Disclosure: The following represents my opinions only. I am not receiving any compensation for writing this article, nor does Hydra Capital have any business relationship with companies mentioned in this post. I am long every stock in this article.
I love days like this in the market, because they force people to think about what they own and why they own it. It’s easy to lose the plot when anyone that threw darts at the market over the summer likely did quite well, regardless of what they bought. To me, liquidity continues to be the number one driving factor in the market, with the Fed signalling that interest rates could be on hold for “years” (or at least until sustained inflation picks up). Low rates are forcing a massive rotation of debt into equity at a time when governments around the world are pumping (and will continue to pump) as much money as they can into their economies to offset the impacts of COVID-19. Meanwhile, the impact of COVID-19 on the markets has been to concentrate business in the hands of tech companies and select retailers/goods manufacturers who were able to capitalize on the opportunities created by public policy response (i.e., school closures, working from home, mall closures, and lockdowns). Working in the hotel or airline business? It feels like the world has ended. Got a bike shop? Wow, I bet you didn’t know that business could be so good. Patio heater sales? Through the roof. That goes for Sea-doos as well. And Harleys apparently. The impact of COVID-19 has been dramatically different across different income levels. While some struggle to make ends meet, others are wondering which Porsche to buy after they got long ZOOM or NFLX a few months ago. THAT’s the market that I see correcting today… a bunch of overvalued stocks that have become such a big component of the indexes that they have split the market into over valued and undervalued silos. At times like these, every investor has to check their market views in the context of what’s happening out there and react, or not react, accordingly.
Personally, I’m not worried about when a stimulus package will come. I’m also not worried about some kind of widespread civil unrest in the U.S. on the back of U.S. election results, but that’s just me. I think that the simple truth is that, no matter who wins the election, stimulus will be close behind. Maybe it takes a month to get all of the votes counted, maybe it takes two months, but once the votes are cast (which they will be after next Tuesday) voting along party lines in the U.S. senate should fade as senators really start thinking about looking after their constituents. Think about it… if the votes are in and you’re a republican/democrat senator, whether or not you vote to approve a stimulus package has no bearing on the outcome of the election or the fate of your party… at that point, you will be more interested in plugging the holes in the leaking ship of your constituency with stimulus payments to those who need it most. What would be the sense is delaying another round of checks to citizens on the eve of the Christmas season? It would be economic suicide for the U.S. to do that ahead of the single biggest shopping event of the year. The is no gain to be had by denying U.S. citizens of the help they need today when the cost is literally the stroke of a pen and the entering of some zeros on a balance sheet. All of that aside, I guess my point is that governments will keep printing zeroes on their balance sheets until this COVID hysteria subsides and life gets back to normal. But then what?
There is massive pent up demand in the economy right now that simply hasn’t been able to be met because of the effects of COVID on supply chains and labour. Once normalcy returns, probably post-vaccine, that pent up demand is going to pull through the same straws that it always has, which means that there will be a lot more people standing on the buy side of a market where the selling pipe hasn’t gotten any bigger. You know what that creates? A scarcity/auction market. Those who want their goods and/or services first will inevitably pay more. To me, this would seem to be how inflation will manifest itself going forward. Imagine the bookings on airlines once COVID is in the rearview mirror. Capacity has been cut to the bone. As things open up, it will take time for everyone to staff up again from baggage handlers to front counter staff. Imagine hotels. “Sorry sir, that’s the only room available and I need an answer in the next 24 hours because we’re sold out at the moment”. Restaurants? They’ll be jammed. Weddings. Parties. Sports events. Concerts. Remember those? So does everyone else. They (myself included) long for that return to normal and will drink a long drink of it when it’s available.
