On Target Newsletter
2021.05.22
In this issue:
- Commodities boom
- The inflation threat
- House prices
- America’s elite
- Microchips
- Renewables
- Infrastructure
- The pandemic
Good Prospects for Unloved Mining Shares
Commodity prices are surging and there’s the prospect of demand for some natural resources exceeding supplies for years to come. Some leading investment advisers now say that we’re in the early stages of another “super-cycle.”
Prices of copper – in some ways the most important industrial metal – have hit new record highs above $10,700 a ton. Lithium, used in electric vehicle batteries, has doubled in price this year. Cobalt, another key ingredient of those batteries, has gone up 50 per cent in six months.
Iron ore, the basic material in steel; palladium, the precious metal that goes into catalytic converters to curb harmful car emissions; and timber, widely used in construction; have all hit new highs. Key agricultural commodities, including grains, oilseeds, sugar and dairy products have also jumped, with corn prices above $7.50 a bushel for the first time in eight years, soyabeans more than $16.20,.
The buoyancy in commodities comes after ten years of weakness. Low prices have driven producers to cut back output and discouraged them from investing in expansion. Emerging imbalances between supply, stockpiles and demand eventually adjusted balances in favour of higher prices. Inventories are low. Covid has disrupted supply chains.
But now demand and prospects of future shortages are being lifted by accelerating economic growth as the world bounces back from the pandemic, supercharged by Biden’s mega-spending plans. The dollar, the principal global measure for commodity prices, is weakening, magnifying the scale of price rises.
A new factor is the prospect of huge demand for materials essential to delivery of the global electrification revolution. Electric vehicles, renewable energy suppliers, battery farms, are all going to require enormous quantities of minerals such as copper, lithium, aluminium, nickel, rare earths. To build and service a single large wind turbine, for example, requires about eight tonnes of copper.
The metal is a “cornerstone for all electricity-related technologies,” says a new report from the International Energy Agency, The Role of Critical Minerals in Clean Energy Transitions. But expected supply from existing mines and projects under construction is estimated to meet only about 80 per cent of the copper the world will need by 2030.
Resource quality is declining. In Chile, the largest copper producer, the average grade of copper being mined has contracted by 30 per cent over the past 15 years. Worldwide, mining company executives have been reluctant to invest in new supply. They have been scarred from the negative experience of the last bear market; it’s difficult to find rich new deposits, particularly in locations with stable, business-friendly political environments; greenfield developments require enormous amounts of capital and typically take ten years to bring into production. David Haynes of ANZ bank says the current pipeline of projects likely to start producing within the next few years will only add about 2 per cent more to forecast mine supply.
Rising prices and prospects of much greater and relatively stable demand are transforming the picture. Bank of America said in a research note earlier this month that copper prices could double, to $20,000 a ton, as early as 2025. “Copper is the new oil” says hedge fund Livermore Partners’ David Neuhauser. Goldman Sachs says green demand will match, and then quickly surpass, the additional demand for copper that China generated to bring the earlier commodities boom. But, says Kathleen Quirk of the mining giant Freeport McMoRan, copper isn’t like oil, where there was a major new source of supply – shale production.
Shares don’t yet fully reflect the fast-improving environment
Commodity prices have started to get a lift from demand from investors seeking “real” assets that tend to appreciate when inflation becomes, or is feared will become, a bigger risk to portfolios. Goldman Sachs predicts “an overheating economy and physical inflationary pressures” in the US. The bond market has started to reflect those inflation fears, climbing to its highest level in eight years.
Shares, however, are still a long way from adequately reflecting the fast-improving environment for mining companies. At current prices earlier this month the value including net debt of BHP, the world’s biggest, was just 3.5 times its forecast earnings before interest, tax, depreciation and amortization this year, according to estimates from the Swiss bank UBS. Similar comparisons were about 3 times for Rio Tinto, 3.6 for Anglo American, under 3 for Glencore.
