Why the Commodity Bull Market Is Just Beginning

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0:08 So why are commodities cyclical? I think a lot of investors and listeners will appreciate that they are. But what drives that cycle? And most importantly for us today, of course, is where do we sit in that cycle? And I think that's what's so exciting. Because the commodity cycle, although it can be very abrupt and it can be very, very large in magnitude and duration, it does follow some rules when you start to really look at the history.

0:32 And when you follow those rules and apply them today, they tell you that today, unlike 2012, we very much are in the early stages of a strong bull run.

0:49 Welcome to Merrin Talks Money, the podcast in which people who know the markets explain the markets. I'm Merrin Somerset Webb, and this week I'm speaking with Adam Rosenzweig, co-founder and portfolio manager at Goering & Rosenzweig, an investment firm focused on researching and investing in the natural resources sector. Now, both gold and silver have done well this year. We have been watching them. Gold reaching record highs before falling back quite significantly, actually, and natural resources in turn outperforming over the last five years. However, I wanted to bring on Adam to talk about all this because we wonder, are we at the beginning of a commodity super cycle or is the actual cycle kind of over? And what

1:27 happens to gold? It's gone up a lot. Now it's gone down a lot.

1:30 What next?

1:31 So we talk about how he sees the gold price performing for the next 10 years. We talk about how his firm are thinking about oil in the wake of the Iran war, why he believes commodities could still be near the beginning of a major bull cycle. Adam, welcome to Meron Talks Money.

1:46 Wonderful to be here. Thank you.

1:47 Now, listen, I think what I would like to do, if you don't mind, is set us up a little here, because you have an idea about how the commodity cycle works and how you invest through that cycle. So can we just start by you giving us a run through of how your ideas about commodity cycles really work?

2:07 So to give you a little bit of background, we run a natural resource equities strategy, and I've been doing this for about 20 years. And My business partner, Lee, has been doing it for 35 years. And the process has evolved a little bit over time, but really we try to keep it as consistent as possible because it's shown to work fairly well over the cycles. But there was one big thing that we missed, and this goes back about 15 years or so. And I think it informs a lot of the work that we've done since, and I think it informs the way that we think about commodity cycles. And what that is, was that in 2012, We'd had a nice, good, strong bull market in resources.

2:47 We'd seen commodity prices move up quite a bit. And the stocks had done quite well. And some people were saying maybe we're getting close to the end. And we really didn't feel that. And the reason we didn't is because in our core, we're value investors. And although the commodity price had moved up and the stocks had as well, they were printing so much money and doing so well.

3:07 That they were actually relatively cheap.

3:09 And so I think I wrote with the hubris of a 20-something back then that perhaps this is the end of a bubble, but I've never seen a bubble burst at 10 times earnings. And of course, that was entirely wrong because the commodity market was about to roll over and enter into essentially an eight-year bubble. protracted extreme bear market that saw commodity prices fall.

3:32 But the stocks were cheap at the time. So what did we get wrong?

3:34 But weren't there any old hands around at the time, Adam, to tell you that this is just like the chip cycle that you sell when stuff looks cheap because that's when supply is about to turn or has turned?

3:45 The cycle did seem a little bit different.

3:47 We'd had such a bad underinvestment period in the 90s that we were in a bit of a shortage of a lot of things. China was in its period of strong, robust growth. And so it did really seem as though we were going to have good times for some time to come. And again, when you looked at those valuations, they seemed to be relatively modest and certainly.

4:08 Not cause for alarm. But you're right, we did all miss something.

4:11 And I think a lot of the old hands did, and I did as well, and Lee did as well. And what we missed was the capital cycle piece of it. We had had a huge capital investment cycle that really started in the early 2000s and probably hit its crescendo sometime around 2010 or 2011. And that was about to bring online a tremendous amount of new supply. That was true in Australia with iron ore, in Indonesia with coal, and most notably of all, I think, in the United States with shale oil and shale gas.

4:41 And so the commodity price was about to fall.

4:43 And what looked like nine times earnings was about to become 30 and 40 times earnings in Except, of course, the stocks collapsed and spent the next several years in a bear market. So we actually navigated that fairly well. We were sort of down in line with our peers, in line with the indexes. But it really informed this capital cycle view that we've come to appreciate. So why are commodities cyclical? I think a lot of investors and listeners will appreciate that they are. But what drives that cycle?

