Putting My Neck on the Line
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Putting My Neck on the Line
Mammoth Memo on How I Am Positioning My Personal Portfolio
Note: There will be no Weekly Recap this week, not because nothing has happened in the world, but was too busy sorting out the portfolio, researching and writing up the below. The Weekly Recap will be back next week.
Now that my portfolio clear-out is complete, it’s time to reinvest that cash in some new ideas. If you want to see what was in the previous portfolio, please check out the article I wrote a few days ago:
This is what people who are interested in economics and markets love doing the most. Finding some businesses and stories to back and seeing whether our intuitions are correct.
It is the first time I have written down in a public domain my trading ideas for comment and criticism. To be honest, I am quite nervous about doing this. I am putting myself at risk of looking like an idiot when none my of ideas end up working out! Added to that I have also chosen to start doing this at what appears to be the most uncertain of times with markets experiencing significant levels of volatility. Doesn’t seem like a very smart move, but who doesn’t love a challenge?
Before I go into individual themes and some of the stocks I will be buying, let me try and explain my current global economic view first.
I would suggest you get yourself a comfortable seat as this is going to be a long one.
As always, none of this is investment advice and is purely for informational purposes.
Current Economic Environment Massively Oversimplified
The beginning of the year started with a series of events that gave us the perfect inflationary storm. Supply-side issues from the reopening process after the Covid-19 pandemic, causing an initial smaller rise in inflation, were beginning to calm.
Then, Russian President Vladimir Putin decided it would be worthwhile invading Ukraine. This shook global energy markets as Western countries began sanctioning Russia in order to stifle its economy in response to military aggression. This included the West choosing no longer to source its oil and gas from Russia.
Fig 1: European Gas Prices Source: Reuters
This in particular hurt European economies which use natural gas as a predominant energy source (particularly in countries such as Germany). Natural gas was before imported in huge quantities from Russia via pipelines such as Nord Stream. Huge volatility has since been seen in gas prices, as countries began buying up as much natural gas from other countries than Russia to keep stores full ahead of winter.
Fig 2: European Gas Storage Levels Source: AGSI, The Spectator
Natural gas prices spiked in early autumn as these stores were being filled up, however, more recently prices have fallen all the way down. A warmer autumn has meant that there has been little need to take gas from this storage and as such no additional demand for gas buying, dampening prices.
The oil market has responded a little differently however to the West no longer looking to import oil from Russia. Oil prices generally rallied after the Ukraine conflict began in a similar way to gas (a fall in the supply of oil because Russian oil is no longer being imported, leading to an increase in price), but since then oil prices have fallen and since stabilised around the USD 90 a barrel mark. This again is around supply and demand dynamics.
Fig 3: Brent Crude Price Source: Marketwatch
Economies globally are beginning to slow as a result of rising inflation and the methods Central Banks are using to manage that inflation. Falling global economic output suggests oil prices may fall.
This has begun to cause a rift between two of the world’s largest exporters of oil: the United States and Saudi Arabia. In response to falling oil prices since the summer, Saudi Arabia and the rest of OPEC (Organisation of Petroleum Exporting Countries) have started cutting the supply of oil so as to keep the oil price higher. This has annoyed Joe Biden and the United States who are looking to keep oil prices down to help with the lowering of inflation. Politically it is also good for Biden to have lower oil prices since it is then less expensive for voters to fill up their cars and trucks ahead of the Midterm elections.
This political pressure can be seen also as Western leaders try and work out where to set a price cap on Russian oil. Initially, a fairly low cap of between USD 40 - 60 a barrel was rumored, however, it is now expected the level is to be higher than that. This is because there are worries around supply issues. Allowing the cap to be a touch higher will allow more Russian oil into the market, lowering supply and keeping prices stable.