Mining giants are set to record big earnings this year and should comfortably surpass the profits made during the last commodity bull market a decade ago. They will spew out cash, having cut back sharply on new projects. JP Morgan reckons Rio and BHP are likely to pay the largest dividends in corporate Europe this year, distributing almost $40 billion to shareholders.
So why are market ratings so low?
The problem seems to be caution fertilized by long memories. When commodities last traded in the highs of an exuberant super-cycle, that marked the top. The LME metals index, a gauge of metals trading in London, fell 50 per cent over the next five years. The market capitalization of London’s five largest listed mines fell 75 per cent.
“There are reasons for thinking things are different this time,” says the FT’s Neil Hume. When commodity markets tanked from 2011 the cycle was already mature, with industrialization of China, the main driving force behind high prices for natural resources, well-established.
“This cycle is still in its infancy. The global recovery programmes that governments are putting into plan today are more commodity-intensive than was the case after the [global] financial crisis. That makes commodity markets less dependent on China.”
Mining companies are also more disciplined and focused on shareholder returns than they were ten years ago. “After a near-death experience in 2014, when the sector was left struggling to service debts piled up in the boom years, balance sheets are in much better shape.”
Inflation: Does a Big Shock Await Us?
The US government is pumping money and credit into the economy on a mindblowing scale equated with a war-time splurge. The excuse is that it needs to counter the damage done by the pandemic, but the Biden administration views it as an opportunity to pour money into its favoured interests – voters, welfare, public services.
The recovery package it has already forced through Congress was for $1.9 trillion. It’s asking for $3-4 trillion more. Olivier Blanchard, former chief economist of the IMF, says that federal discretionary and automatic fiscal support for the economy amounted to 12.6 per cent of GDP last year and is planned to be another 12.8 per cent this year.
According to his estimates, that is three times as big as the US output gap – the shortfall of actual from potential output due to the pandemic. Reality is that the pandemic has provided an excuse for what politicians like most – spending taxpayers’ money, or simply printing the stuff, without worrying about consequences.
The central bank, the Federal Reserve, is happy to facilitate the process, keeping interest rates ultra-low and continuing to pump $120 billion into bonds every month.
It’s ignoring evidence of a strong economic recovery – economists are raising their expectations to as much as 7 per cent growth for this year. “Signs of market froth are multiplying in an ‘everything rally,’” says the highly respected commentator Mohamed El-Erian. More companies are warning about rising input costs. Employment cost growth is at its highest quarterly rate since 2006.
Economic policy is shifting towards favouring consumer spending. “The resulting surge in demand is coming when companies are dealing with supply chain bottlenecks, higher commodity prices, industrial concentration, pervasive inventory shortfalls and in some cases labour issues. Chip shortages have already shut down some production facilities.”
The looming threat of inflation
Things are looking like a bubble. That could well end with an explosion in inflation. Will it?
The Fed predicts that the coming rise in inflation won’t be serious; that consumer prices will only rise moderately, to an annual rate not much above 2 per cent; that it can be tamed by moderate braking measures when required; and that it’s still far too early to think of tapping the brakes.
Most economists seem to agree, but not all. Larry Summers, the former US Treasury secretary, has warned that there is a risk of a big jump in inflation and the Fed could delay tightening up.
He hasn’t said so, but my view is that the thinking of central bankers has become dominated by fear of deflation; they will almost certainly be unwilling to risk that their actions torpedo economic growth, infuriating the politicians; and that pushing up interest rates could trigger a corporate debt default crisis.
The Fed’s replacement of its traditional “forecast-based” policy framework with the new “outcome-based” approach means the world’s most powerful central bank is committed to having to wait for months of rising inflation before responding, instead of acting in anticipation of an emerging problem, as I have always expected central banks to do.
Summers warns that exploding inflation and late/reluctant tightening up could produce a financial crisis and a deep recession before 2024. {That could well mean Trump’s return to power).