Meanwhile there are policy and attitude shifts that are incredibly positive for certain sectors. Copper is probably my favourite multi-year theme. The whole green wave thing that’s sweeping through markets and industry is incredibly bullish for copper. An electric vehicle contains about 4x as much copper as a gas-powered car. Transportation demand (cars, trucks, trains, boats, planes) for copper is around 11% of total current copper consumption. Cars are the biggest part of that 11% and we’re talking about that multiplying that wedge by a factor of four over, say, the next 15 years, at a time when permitting large mines is getting harder and harder. Likewise, solar panels take 4-5 tonnes of copper per megawatt (MW) of installed capacity, or 4,000-5,000 tonnes per gigawatt (GW). The U.S. currently generates about 1.8% of its electricity from solar power, producing around 72 GW per year. Electricity production from natural gas and coal is currently more than 30 times that number (38.4% and 23.5% respectively). Perhaps 20 GW of new solar capacity was hoped for in 2020 before COVID hit. Just to replace coal alone, solar generation needs to grow by a factor of more an 1300%. While achievable, it’s going to take some time to make that transition. With the hopes (aka crazy high valuations) that are being pinned on solar and EV stories right now, I sure hope those folks are long copper too. And don’t even get me started on nickel, which is far more scarce than copper and equally valuable in the electrification theme due to the NMC chemistry that is set to dominate the lithium-ion battery space for the foreseeable future.
The investor apathy, and government policies, towards the existing energy sector has interesting implications as well. While we are currently swimming in oil due to decreased COVID demand, the capital investment flows in upstream projects has been abysmal for YEARS now. Meanwhile, banks are pulling back from the oil sector on ESG concerns, leaving even less capital for energy firms to work with to maintain production, pay down their debt, return capital to shareholders, and then maybe, just maybe, grow a little during periods of sustained strong pricing. Now, as much as everyone thinks we’re going to flip a switch and be an electric economy tomorrow, the reality is soooo far from that. About 1% of current normalized oil demand is offset by the entire EV car fleet. Let’s assume the global EV fleet DOUBLES in 2021, which it won’t. That would offset another 1% of oil demand. For perspective, the natural decline rate the world’s oil production as a whole is around 7% per year. To put it another way, global oil producers need to bring on 7 million barrels per day of capacity, every year, just to stand still. What’s your sense of how most global oil producers (I’m talking about huge companies here, not small cap outliers) are feeling right about now? Do you think that they’re thinking about increasing production a lot with oil at $38/barrel? No way. They can’t. And certainly not within the next two years unless oil prices went up $20-30 tomorrow. Starting to see the disconnect? The development pipeline of new large scale projects is largely empty. What happens ten years from now is anyone’s guess, but the cake is already baked for H2 2021 and 2022… oil is going to be in short supply and there’s nothing anyone can do about it unless oil prices are much higher. That’s a long way from now, but anyone paying attention should start to see the signs in the later half of next year if my view is correct… and just to be clear, my view simply echoes what much smarter and deeply-resourced energy analysts are saying on the topic, but their logic seems very sound to me. Based on similar logic in the North American gas market, I like natural gas a lot here, especially the Canadian producers. I am not alone in this view either, as many large and small investment banks have highlighted the vulnerability of the gas supply due to lack of drilling, low prices, steep declines, and limited access to capital.
In a nutshell, I remain unfazed today. I am sticking to my main stories and themes, which collectively are bullish energy, gold, and materials. I own too many names to talk about them all, but I’ll run through a “top ten” to give some sense of my thinking.
Nutrien (NTR.TO, last at $53.48)
I still like this one as a value play. Crop prices are screaming higher across the board and that’s good for farmers and what’s good for farmers is good for Nutrien. It’s big, it’s liquid, and it has a nice 4% dividend and a good outlook. I think it also has torque to a developing soft commodity cycle, so I’m long a big chunk of it.
Something a little different to keep an eye on is Verde Agritech (NPK.TO, last at $0.62). Perhaps the ultimate sleeper ESG play, this little company has a deposit in Brazil that is rich in glauconite and it has done field tests of its Super Greensand product, which is finely crushed to a consistency not unlike, ummm, sand. The stuff makes for healthier soils and waterways as it is a truly slow-release fertilizer, suitable for organic and conventional agriculture alike, where soil health is an increasing concern. Super Greensand also replenishes critical micronutrients in the soil, something that conventional fertilizers just can’t do. I’ve followed this for the better part of decade and will watch for the company’s results next month to get some sense of where this is heading. If this name catches the eye of the market or an established industry participant, things could get silly because the scale-up of this asset would spit out numbers that verge on ludicrous. I own a little, because the stock is horribly illiquid, and I’ll watch to see which way it seems the wind is blowing after they report next month.