Fig 4: US Strategic Petroleum Reserve Stocks Source: @charliebilello
In response to the OPEC supply cut, Joe Biden has been selling down the US Strategic Petroleum Reserve (SPR). Biden has been steadily selling this reserve since the beginning of the year and has now sold even more of the reserve to increase oil supply in the market to counteract OPEC. The issue is, that reserve is now falling to very low levels, the lowest levels since 1984. The White House announced that it would only buy up oil stocks again to fill the reserve when oil prices are between USD 67 and 72 a barrel. A level which the US Energy Inflation Administration is not forecasting to happen for a long while. The US will run out of options when it comes to matching OPEC’s management of the oil price.
As such I expect oil prices to remain elevated in the short to medium term.
The world is now looking for new sources of energy, with countries wanting to become increasingly self-sufficient and not dependent on imports from warmongering states. This has led to significant changes to how energy is bought and sold across the world, but also a lot more effort is being made to find new sources of energy for increased energy security. There was already a significant push towards renewables as energy sources in an effort to curb climate change, however, there is now even more drive to make renewable sources viable so as to achieve these energy security goals.
The problem is that the infrastructure simply isn’t here yet to be able to convert all the energy to renewable sources. Countries are looking to get to energy security much sooner than the time it will take to get renewable sources online. However, energy storage will be a key part of the energy plan going forward. Not only does energy storage help with energy security, but also solves the intermittency issues that come with renewable energy sources. This suggests to me that what we have seen in the last six months is a shift towards extending the use of gas as an energy source to prioritise energy security, whilst the infrastructure is put in place longer term for renewable energy.
Since sanctions on Russia won’t be lifted any time soon even if the war ends tomorrow, I expect there to remain significant demand for natural gas in the medium term, keeping average gas prices up, as countries have to repeatedly stockpile gas for their short-term energy usage. Additionally, I see an increased demand for renewable energy sources because of both climate change and energy security goals, and in particular nuclear energy because of its reliability and because it is quicker (in order to get the same amount of energy output) to build nuclear power stations than other renewable energy sources.
Going back to inflation, and what Central Banks are doing to combat it. With inflation rising and getting more stubborn, Central Banks have been increasing interest rates. In theory, higher interest rates should slow down demand and as such cool down prices. Consumers will see their disposable income fall significantly as the price of goods has already increased with inflation, and now with the rise in rates, we will see increases in mortgage costs.
As such I want to avoid exposure to consumer cyclical businesses as much as possible. I also believe this will impact technology names also. Many large US technology companies derive a significant portion of their revenues from advertising. As companies see their margins fall both from rising inflation and falling consumer demand, then there is less to spend on advertising.
Additionally, rising interest rates will impact companies that are heavily indebted. As such I am looking to focus on companies with strong balance sheets, and if they have debt, they have plenty of cash flow to service the interest on the debt.
The global economy is expected to grow in the next few years, despite slowing Western economies. This is thanks to continued growth from developing economies. However, many developing economies have suffered hugely because of pressures of inflation and rising dollar interest rates, with Sri Lanka being a prime example with its recent default. There are concerns around Pakistan, Egypt, Ghana and others.
Which emerging economies are best placed to deal with current headwinds going forward? Economies that are faring particularly well are those whose currency has held up against the dollar, thanks to raising interest rates for their own domestic currencies faster than the Federal Reserve in the US.
Whilst the pound, euro and yen have been pummelled when compared to the US dollar as a result of the Federal Reserve’s aggressive rate rising, there are emerging market currencies that have fared much better (though not all). A stronger currency means importing raw materials, food and energy become much cheaper for these countries as compared to say in Europe, keeping domestic inflation down and helping demand locally.
As such I am considering opportunities in Central and South America, in certain parts of Asia such as India and Indonesia and in Africa such as Nigeria.
Fig 5: Performance of Global Currencies vs US Dollar This Year Source: GoogleFinance
What is key to emerging market economies are raw materials and energy. These are requirements when it comes to increased industrialisation and development. If the healthiest economies over the next few years are emerging markets, then I expect demand for commodities and energy to remain elevated.
With populations also growing much faster in those regions, this need for energy will only increase. Increasing populations also require more food, and as discussed previously with regard to energy security, with the geopolitical picture only worsening, food security will become increasingly important.