Latest news is that the US economy is already showing higher inflation. The Consumer Price Index soared in April to an annual rate of 4.2 per cent. The month-on-month rise was the sharpest since September 1981. Markets reacted by pushing up inflation expectations, taking the five-year breakeven rate on ten-year Treasury bonds to 2.75 per cent, the highest since May 2006.
Markets are hoping that the US Federal Reserve will continue to delude itself that inflation isn’t going to be a problem, ignore the evidence, and keep interest rates at zero for another year. Perhaps they’ll be right. But if opinion shifts it could come without much warning and deliver a very nasty shock. Michael Levitt suggests in The Credit Strategist that the danger level would be a 2½ per cent on ten-year Treasury bonds. They’re now about 1.7 per cent.
Another surprising piece of American news is that growth in employment is slowing down despite economic recovery. After an increase of 776,000 jobs in March the figure for April was only 266,000. That is despite rising complaints by employers that they can’t get workers. The proportion of job openings in small businesses that couldn’t be filled has risen to a record 44 per cent.
President Joe Biden is obsessed with jobs — claiming his policies are a good thing because they’re creating them. But latest news proves he’s often wrong.
An estimated 42 per cent of unemployed Americans are currently getting more in welfare benefits than they would be in work. There are still some eight million who lost their jobs because of the pandemic who are still out of jobs.
Steve Rattner, who served in the Obama administration, says: “With enhanced benefits, workers… can now make more on unemployment than they did at their jobs.” He compares benefits of $11.23 an hour in Pennsylvania to the minimum wage of $7.25 for a 40-hour working week. Those with jobs such as pre-school teachers, hotel clerks, dishwashers, do better to stay at home and collect their benefits.
Some federal welfare benefits are due to expire in September and many Republican-governed states have announced they will opt out of the federal enhanced unemployment handouts of $300 a week as early as next month.
However the additional welfare programmes introduced during the pandemic are going to be extremely difficult politically for governments everywhere to unwind. Once people get a taste of higher incomes for doing nothing, they are going to protest loudly at the withdrawal of handouts.
Abundant Cheap Credit Boosts Home Prices
House prices in developed economies are soaring. In America they increased by 11 per cent in the 12 months to January, their fastest pace in 15 years. In New Zealand, prices are up by 22 per cent; in Germany by 9 per cent and in Britain by 8 per cent.
How can this be happening in a world where economic growth has been devastated by governments’ anti-pandemic policies?
“Home values, like the price of other assets, have been boosted by low interest rates and fiscal stimulus,” says The Economist. “Many households have spare cash sloshing around – savings rates have increased by more than half in the rich world – and borrowing has rarely been cheaper.
“Separately, Civid-19 has caused a shift in demand away from big cities to housing in less crowded places. The expectation that commuting may no longer be daily has caused house prices in suburban locations to rise faster than in cities – reversing a decade-long trend.”
Does the boom have room left to run?
Bulls argue that government stimulus programmes and pandemic shutdowns have lowered consumer spending, leaving household balance sheets unusually healthy. Remote working has encouraged people to prioritize their living environments. Interest rates are near all-time lows.
Bears’ counter-arguments are that those interest rates have been rising quickly; that mounting debt will force governments to tighten their belts. Rents in big cities have fallen sharply.
The Economist’s statistical forecasting model for house prices suggests the rally is likely to stall but not to reverse. It expects appreciation to slow to 3.4 per cent this year and to 0.7 per cent by 2023. Among big markets the model is most bullish for the next two years on France and Germany.
The Elite Seeks to Entrench Its Power
In the past American presidents have used the first of their four-year terms to do the nasty stuff, pushing through unpopular changes, saving the nice bits for closer to next elections. Joe Biden is doing the opposite. He’s immediately spending or trying to spend public money on a scale so lavish that it’s comparable to mobilizing for a world war. What’s going on?
The Biden administration is gambling that it can use its wafer-thin control of federal government to force through measures that will entrench Democrats’ defences against the rising threat from populist Republicans. Time is short because in the mid-term elections only 18 months away the Democrats could easily lose control.
