Tech Bear, Commodity Bull

This week I figured I’d explain my thesis of what’s going on with markets, and why I expect we’re at the early stages of a bull market in commodities despite the bust in speculative tech, downturn in stock indices, rate hiking cycle, and pending recession.

The first idea I wanted to show was that of the decade themes I’d come across about years ago – own gold in the 70’s, Japan in the 80’s, Tech in the 90’s, Commodities in the 00’s, Tech in the 10’s, so now what. It makes sense to me that commodities are cyclical, going through cycles of over-production and price collapse, chronic underinvestment & consolidation, underproduction while the world works through stockpiles from the past, rapid increases in the commodity spot price, then massive investment in the sector until we hit overproduction again.

In order to show this, I first looked to the ETF’s, but they are all created recently. Yahoo Finance doesn’t let you make log charts so multi-decade charts don’t work, and they let you download historical data for stocks but not for futures. So here’s the proxies I came up with using Microsoft for tech, Alcoa for base metal miners, and Barrick Gold for gold miners, importing into excel, and then messing with the log charts to make them look somewhat reasonable (log 2 worked the best; log 10 just had too much space between the axis):

All I can say here is, real world price trends won’t always match your theory. Maybe better proxies would fix it because of idiosyncrasies of the individual companies over the decades, who knows.

I can tell you that the reason I focused on mining stocks rather than oil is because the fracking cycle shortened the curve. With fracking in the US, we could get oil wells drilled and supplying in a year or two and they would run dry a year or two after that, whereas previous oil supplies such as ocean rigs would take nearly a decade of investment and then produce for a long time. Mining still can’t be rushed, it takes years to get a project going and then it will produce for a long time.

Uranium has the most classic bullish supply cycle going on, and I am strongly considering increasing my allocation to that sector. After working through massive stockpiles following the shutdowns driven by the Fukushima disaster, we are in a massive worldwide cycle of nuclear plant construction while mining capacity is glaringly inadequate. Follow Justin Huhn and his Uranium Insider for more information there.

Gold miners are simply grossly undervalued in regards to price. I posted a chart on that 2 posts ago (May 7th), so I won’t re-post it now, but I can’t easily explain why that is. Its tempting to question the fundamentals, perhaps its much more costly to mine and the new grades arent as good, but I don’t think thats it. Besides, fundamentals often have much less to do with stock price movements than most people think.

We’ve seen an incredible decade where money has flooded into the SPY and QQQ indexes more than ever, with the result that value stocks got cheaper while big growth stocks skyrocketed. Other trends from ESG to outright political hostility towards anything involving energy or mining have played a big role as well, leading us to a world of chronic under-supply of many critical materials.

The way I see it, demand for many commodities such as oil and copper have never recovered from the covid crash, while supply has been hit so bad that prices are near all-time highs in many key markets. Here are some examples:

We fly a lot less planes today (with higher priced tickets):

We certainly haven’t increased industrial/mining production in the past 20 years according to this chart:

China’s copper demand hasn’t been decreasing despite lockdowns and property busts and everything:

US production of oil is still down at 2018 levels, and is set to fall sharply do to lack of investment. DUC = drilled but uncompleted wells. With fracking, wells are pre-drilled and then tapped later to produce their oil. We are blocking new drilling for fracking, so the uncompleted wells are falling sharply as they are tapped for use, and oil production will plummet when they run out.

Sorry about the crazy chartstorm above, but I am a retail investor with a full time job and no subscriptions to proprietary data, so I am limited to the random array of charts I can get from yahoo finance, the st louis fed, and whatever google searches can bring up.