Therefore I am considering significant exposure to commodities and in particular agricultural commodities.
The elephant in the room however is China. China has driven most of the commodity and energy demand in recent times thanks to its huge growing population and rapid industrialisation. We are seeing growth in China slow, as a result of namely the real estate crisis and Xi Jinping’s increasingly authoritative rule. Although the economy is slowing, it is still growing significantly at a rate of approximately 3.5% a year. There will be significant demand still for commodities and energy from China. As such I am looking to not add direct exposure to Chinese companies (beyond the small exposure I already have) because of the political uncertainty but am comfortable with commodity exposure globally as I expect China to continue needing huge amounts of commodities in the medium term.
Portfolio Construction
So to summarise, I am looking to construct a portfolio that will:
Benefit from the need for economies to guarantee short to medium-term energy security (increased use and storage of natural gas);
Benefit from increased need for energy storage (improvements to energy infrastructure and battery development);
Benefit from a drive towards renewable energy sources including nuclear;
Benefit from the healthy positions of certain emerging economies and their demographics (commodities, oil and agriculture);
Invest in companies with strong balance sheets and healthy margins to service debt to mitigate the impact of rising interest rates (low net debt ratios and high levels of interest payment coverage);
Invest in companies that have sufficient free cash flow generation to not only support the healthy running of their businesses but also look to generate shareholder value (high dividends and regular share buyback programmes).
Initially, this might seem like this will be a portfolio that is going to be very environmentally unfriendly. That is something that has raised some questions and worries for me. One thing I certainly am not is a climate change denier or someone who cares little for the environment.
What I think this exercise has shown me is how much the world has changed in the last few months let alone the past few years. I truly believe that renewable energy resources are the future, however we have to be realistic and the current world outlook has significantly delayed efforts to expand renewable energy.
The priority is being able to provide stable and secure energy in the near term to households with any energy price increases being as manageable as possible to the consumer, whether these prices are dampened by market forces or policy. Unfortunately, whilst the infrastructure is put in place to deliver secure renewable energy to everyone (both in developed and developing economies), there will have to be a longer dependence on gas and oil in the shorter term. That is an inevitability, things can’t change overnight. If the recent rises in energy prices are already close to unaffordable, the costs of a very rapid change to renewables would be catastrophic to the world economy.
We can blame corporations and we can blame politicians for not having the foresight to have better prepared the world, but that is not what I am looking to do here. I am looking to the future and trying to best position my portfolio given how the economy is changing.
I would also like to add that I won’t be including any information as to how I am sizing different positions in the portfolio. Also, this is a dynamic portfolio, although I might add some companies to the portfolio now, I could remove them very quickly if I wish and also hold them for a very long time.
Managing a portfolio isn’t purely picking trades, but also risk managing those trades, cutting and adding exposure as we go. That is not detail I will go into here, nor will I give going forward. You can consider that the Porchester “special sauce”.
I will split the portfolio into broader themes, that should be able to encapsulate the bullet points above, briefly discuss the dynamics behind each and then run through some of the companies I will be adding to reflect each theme on a very high level. Note also that I am not covering all the positions I have in my portfolio.
I am also a UK-based investor, and as such my portfolio will be predominantly using stocks listed in London or New York. Helpfully those exchanges have plenty of companies that fit the bill.
Copper & Metals Vital to Energy Transition
Copper is a vital metal when it comes to renewable energy and increased energy security, and given the increased expected demand, there will likely be a large gap in supply. Added to that the fast-increasing demand for electric vehicles, a dramatic rise in the price of copper is on the cards.
Part of the problem is because of environmental, political and social pressures, mining licenses are being granted increasingly less by authorities. Fewer new mines mean a falling supply of copper just when demand is picking up fast. A perfect storm for higher copper prices.
We are already seeing copper mines being offered longer-term deals by copper buyers so that buyers can secure supply, over fears of supply deficits in the future.
