Macro-Economic Environment
SUCCESSFUL INVESTING IS ABOUT HAVING EVERYONE AGREE WITH YOU- LATER…Grant’s Interest Rate Observer
As equity markets continue to make all-time highs, the commodity markets continue their march towards perceived irrelevance.
The relative valuation of “old school” companies (many of them commodity producers) is reflected in their discount to technology and other asset-light sectors. The bifurcation that we have seen over the last 18-months across the broader markets has pulled capital away from these essential sectors even more.
Despite the market’s fixation with the Fed and its perceived “tightness”, liquidity has been more than adequate. In fact, liquidity is as accessible (broadly speaking) as it was in 2022.
A glance at some historical comparisons with past inflationary periods would suggest that the markets are not giving enough credence to what could go wrong…really wrong.
The recent highs in gold have completely run counter to what one would have expected. Despite falling gold ETF volumes, rising real rates and a rising Dollar, gold prices have continued to soar.
Takeaways: Oftentimes when markets are currently undergoing some kind of secular shift, one market will give you a “tell”. As is usually the case, this “tell” will be ignored by the broader public, which is more fixated on the accepted common narrative. We believe that gold is that “tell” and that the recent highs in gold prices are an indication that the market’s assumption of dis-inflation is wildly misplaced.
Commodities/Energy
The “everything” rally truly appears to contain a little of everything. Bitcoin and gold - both at record highs - are wrestling for the “store of value” crowd that is now clearly age-dependent. The break point appears to be about 35 years old. Those in the below 35 cohort view gold as little more than shiny rocks, whereas those falling in the over 35 camp see Bitcoin as a clever, made-up scam. NFTs are even back in the headlines, with the most prolific transactions occurring in the CryptoPunk, Bored Ape Yacht Club and Pudgy Penguin collections. Remember Carvana (CVNA)? The “extend and pretend” debt-saddled used car company is up more than 11X over the past year.
Market participants have increasingly become a product of our instant gratification world, including their collective expectations of immediate investment returns. While this creates large and dangerous distortions in the equity (and crypto/NFT) markets, mis-informed capital allocations provide significant opportunities in our realm. Some of the most prominent examples are found within energy, with the dual rush to increase the use of renewables while shunning fossil fuels. Expectedly, this created massive dislocations in sectors including: battery-related minerals/metals, coal, oil, automakers, solar, and wind. This misallocation of capital also helped stoke broad-based inflation.
As David Einhorn of Greenlight recently described, valuations simply don’t often matter if the market fails to ever come around to your thesis. One has to look for the company itself to pay you…via buybacks, dividends, etc. Thus, you cannot rely on other investors eventually recognizing and revaluing any individual security. We agree, which is why we focus on commodity and cyclical investments that possess fundamental (consumption) characteristics that simply cannot be replaced. These industries that fly under the radar of the Magnificent Seven (now the Fabulous Four) are where the most advantageous risk-adjusted returns in the market lie.
Nothing reeks more of “now” than election-cycle politics. Spending cuts are not considered vote-getters, which promotes perpetual debt-fueled outlays. Since politicians won’t rein in spending, the markets are increasingly showing them what happens when you don’t (higher rates and inflation). Geopolitical volatility that is off the charts is also adding to the mix. This is (or should be) Kryptonite to high-growth, MOMO equities. However, commodities have historically shined during inflationary and supply-threatened periods. For those that believe we have turned a secular corner, like us, this sets up for a decade of commodity-related outperformance.
Takeaways: Market rotation will occur as higher interest rates and inflation become more entrenched. When even Treasury Secretary Yellen capitulates with recent comments about rates not returning to pre-pandemic levels and expressing regrets over calling inflation “transitory”, you know we’re in for a wild ride.