Anyway, I’ll summarize my perspective here:

  1. I agree with deflationists like Jeff Snider & Dave Rosenberg that we are actually seeing signs of acute dollar shortage in the system and we’re likely in a nasty recession already (GDP was surprisingly negative in Q1, at -1.4%).
  2. This downturn will have an enormous effect on the general stock indices if margin debt reduces to anything near its pre-pandemic levels. It has already been decreasing since October.
  3. Despite the recessionary trends we see including the active lockdowns in China, many commodities like copper, gold, and oil are at or near their highs.
    1. I believe that this means we will be stuck in recessionary conditions until we actually improve supply conditions for raw materials. Instead, we see production declining in many key sectors – particularly oil and farming. Mining will be complex going forward as populism in emerging markets explodes, and I might not be riding the best horse here, but I see an under-invested and under-priced sector and I’m taking a risk there.
    2. I realize that 2008 saw similar conditions in terms of peak commodity prices preceeding a downturn. I just believe that what we see much more resembles the 2000 tech bust that led to a commodity bull market. In the 2008 commodity peak, miners and drillers were flush with cash after an era of massive expansion.
  4. Right now it feels like investment money is much more crowded in the tech sector than in the commodity sector, and I expect investment funds to slowly rotate toward commodities over the next several years. This will be volatile, especially in sectors like Uranium which are relatively tiny in market cap and volume, but the small size leaves a lot more room to grow.

Here’s where my latest allocations landed:

  • HEDGES (14.9%)
    • 14.9% TLT Calls
  • PRECIOUS METALS (32.9%)
    • 4.2% AG
    • 3.9% SILV
    • 3.4% MTA
    • 3.2% SLVRF
    • 3.0% EQX
    • 2.4% LGDTF
    • 2.0% SSVFF
    • 2.0% SAND
    • 2.0% RSNVF
    • 1.5% HAMRF
    • 2.0% MGMLF
    • 1.1% MMNGF
    • 1.4% DSVSF
    • 0.9% BKRRF
  • URANIUM (20.5%)
    • 4.4% CCJ
    • 3.1% DNN shares & calls
    • 2.7% BQSSF
    • 2.5% UROY
    • 2.1% UEC
    • 2.7% UUUU
    • 1.6% ENCUF
    • 1.4% LTBR
  • US CANNABIS (16.1%)
    • 1.9% AYRWF
    • 2.0% CCHWF
    • 1.8% CRLBF
    • 2.4% CURLF
    • 2.1% GTBIF
    • 2.4% TCNNF
    • 1.7% TRSSF
    • 1.9% VRNOF
  • BATTERY METALS (10.3%)
    • 5.1% NOVRF
    • 3.8% SBSW
    • 1.4% PGEZF
  • CRYPTO (2.3%)
    • 2.3% XRP
  • OTHER (3.0%)
    • 2.5% DOCN (cloud computing)
    • 0.6% OGZPY
    • 0.1% ATCO calls
  • CASH (-0.1%)

I didn’t trade much this week. I sold an out-of-the-money covered call in DOCN as I don’t expect it to be higher after next month’s fed hikes, and I bought a bit more UUUU because it is one of my favorite Uranium plays and I currently feel under-allocated there.

Right now is really all about patience. Everyone knows that the Fed will continue to hike aggressively until something breaks, so sentiment is very negative. I don’t want to cram into puts because we could have an aggressive bear market rally at any moment, and I don’t want to cram into TLT calls because I could be wrong about how long it takes the Fed to pivot and how high TLT ultimately goes.

I am fully invested, and I feel that everything I’m in is both cheap and ripe for a major move higher in coming years. I don’t want to use much leverage – either in margin or in call options – because we could easily go much lower; we haven’t even seen forced selling hit the markets yet. So basically I’m waiting. If there is a massive selloff, I’ll nibble at some really cheap mining shares as long as my margin doesn’t get too high, and if there is a significant bear-market rally then I plan to sell out-of-the-money covered calls on all of my positions again.

Best of luck, whatever your strategy happens to be.

About johnonstocks

I've been trading stocks since 2003, active on Motley Fool's discussion boards and using first Hidden Gems, then Global Gains. I no longer have the newsletters, but I keep up on the WSJ and read David Rosenberg everyday at gluskinsheff.com. Education: CFA level 2 candidate MBA-focus in Finance, Marshall, University of Southern California - expected Dec 2010. BS Mechanical Engineering, UC San Diego, June 2002
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