Additionally, the huge copper stockpiles that China has are now, well, no longer huge, and are near empty.
Fig 6: Chinese Copper Stockpiles Source: Bloomberg
With China being the world’s overwhelming consumer of copper, inevitably there will be huge future demand from China for more copper. Electric vehicles are also very popular in China so even more avenues for increased demand for copper from China.
Fig 7: Global Copper Consumption Source: S&P
Copper is not the only metal important to delivering renewable energy. There is a whole host of metals crucial to building out renewable energy sources, particularly when it comes to battery technology and to energy storage. Compared to conventional vehicles and energy sources, nickel, cobalt and zinc also will have a huge part to play.
Fig 8: Metals Required for Greener Energy Source: Ecora Resources
Below is the table of stocks that I will be adding to the portfolio as part of my copper strategy:
All of the above companies have exposure to the copper mining industry, whether that trading in copper or mining it. I will not cover every single name in significant detail here, however, they give me broad exposure to copper from large miners to small ones and across different regions, including developing economies that I have a particular interest in.
The idea is to hold these for a while, potentially reinvesting the dividends into new up-and-coming miners as I go. The energy transition won’t happen overnight, I will benefit over a much longer term as compared to some of the portfolio’s other strategies.
They have healthy balance sheets with very little debt and are able to service their debt with significant free cash flow. Additionally, my equity positions will be supported by high dividends and frequent share buybacks.
Some of the companies also gives me exposure to other metals that will play an important role in energy transition, for example, Glencore is an important producer of cobalt which is used in electric vehicle batteries and Anglo American is one of the largest producers of platinum which plays an important part in zero carbon fuel cells.
Ecora Resources is a little different to the other companies that make up this strategy in that it is not a miner. It instead acquires royalties from low-cost mining operations and thus directly benefits from rising metal prices without having to set up mines themselves. They also have a particular focus of buying royalties in metals that will be important for renewable energy transition, with over 80% of their expected exposure being in these types of metals.
Currently the royalties assets they are holding are predominantly in coal, however the company’s intention is to use the returns from the coal to invest in these metals royalty streams that are currently in development.
I am not taking the risk on mining operations by holding Ecora simply the price of the commodities which helps to diversify my exposure.
Uranium
Uranium is the key component when it comes to nuclear energy generation. Uranium is mined as “yellowcake” or triuranium octoxide, then refined into a gas in facilities in the United States, China, France, Russia and Canada. This is subsequently enriched to bring out the uranium isotope and converted into fuel rods. These fuel rods are then used in nuclear reactors where the uranium atoms are split to create energy.
Fig 9: Uranium Price Source: TradingEconomics
Currently, 10% of global energy generation is from nuclear sources and this is set to increase. The World Nuclear Association expects a growth of 55% in the nuclear sector between now and 2040. There are 427 nuclear reactors in the world currently with another 56 planned or under construction, with this number set to increase with the recent political drive towards energy security and renewables.
Nuclear is a very low-carbon source of energy and is efficient and reliable. Whereas previously it would be very costly and would take significant time to build a reactor, there has been significant development when it comes to small modular reactors which can be easier and much quicker to build.
Reactors generally have to refuel every 18 months and uranium is principally sourced via long-term contracts, usually three to five years. Large uranium inventories aren’t in fact ready to be used as fuel since they are usually in the process of being enriched or held as a reserve.
Fig 10: Uranium Production by Country Source: Yellow Cake PLC
Typically 80-85% of uranium requirements are purchased on long-term contracts, however, currently, only 79% of the European and 38% of the United States’ uranium requirements up to 2025 have been contracted. This gap will have to be filled somehow, likely by significant buying in the spot market in a few years’ time. This would be a significant catalyst for uranium prices to rally in the shorter term.
Given the necessary push towards renewable energy and energy security, I believe nuclear will play a huge part since it ticks most if not all of the necessary boxes. I expect uranium prices to rise in the medium term as governments turn increasingly to nuclear for their energy mix.