My friend Bill Bonner says Hillary Clinton “made one of the most tone-deaf political blunders in history by referring to these people as ‘deplorables’. Over the years those deplorables have drifted towards the Republicans.”
From a classical conservative perspective, Donald Trump made little sense with his policies and proposals. “But when it came to the cultural notes, he seemed to have perfect pitch”
Since the 1990s the two parties have switched. Republicans “now represent the working class and the hustling, small-business-owning petite bourgeoisie. The Democrats are now the party of the Grand Bourgeoisie – big business, the rich, the elite, the media, the universities and the government itself (including the Pentagon).
“The trouble with this realignment, from the Democrats’ perspective is that there are relatively more deplorable voters than elite voters.”
They are attacking this problem with several initiatives to tilt the balance of power…
► Seeking to pack the Supreme Court by adding four judges sympathetic to its interests. “Fortunately that idea seems to be going nowhere, with several Democratic senators facing re-election afraid to touch it.”
► Seeking to pack Congress by giving the District of Columbia, the capital city of Washington, statehood. With that would come two senators and one congressional representative. The three new hacks would be reliable, guaranteed votes for the Democrats. However that effort is also unlikely to pass.
► The massive fiscal spending plans that aim “to win back working-class votes by handing out good-paying jobs in the ‘infrastructure’ boondoggle [only a small percentage of which will actually be for infrastructure]… along with free schooling and other giveaways in the ‘families’ programme.
“It might work.”
Giant Factories for Microchips
The shortage of semiconductor microchips keeps getting worse. Why can’t we just make more? Bloomberg explains…
Chip plants run 24 hours a day, seven days a week. They do that for one reason: cost. Building an entry-level factory that produces 50,000 wafers per month costs about $15 billion. Most of this is spent on specialized equipment – a $60 billion market last year.
Three companies — America’s Intel, South Korea’s Samsung and Taiwan’s TSMC — account for most of this investment. Their factories are more advanced and cost over $20 billion each.
This year TSMC alone will spend as much as $28 billion on new plants and equipment. Compare that to the US government’s attempt to pass a bill supporting domestic chip production… for just $50 billion spread over five years.
Once you spend all that money building giant facilities, they become obsolete in five years or less. To avoid losing money, chipmakers must generate $3 billion in profit from each plant. But now only the biggest companies, in particular the top three that combined generated $188 billion in revenue last year, can afford to build multiple plants.
Here are some additional comments from Eoin Treacy in FullerTreacyMoney…
Semiconductor factories are largely automated so they were not particularly impacted by the global lockdowns. Demand for their products surged during the lockdowns as stay-at-homers bought new computers, smart phones and tablets
Factories running on thin margins and under constant threat from obsolescence do not operate with a lot of spare capacity. That is the primary reason we now have a semiconductor availability issue. The demand curve has accelerated well above the ability of supply to keep up. The increasing dependence of the automotive sector on chips has been building for a while and will contribute to the investment case for more supply.
In predicting how long this condition will last, demand is more important than supply. It takes years and billions in solid investment commitments to build a new factory. With the US, Europe and China laying plans to invest in additional new supply, a crash in prices has to be considered likely eventually when all of that new supply comes to market.
However in the short term the growth trend in demand is likely to remain firm and supportive.
A Cautious View of Renewables
The true costs of renewables are fudged by not counting external and replacement costs, argues commentator Charles Hugh Smith…
► Virtually all the “heavy lifting” of creating the systems has to be done by mining, manufacturing and transportation that require abundant quantities of hydrocarbons, especially oil.
► After 15 to 25 years all alternative energy systems and structures have to be replaced, requiring substantial reinvestment.
► Wind and solar energy is intermittent and therefore require battery storage on a scale that won’t be practicable. Also batteries don’t last very long. The percentage of lithium-ion batteries being recycled is near-zero, so they will end up as costly, toxic landfill.
► External costs of alternative energy are not taken into account. For example, the environmental damage caused by lithium mines is not costed into the price of lithium batteries.