Touchstone Exploration (TXP.TO, last at $1.65)
The Chinook discovery excitement has waned, but my view remains bullish. Cascadura Deep should start drilling any day and recent interviews with Paul Baay (available online via google searches) have indicated that the deepest pay interval at Chinook may correlate with the targeted trust sheet at Cascadura Deep, perhaps implying that the two could be connected. If that’s the case, you could start pushing 1 TCF of gas at Cascadura-Chinook alone. Right now I think that TXP is basically priced for Cascadura as is, with zero value for Chinook or any additional exploration upside (Cascadura Deep, Royston, or any of the other 20 or so remaining targets). I don’t mind carrying a nice chunk of this around as it bobs up and down. By the end of the year there should be a gas sales agreement in place and Cascadura Deep should be drilled. With Halloween on Saturday, Christmas is coming faster than you think, so I don’t want to get too cute with this. Could it go lower? Sure it could, but I can’t pick a bottom here and I see little correlation between the ultimate value of TXP’s project and the S&P index and when exactly a U.S. stimulus package is rolled out.
Tag Oil (TAO.V, last at $0.18)
I’ve posted recently on this and I have little more to say. The Australian assets have been sold, which will bring cash closer to 19 cents per share when the deal closes. It’s all about Abby and the team. They’re shopping at a great time, so I think my patience will be rewarded and I view my risk level as low given the cash backstop and quality of the board and management here.
Through listening to, and reading articles from, people much smarter than me on the natural gas macro picture, I’m of the view that either a normal or colder-than-normal winter could result in a very tradable move in the Canadian natural gas producers. My favourites are Advantage Oil and Gas (AAV.TO, last at $2.12), Birchcliff Energy (BIR.TO, last at $1.83), Tourmaline Oil (TOU.TO, last at $17.62), Arc Resources (ARX.TO, last at $6.52), and Spartan Delta (SDE.V, last at $2.87). They all appear fundamentally cheap to me (TOU and ARX are the only dividend payers currently, but all will generate significant free cash flow at strip pricing), with good (and improving) balance sheets. The first four are the easy ones as they are liquid, but discount shoppers might like the look of Spartan the most. It trades at around half the EV/DACF multiple of its peers despite having almost zero debt and high quality assets run by a proven team. Hmmmm.
I’m light on exploration, but heavy on cheap producers and ounces in the gold sector. My favourite producers are Karora Resources (KRR.TO, last at $3.11), Alamos Gold (AGI.TO, last at $10.81), Premier Gold (last at $2.72), and Roxgold (last at $1.70). I own a little Iamgold (IMG.TO, last at $4.72) as well because it’s just too cheap on the comp sheets. All of these companies trade in the 0.5-0.8x P/NAV club and all have great balance sheets. AGI just reported a great quarter, and Premier is eventually going to split into two companies, a Nevada-focused story and a Canada-Mexico one. I think that’s a value creating event, but I have no idea on timing or firm confirmation that it will happen, though there’s been lots of talk about it. KRR is a crazy cheap (about 6x free cash flow) 100,000 oz/year producer in Australia that has a pile of development opportunities in front of it that might make it look more like a 200,000 oz/year producer in 5 years with a little luck with the drill bit. Changing gears to Africa, Roxgold has some “country risk” attached being in Burkina Faso, but the assets are good, and only getting better, so I think one day it will be taken out.
Little New Oroperu deserves its own paragraph in this section. So far, so good on this one as the Barrick earn-in deadline approaches. My view remains unchanged from earlier this year in that Lagunas Norte is worth a lot more with the Tres Cruces ore, full stop. ORO’s Tres Cruces would add high-margin oxide ore that could/would/should serve as the early production material for a Lagunas restart and would add “critical mass” scale to the sulphide resource, pushing it to over 7 million ounces on a combined basis without drilling a hole. For reference, assuming US$1000/oz margins on the oxides (which is arguably conservative), Tres Cruces represents US$400-500 million of cash flow (that’s with me assuming a 0.4-0.5 million ounce oxide resource) waiting to be picked up (truck, shovel, and haul road) while the sulphide development plan is put in place. This needs to get sorted out before this New Year’s Eve, so tick tock.