Below is the table of stocks that I will be adding to the portfolio as part of my uranium strategy:
Cameco is one of the world’s largest uranium miners with mining operations in North America and Kazakhstan. In their strategy, they highlight a particular focus on building a portfolio of long-term contracts to sell uranium to buyers, to give stability and longer-term value. This is positive for us as an investor, guaranteeing future cashflows to the business to support investment, debt servicing and dividends.
In their latest quarterly report, they highlight market concerns around supply on the back of geopolitical tensions, in particular exporting uranium out of Kazakhstan. This is why we have seen an increase in the price of uranium this year. Though this is positive for miners like Cameco, as it’s the downstream utilities that pay for the increased price.
Production has doubled this year as compared to the year before, thanks to Covid-19-related concerns receding. This paired with the large increase in uranium price has seen revenues increase by 33% for the nine months to September as compared to the year before.
Exposure to Cameco gives me exposure to longer-term uranium contract prices, via a well-capitalised miner which is one of the market leaders. Being based principally in the United States means the company is less at risk from geopolitical issues, whilst still having exposure to Kazakhstan which makes exporting to China and other Asian economies much simpler.
As nuclear energy becomes a more important part of the world’s energy mix, Cameco will benefit.
Kazamtomprom is the world’s largest uranium miner (24% of the world’s supply) and Kazakhstan’s national operator for the uranium market in the country. It is particularly well placed when it comes to the largest nuclear energy markets such as China, Russia and Japan. The company also has priority access to Kazakhstan’s uranium deposits.
The Ukraine conflict has caused issues for the company. Settling uranium exports to Russian companies has been difficult as sanctions have introduced barriers to settling in USD. Additionally, a significant amount of Kazatomprom’s exports are done via the Port of St Petersburg and there could have been an impact of sanctions on exports. The company reassures that there have been no issues with exporting worldwide via the port, and despite this is looking to open up export via other routes such as the Trans-Caspian route.
The company has seen revenues grow +110% (in KZT terms) as compared to last year, and profits have risen +188%. This is primarily thanks to the increasing uranium price. Like Cameco, Kazamtomprom has a very healthy balance sheet with plenty of cash and little debt.
Whereas Cameco gives me exposure to the American export market, via Kazamtomprom, I gain exposure to the rest of the uranium market. In particular exposure to China and Russia who are massive uranium importers.
Yellow Cake PLC is a Jersey-listed vehicle that buys spot uranium and holds it. Very simply by holding shares in Yellow Cake we are effectively buying a uranium inventory, and not a miner such as the companies above.
The previous two companies would see us gain exposure to principally the longer-term uranium contracts, as the miners sell to the buyers under those agreed contracts. Here with Yellow Cake, we will have exposure to the much shorter-term spot uranium market.
Another compelling reason to hold the vehicle is that the traded stock price is in fact below the value of the uranium held by the vehicle, we are in essence buying uranium at a discount.
This mix of uranium mining companies and Yellow Cake should give me sufficient exposure to both the shorter and longer-term price fluctuations of uranium. We expect both to rise given the catalysts described earlier.
Fertiliser
Russia and Belarus were the largest exporters of fertiliser in the world, and as a result of the Ukraine conflict and the associated Western sanctions, over 40% of global crop nutrient potash exports have now been shut off. The main destination for these fertiliser exports is large population nations such as the United States, China, India and many developing nations. Some fertiliser prices increased as much as +300% this year as a result of the conflict.
Fig 11: Global Fertiliser Prices Source: Politico
Squeezed supply of fertilisers has seen prices rise very quickly in the short term. Although prices have now receded from this spike, they still remain very high as compared to historical averages. Medium and longer-term demand will also remain elevated as populations continue to grow, particularly in developing economies. The only limiter to supply is newer technologies that limit to need for fertiliser, however those take a significant amount of time to become embedded, particularly in developing markets.
Additionally, increased agricultural commodity prices will also add to demand. High prices for important crops such as corn and soybeans encourage growers to increase production, and as such require more fertiliser. Prices for such commodities are currently 25 to 35% higher than the 10-year average.