Grid-distributed electricity sourced from renewables has more than doubled over the past decade from 1,336 trillion watt-hours to 2,579. It can still be very expensive, but becoming less. According to a 2017 study, the average cost over a generating asset’s lifetime is 14 US cents per kilowatt/hour for offshore wind and 10 for solar, but just six cents for onshore wind.
Trillions of dollars are being committed to building carbon-free infrastructure, whether that be solar, wind, geothermal, nuclear or hydrogen. As that buildout gets under way it will require massive fiscal support, regulatory bypasses for permitting, and taxation supports in the form of carbon credits, says Eoin Treacy. “It will also result in a significant near-term boost in demand for all manner of resources from copper to lithium and from coal to oil.”
Infrastructure: Lots of Pork in the Barrel
Most of us think that “infrastructure” means very large physical structures – bridges, tunnels, roads, railways, airports. Useful things that we’re generally in favour of, but needing large public bodies to finance and manage.
Joe Biden is using the word as a way to slip through huge amounts of spending that Democrats favour for their own political interests – ones that most of us wouldn’t normally categorize as infrastructure.
His proposed mega-package allocates only about $400 billion – less than 10 percent of the total — for projects normally classed as infrastructure. The rest is to be spent on a cornucopia of Good Ideas — windmills, solar panels, subsidies for electric vehicles, even school repairs (as a pay-off to teachers’ union, which are among the Democrats’ loyalist supporters). Even more is to be lavished on items that have nothing to do with infrastructure such as day-care tuition, unemployment benefits, community organizers and other social welfare programs.
All to be paid for by higher taxes, printing money or higher public debt. The resulting unprecedented growth in its debt-to-GDP ratio will put the US into the same super-debtor league as Lebanon, Greece and Turkey.
Update on the Pandemic
Some interesting items that caught my attention…
► “There is not a single documented Covid infection anywhere in the world from casual outdoor interactions such as walking past someone on a street or eating at a nearby table,” reports the New York Times.
► The risk of dying from diseases deadlier than Covid-19 such as cancer has risen significantly as medical resources are diverted to give greater priority to fighting the virus. In Britain the number of patients facing long waits – at least six weeks — for tests such as MRI scans, ultrasounds and gastroscopes has risen ten-fold in the past year from 29,832 to 327,663.
► The US Centers for Disease Control has quietly released new guidelines to laboratories recommending they lower their cycling threshold for the standard PCR test to a maximum of 28 – but only for patients who have received a Covid vaccine.
A problem with PCR is that the higher the number of cycles used in testing samples, the greater the chances of false positive readings. Worldwide it’s common to use thresholds of 35. So why aren’t lower and therefore more accurate thresholds used for everyone, including all those who haven’t yet been vaccinated?
Robots Down on the Farm
American farmers, struggling to recruit seasonal labour, are starting to use machines for jobs such as weeding. That used to be considered a task too difficult to mechanize, but no longer. Seattle-based Carbon Robotics’ “autonomous weeders” are tractor-sized machines that use artificial intelligence, cameras and lasers to distinguish weeds from crops and destroy them. They can clear 15 to 21 acres of unwanted vegetation a day. Weeders will reduce farmers’ need to use toxic herbicides.
Automation has become a growing presence in fields, even orchards, as American farmers find ways to reduce their dependence on human labour because of shortages. The Western Growers Association says that over the next decade it aims to automate half of the harvesting of crops including fruits, vegetables and nuts. Robots are being developed to pick strawberries and apples.
Is an F35 Really Worth $138 Million?
The F35 Lightning, the most recent introduction into service of the West’s fighter fleet, is “the greatest boondoggle in American history,” claims Julian Macfarlane. Costing $138 million apiece and more than $36,000 an hour to operate, over its life-span it will cost the American taxpayer $1.7 trillion.
But it’s “slow, maneuvers sluggishly, and cannot fire its new lightweight Gatling [cannon] without destroying the housing… and the airplane. It suffers from 13 ‘class one’ defects that endanger both the aircraft and its crew.”
