Our 4 Big Themes
I wish I could get rid of all the weapons on the planet. I know it’s a pipe dream, but if I could, I’d do it in a heartbeat.
The conflicts in the Middle East are deeply unsettling on many levels, and I’ve refrained from inundating your inboxes about it. For one, we are heavily invested in assets that stand to gain significantly from the conflict’s escalation, especially if it disrupts energy exports. However, that’s hardly what I’m hoping for.
Our investments in natural resources were driven by underlying supply and demand fundamentals, predating the Middle East conflict. If anything, war only underscores the importance of natural resources, essential materials underpinning our globally complex societies that wouldn’t function without them.
The United States (and the rest of the globe) has experienced a 9-year underinvestment cycle in oil and natural gas production, which is what always leads to the next great commodity bull markets. The primary source of production growth in the United States, the Permian Basin in West Texas, is starting to plateau. When it plateaus and rolls over, the markets will have an OMG moment (thanks to Mike Shellman for that zinger).
The unfortunate Middle East conflict could turn the OMG moment into something much more brutal if the Strait of Hormuz is jeopardized (17% of all global oil exports go through the strait) or if Iran becomes directly involved. I’m certainly not hoping for $200 to $300 oil; I’m rooting for world peace.
The upcoming OMG moment for oil and gas shortfalls will be more than sufficient for our accounts to trend to dizzying heights over the next couple of years, from a fundamental perspective.
Nevertheless, the world is a couple of missteps away from a much larger energy crisis if the Middle East escalates. It couldn’t hurt to re-emphasize the underlying bull thesis that is taking place regardless of the war’s outcome by browsing recent insights articles.
I was perfectly comfortable sitting in these assets pre–Middle East; but any escalation merely means our wealth is even more protected from energy chaos.
Paradigm Shifts and Ultrasound Assets
It’s understandable why large institutional and generalist investors are dismissive of critical resource industries at certain junctures. They run counter-cyclical to the stock market. When general equities perform well over extended periods (typically 10-to-15-year cycles), commodities perform poorly, and vice versa.
After long periods of either secular trend, investors become psychologically conditioned and anchored in one direction or another to whatever had been working. Extrapolating past trends into infinity is a mistake—everything is cyclical. The details are in the fundamentals.
The commodities bull market is well underway, which doesn’t bode particularly well for the general stock market (it’s the de facto reason why Buffett’s only large investments in the last 7 years have been in energy stocks).
However, investing in natural resources takes years of experience and know-how. Where does one start? Even with experience and know-how, it happens to be one of the most time-consuming of all sectors. The moving pieces in natural resources on a week-to-week basis are endless (geopolitics, regions, production targets, supply and demand, import/exports, capital structures, competing resources, depletion rates, inventories, etc., are all moving parts and issues to decipher).
With every natural resource, deficits have always turned into surpluses and vice versa (creating the cycles). For example, if oil goes to $200 a barrel and stays there for several years, capital will undoubtedly chase more production growth with the enticing returns to be garnered. These dynamics will take the resource from undersupply to oversupply, setting the stage for the next major secular trend (general equities perform well during times of energy abundance).
If I were to run an ETF or mutual fund, I’d name it the Abundance Fund or Surplus Fund and rotate between these long-term secular trends for the ultimate convenience of investors. This is what I do for individuals and my investors.
One of the keys to understanding natural resources is they have price elasticity. Prices will ultimately dictate equilibrium, like a pendulum; however, prices never swing to the middle and stop. The vicissitudes are wide, lulling the general population to sleep as it swings too wide in either direction over a period of years.
On the other hand, Bitcoin is the most inelastic asset on the planet. Demand could increase by infinity squared (that’s a lot); the price would increase in unison with such outrageously high demand. Still, the ASIC miners that provide the complex calculations to prevent double spend and verify the transactions on each block can never increase the supply of Bitcoin—no matter how high the price is.
There is no entrepreneurial arbitrage for the miners in Bitcoin between supply and demand gaps, but there is for every other commodity, whether it be silver or soybeans.
As of right now, the vast majority of Bitcoin, 87%, isn’t moving onto exchanges and is being held for the long term. This leaves just 13% of the supply liquid and on exchanges for trading. Any material increases in demand, and the price goes through the roof with no offsetting supply.
Bitcoin is truly programmed to increase over time. It could go to $5 billion a coin, but there is simply no entity in the universe that can increase the supply except for sellers or profit takers. In my view, given the lack of complexities of Bitcoin compared to every other asset in existence, and its transparency and efficiency compared to every other commodity or central banking system, for most investors, Bitcoin is the single best long-term savings vehicle in the world.
There’s not a single large asset class that has beaten Bitcoin since its inception, and there is unlikely one to beat it over the next 2-3 years or over the next 10 years. Bitcoin is an ultrasound monetary asset that has no long-term inflation rate in an inflationary world.
On the other hand, I consider our largest positions in the natural resource space to be ultrasound assets in an inflationary world as well. With our largest oil and natural gas producers, not only are there no shares being issued on a net basis, but the reverse is true. Our largest oil and natural gas producers are prolific buyers of their own stock, and share counts are dwindling, increasing our economic advantage in extremely valuable resources.
If a company repurchases 50% of its shares and the price-to-earnings multiple remains flat, it results in a 100% return. A buyback of 67% of shares translates to a 300% return, 80% cancellation equates to a 500% return, and at 90% buyback, the return becomes 1,000%.
Over the next few years, we’ve got a few companies that fit these high repurchase rates quite nicely. As for inflation, one of the key inflationary inputs is petroleum. While estimates vary, petroleum inputs account for 40% to 50% of the Produce Price Index inflation rate, and a bit less in the Consumer Price Index.
One of the only legitimate ways to bring down inflation is to have a raging bull market in oil and gas producers, and other energy-related areas. Not only is owning these types of assets in the sweet spot, but they are also the very remedy to make living conditions much better all over the world. Owning these assets doesn’t just help Avoid the Inflationary Era’s Pitfalls but should also help propel wealth much higher over next couple years and protect capital.
Best regards,
Nicholas Green, CIO
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