing Cracks in the Foundation
There aren’t many themes in markets that we can find consensus on, but Commercial Real Estate (CRE), and its impending demise, is one where most participants agree – a reckoning is coming.
Higher rates, which incite an almost instant reaction in equity markets, have more of a lagged reverberation through markets like CRE, which takes time to reprice and whose value is largely determined by fundamentals and long-term macro inputs as opposed to the hyper-sensitive trading algos that move stocks every time J. Powell’s name makes its way into the headlines.
But eventually, they catch up – especially as eroding fundamentals are caused by long-term paradigm shifts.
Remote work is the paradigm shift of our day and corporate landlords are struggling to keep offices filled, causing big real estate investors to already begin to panic (e.g., Blackstone pausing redemptions and Vornado pausing dividends).
Now come higher rates, which increase the Cap Rate used to value real estate, and you have a double-feature horror show lined up – eroding fundamentals and an unfavorable macro environment.
What’s more, is the amount of CRE debt that needs to be refinanced in the next few years – estimated at about $1.5 trillion before the end of 2025. And yes, that debt will need to be refinanced at today’s environment of much higher rates.
Given this backdrop, it’s no surprise that the California State Teachers Retirement System (CalSTRS) (the third largest pension fund in the U.S. at $307b and manages the retirement of ~1m teachers), recently announced they’re preparing to write down a portion of their $51 billion real estate portfolio.
The scary thing for CalSTRS, and other pension funds around the world, is as they prepare to write down their RE holdings, you can be almost assured they’re looking at the same math for their Private Equity holdings, whose outsized returns over the past decade have been primarily fueled by cheap capital, and are another corner of the market where most participants agree – a repricing down is long overdue.
Check out Roger’s macro section in last month’s Research piece to get a deep dive into how this may play out.
Steve Eisman (or Steve Carell of 'The Big Short' fame) is in the ‘The Fed isn’t going to pivot anytime soon’ camp, and was recently interviewed by Grant Williams, where he lays it out real simple:
“Long-term investors caught up in the old paradigm - low rates and invested in high growth tech - need to adjust to this new paradigm. The problem is, if you’re running $1 billion, and you want to move things around, you can move them around. When you’re running $100 billion, and you want to move things around, you better start early”.
What about when you’re running $300 billion?
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