Rising gas prices in Europe have also limited fertiliser exports from the region beyond just the existing supplies from Belarus and Russia. High gas prices have led to lower nitrogen and ammonia supplies important in the fertiliser production process. As such for my exposure to the sector, I will be focussing on American companies.
Below is the table of stocks that I will be adding to the portfolio as part of my fertiliser strategy:
Nutrien is one of the largest fertiliser manufacturers in the world. They are the global leader in potash assets in the world, all the way up to and including distribution, and the second largest phosphate producer in North America. They are in a strong position all up the supply chain from the initial production and manufacturing to the eventual retail of the products.
With such a broad asset base and distribution network, Nutrien is very well placed to benefit from elevated agricultural commodity and fertiliser prices. With very low debt and high levels of free cash flow, shareholder value can be grown by continued dividends and share repurchases which the company has a history of doing. With the price-to-earnings ratio at historical lows, this gives me also a compelling entry point.
Mosaic like Nutrien is a fertiliser producer, but with much more of a North and South America focus with operations in Florida, Peru and Brazil.
The same factors hold for Mosaic as with Nutrien, with attractive fundamentals and a good entry point.
Nutrien and Mosaic should give me exactly what I need with regard to my fertiliser exposure. Two companies predominantly based out of the US, and as such less impacted by European supply issues who can capitalise on elevated crop and fertiliser prices.
Oil & Gas
I have covered my thesis as to why I believe oil prices will remain elevated in my introductory section. OPEC have all the tools to keep the oil price elevated by cutting supply.
Fig 12: Crude Oil Price Forecasts Source: Bank of America
Again for gas prices, unless Russian gas is sold again on the market, longer-term prices will remain elevated. Although we have seen spot gas prices in Europe rapidly fall, this isn’t the true picture. This is a result of gas storage being full and there being very little short-term demand. Longer-term gas pricing is still elevated.
Fig 13: Natural Gas Spot Prices (white) vs 3M Prices (orange) Source: @robinbrooksiif
Below is the table of stocks that I will be adding to the portfolio as part of my oil and gas strategy:
All of the above companies have exposure to oil, gas or both. I will not cover every single name in significant detail, however, they give me broad exposure to oil and gas across different regions, including developing economies that we have a particular interest in such as in Nigeria.
All have large dividends and share buybacks to give us plenty of value, significant free cash flow and very little debt. Recent earnings for these companies have been announcements of record earnings given the elevated oil price, and despite this, relatively low price-to-earnings ratios as compared to other sectors.
Potential Risks
I am obviously very long commodity prices, if commodity prices begin falling then my portfolio will take a significant hit. This should be mitigated by the high dividends and share buybacks which will help my equity positions retain their value.
An outcome which would significantly negatively impact the portfolio would be an immediate end to the war in Ukraine and the lifting of sanctions. If Russia can overnight begin exporting oil, gas and commodities again to the world, this will significantly increase supply and cause commodity prices to sink. I feel this is unlikely. Even if the war ends, Western economies will keep sanctions in place until there is full regime change in Moscow.
Additionally I am basing my main theory on the Federal Reserve continuing to raise rates aggressively to combat inflation. If the Fed chooses to slow down, and interest rates look like they will stabilise, all the sectors I am choosing to avoid will begin to rally strongly. In this case, although we might miss some added performance we could have had from holding technology companies for example, my portfolio should still benefit as the slowdown in the US won’t be so strong and there will be renewed demand for oil and commodities.
Final Comments
Well, that’s it, I’ve poured all my thoughts and ideas out right here on Substack. I have found it a really useful exercise piecing together my thoughts and putting them all down in words. This has been a rather mammoth undertaking, the biggest personal project of this type I have ever attempted before.
Would love to hear criticism and thoughts you may have, and am happy also to answer any questions!
Porchester
Putting My Neck on the Line
Another great read Ali ! I forwarded this on to people I think will find this interesting :)