Last year there were reports that the Syrians downed an F35 over Syria with a Soviet-era S200 ground-to-air missile defense system. The Israelis claimed a bird did it… over Israel. The Syrians “certainly shot something down, and it wasn’t a bird.”
The Russians have yet to allow launches in Syria by their more modern and far more effective S300 and S400 systems “in a tacit agreement with the Israelis not to exacerbate regional tensions… It is not just that the very, very pragmatic Israelis don’t want to use the unreliable F35 over Syria – they don’t want to provoke the Russians.”
Electric Cars: Waiting for Top-up Takes Too Long
About 20 per cent of buyers of electric cars in California are defecting back to gasoline-powered vehicles, according to a new report by Business Insider, because charging them is such a hassle. The figure is based on people who bought electrics between 2012 and 2018.
About 70 per cent of those who switched lacked access to Level 2 charging at home. “If you don’t have a Level 2 [system] it’s almost impossible” says Bloomberg automotive analyst Kevin Tynan. But even with Level 2 access, it took him six hours to charge his Chevy Volt back to 300 miles of range. Level 1 charging from a standard home outlet puts out about 120 volts of power. Level 2 is about twice that. Tesla’s Superchargers can offer 480 volts.
Comparing Property and Equities
Although the view that property is a better investment than shares has grown considerably in the UK. £100,000 invested in houses 25 years ago would be worth an average of £451,000 today, ranging from £378,000 in Scotland to around £660,000 in London. However the same amount invested in the global stock market would be worth around £727,000, according to investment managers Schroders; “10 per cent more than in even the best-performing regional property market.”
What’s more, these figures don’t take into account costs of ownership such as maintenance, repairs, insurance or taxes, which tend to be greater for property. They also ignore income and the impact of leverage/mortgage finance. The comparison “also does not take into any account the substantial tax savings which can be earned by saving into a pension [fund], nor the substantial taxes and costs associated with buying and selling property.”
Tailpieces
Taiwan: Its stock market was hit hard by news of a surge in Covid infections, coming after news of a drought.
The market is dominated by semiconductor stocks. TSCM, which controls more than half the world market for made-to-order chips, has seen its shares fall by one-sixth over the past four months. However Jefferies’ Chris Wood says that with chips now going into “almost everything,” semiconductor shares should be viewed by investors, not as cyclical plays, but as structural components of portfolios.
I hold several of the island-nation’s semiconductor plays such as TSCM, Silergy, Mediatek and Novatek Microelectronics.
India: The headlines about the ravaging pandemic are dire as hospitals run out of oxygen and corpses pile up. Investors, however, aren’t particularly worried. The Nifty Index of the biggest listed companies has been holding steady, drifting sideways within a range for months. Investors are looking past the spike in infections to the surge in economic activity that they expect to follow as infections decline. Alpine Macro’s forecasting model suggests daily new cases, having peaked this month, should plunge to near zero by August.
China: It has overtaken the US as the world’s biggest destination for foreign direct investment, attracting $163 billion in 2020. Net inflows into America fell to $134 billion. China’s share of global exports rose from 13.3 per cent in 2019 to a record 15 per cent. This is remarkable given all the talk about relocation of production out of China and the Trump administration’s tariffs on Chinese goods.
Electricity: South Africa plans to ease its crippling energy supply crisis by signing a $15 billion 20-year deal with Karpowership. The Turkish company has been building a fleet of floating power stations made from old ships. Those already in operation include two based off Indonesia and Ghana, each generating 470 megawatts.
Nuclear power: Japan has decided to re-start three old nuclear reactors shut down after the 2011 Fukushima tsunami panic.
Latest woke idiocy: Oxford University’s math’s, physics and life sciences faculty has recruited students to research proposals to make its curricula less “Eurocentric” and be “decolonized” by removing from historical works of scientific progress traditional Imperial measurements such as mile, inch, yard, pound and ounce.
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