Copper, Nickel, and Lithium
The electrification/green energy trifecta. China is stockpiling copper, nickel is in need of serious expansion to keep up with battery demand, and lithium is the lynchpin that holds it all together. I think that almost anything copper related is good and the universe of (real) independent nickel companies is so small that you can count them on your hands. Lithium is a little easier to come by, but quality projects are not.
For me, my copper bets are First Quantum (FM.TO, last at $14.10), Copper Mountain (CMMC.TO, last at $1.00, Capstone (CS.TO, last at $1.59), Hudbay (HBM.TO, last at $5.85), and some of pure-explorer Pan Global Resources (PGZ.V, last at $0.59) in the hope that they are on the verge (edge) of something big in Spain. There seems to be an interesting situation developing with Surge Copper (SURG.V, last at $0.31), but I’m not totally clear on the plan there just yet, so I only mention it as something I’m watching to see what comes next (probably exploration drilling at Ootsa).
In nickel, I’m long FPX Nickel (FPX.V, last at $0.48), Talon Metals (TLO.TO, last at $0.30) and a little bit of Canada Nickel (CNC.TO, last at $1.88). FPX excites me the most because it is potentially the “greenest” source of nickel out there. I hope to hear more about that in the coming months and hope that by then people start paying attention to this unique, large, multi-decade, low-cost, project. Talon is drilling for massive sulphide expansions right now in Minnesota, so I’m selfishly wishing them luck as well. Meanwhile Canada Nickel has established itself as a large (400 million tonne to >1 billion tonne depending on how you slice it), low-ish grade sulphide project that should maintain market interest due to the relative lack of other projects with its scale.
Lithium consists of three names for me right now. Critical Elements (CRE.V, last $0.71), Neo Lithium (NLC.V, last at $0.93), and Lithium Americas (LAC.TO, last at $12.32). I currently own the first two and am looking to buy LAC back on further weakness if it materializes. CRE is a hardrock spodumene deposit with attractive-looking economics in Quebec that I think will benefit from the green energy push. In particular, I will be keeping an eye out for European players looking to secure lithium supply for the coming EV revolution. NLC is still my go-to best-in-class pre-development brine deposit in Argentina, which is apparently also viewed positively by CATL (they bought an equity stake in NLC recently), which happens to be one of the world’s largest leading battery manufacturers out of China. LAC is a widely held soon-to-be lithium producer with brine production in Argentina where it has a 51/49 JV with China’s Ganfeng Lithium as a partner. LAC also has a large clay-hosted lithium deposit (Thacker Pass) in Nevada where it is actively searching for a development partner. The scale of Thacker Pass is massive, so any hint of a JV on this project could send the stock flying.
Maxar Technologies (MAXR.TO, last at $35.06)
In the space sector, I’ve traded MAXR around and still like the trend and the “space” theme, so I remain long, but cautious. I like that the reported short interest is still stubbornly high, at around 8.3 million shares as of last report (that’s built-in buying). For a refresher, MAXR is a satellite builder and space robotics expert that is due to launch a new satellite constellation in 2021. That deployment will change MAXR’s market tone from one of high capex and leverage to one of free cash flow and new, higher margin operations. That sentiment shift is already underway, and with MAXR reporting on November 5th, the shorts better be hoping that something goes wrong here. A report I read from TD pointed out that because of MAXR’s tight capital structure, every point of EV/EBITDA expansion translates into a CAD$13/share price move. MAXR currently trades at around 9 or 10x EV/EBITDA, which I think is modest based on its competitive moat and decades-long established relationships with the U.S. government. I’ll respect the chart, but the stock has been good to me thus far.
That’s a lot of ground to cover, so thanks for reading. It’s a jungle out there, so happy hunting.