Macro-Economic Environment
It’s not often that you see a validation of your basic thesis not once but twice during a single week. We are referring specifically to the headline news involving Nornickel and the proposed takeover of Anglo American by BHP.
Nornickel’s decision to move a large portion of its copper smelting operations to China noting the difficulty in dealing with Western banks and the recent imposition of metals sanctions on the LME. Nornickel management noted that “the project will enable us to avoid big losses due to current difficulties with settlements, supply refusals, discounts on our metal and the formation of inventories.” This is significant as European sales account for over 1/3rd of their revenue.
In addition, the company states that they are developing value-added battery technology in conjunction with the Chinese, utilizing both their nickel and lithium deposits.
While one might attribute this move solely as the attempt by one large, quasi-sanctioned producer to simply survive, we believe that it is much more strategic in nature. This is a significant player in the metals business actively aligning itself with China, essentially foregoing business with the West because it views the current situation as permanent. Also, as one of Russia’s largest emitters of sulfur dioxide, Nornickel was facing the need to spend over $4Bln on sulfur capture at two of their copper plants.
BHP’s $60Bln takeover offer for Anglo American. If this deal were to close, the combined entity would control (in total with JV’s) around 11% of all global copper mined production. There is an old line about mergers/acquisitions in the mining business: “Buying a mining company is often like buying a car for the contents of the glove compartment.” This deal would fully adhere to that adage, with the deal contingent on Anglo divesting itself of both the PGM and diamond businesses.
The potential acquisition is instructive both for what they were looking to acquire and what consists of the “non-glove box” commodities. BHP is not interested in the PGM’s, the diamond business or iron ore operations. From an investment perspective, we think that this is a perfect contra-indicator on the ultimate price of all these commodities, particularly PGM’s. Without the safety net of Anglo American, a fully independent Amplats would be forced to face the harsh realities of both the marketplace and the ridiculous business (and we use the term business lightly) climate in South Africa. This can only be ultimately viewed as price supportive for all the metals.
The two events that we just described dovetail perfectly with the foundational reasoning behind our secular view on commodities and real assets.
East vs. West: While proxy wars, and actual wars, are being fought on a number of fronts, the collateral damage is being felt most significantly in commodity markets. We have seen this play out in energy with the Russians, as well as the Saudis, cozying up to the Chinese, much to the chagrin of the U.S. This new development with Nornickel is one further example of the battle lines being drawn in the sectors outside of energy.
The BHP proposal is evidence of several of our structural themes. Most notably, the under-investment in capex across all commodity producers and the understanding that this grab for productive capacity might have to be played out in the capital markets rather than in long-term development.
Takeaways: As we have mentioned several times in SOP commentaries, secular changes are often marked by events and actions that stand outside the norms of standard behavior. While both of the headlines we highlighted may seem relatively benign, we believe that they each are indicative of a world that is sharply breaking with tradition.
Commodities/Energy
With the continuous barrage of commentary on an AI-led future, most market participants are focused and positioned on the chip and software side. The risk level associated with that appears quite high from our standpoint as: 1.) Many of the most popular names are excessively priced in our view; and 2.) There is an East vs. West risk factor involving the potential barring of certain products to China and elsewhere. The one undeniable need of AI is power generation…and alot of it.
The power needs span several commodity-related sectors, including coal, natural gas and nuclear electricity generation as well as numerous (regulated and unregulated) utilities and power storage companies. Furthermore, the draw on infrastructure is massive. On top of every other U.S. infrastructure need (roads/bridges/airports/etc.), is the increased need for data centers. This requires grid contractors, transmission lines, pipelines, power generation equipment and electrical components. Finally, many facets of the technology will need service providers: servers, HVAC (cooling) and backup power. Many of the names that fall under the power umbrella are much more reasonably priced without the inherent risks of product export bans. This is where SOP is focused.
This broad infrastructure buildout is finally happening. This “Fourth Industrial Revolution” is a seminal moment that will have an outsized impact on numerous pockets of the commodities markets.
Takeaways: The aforementioned power side of AI is a present day version of the “pick and shovel” approach to investing in highly emergent technologies. In most instances, the obvious investment in any given theme is often already known, and typically not the most attractive from a risk/reward perspective. We welcome pullbacks in a number of names all throughout the power, and related infrastructure, spectrum.