5:10 And most importantly for us today, of course, is where do we sit in that cycle? And I think that's what's so exciting. Because the commodity cycle, although it can be very abrupt and it can be very, very large in magnitude and duration, it does follow some rules when you start to really look at the history. And when you follow those rules and apply them today, they tell you that today, unlike 2012, we very much are in the early stages of a strong bull run.

5:37 So we need to talk about what those rules are. And what we always say on this pod when we talk about commodities is we always say the solution to high commodity prices is high commodity prices. That's the way it works. Prices goes up, supply ramps up again, prices go down again. And that's just straightforward and simple. And you just have to figure out where you are in the supply chain. demand cycle and you're kind of good.

6:00 But it sounds like you think it's a bit more complicated than that.

6:03 I don't actually. I think that's about 95% of it.

6:06 The one piece that you've missed, however, and that's what's crucial, particularly for investors, is that there's a lag. There's a 10-year lag from when the market gives you the commodity price signal, meaning when the market's in deficit and prices start to scream higher, and eventually that attracts capital into the stocks. Either the companies generate enough cash flow and their multiples are up high enough that you've incentivized them for growth, or they actually do equity offerings and bond offerings and attract new money, and they usually do both.

6:38 And then they start to invest in new projects. And if that supply came online instantly, then indeed the cure for high prices would be high prices and you'd have no volatility or commodity cycles whatsoever. You'd be stuck forever at the essentially incentive price to bring on new supply. But it takes 10 to 15 years. And unfortunately, that number is getting longer. That duration is not shrinking.

7:02 It's expanding. It's expanding for, I think, two reasons.

7:04 First, We've explored and developed a lot of the easy-to-find resource bases in the world. You know, if you look in the 20th century, now the 21st century, we've produced and consumed more in the last 15 years than in all of human history before that. And so, you know, we've found a lot of the easy-to-find stuff. So what we find now is offshore, it's deep porphyries a kilometer underground, it's in remote locations. It takes longer. The second thing is that the environmental concerns have really ratcheted up. And so you now in places, really a lot of places in the world, but certainly Canada, Australia, United States, you have to do a five-year environmental survey just to get baseline readings before you can think about developing a project.

7:47 And people ask me, well, can we compress that? And I said, I'm not sure how you can compress a five-year baseline study. So we do have this long lag between that price signal and when the supply comes on. And in those interim years, Commodity prices move up and they up and up longer and farther than anyone expects because the market's now seeking out the price to squeeze out the marginal unit of demand.

8:10 And we're all very, very, very.

8:12 Price inelastic when it comes to the things that we consume, particularly energy. Eventually, though, you'll hit a point somewhere mid-cycle where you've invested just enough to eventually bring on enough supply to rectify everything. And what happens after that? Well, we're still waiting in the wings for the supply to come.

8:30 And so prices keep going up. And everything from that mid-cycle on, by definition, is excess capital.

8:37 It's too much investment.

8:38 And what that means is that just as the new supply is coming online, just as the deficit gives way to a balanced market, you look behind you and you have a tsunami of new projects still about to come online. And that's what ruins the party for everybody.

8:52 Then, of course.

8:53 We have too much supply. Prices collapse. Everyone writes off the industry. Money flows out. It's a very manic industry. People either think it's the cure for all of their ills or they say, I swear it off forever. And eventually depletion takes hold and the market ratchets a little bit tighter. Everyone extrapolates the negative trends that have been going on and they miss the turn. And that's where we like to focus is right in that turn when things seem bad but are actually getting better.

9:20 And then occasionally you get what you call a super cycle.

9:23 Right.

9:24 And that's, for example, the great super cycle in our investing lifetimes was the one with China's urbanization, when suddenly the amount of copper and steel, the amount of energy being used in China went beyond all expectations. And that was a really fun super cycle to be invested through. Right. Yeah.

9:39 Look, I do take issue.

9:41 And I've said this in the past with the term super cycle, because on some level, what it's trying to do is suggest that something other than a cycle, you can have a big cycle.

9:50 What's wrong with super cycle? Why is super cycle worse than very big cycle?

9:54 Well, I think that the problem is when people hear the word super cycle, they feel that this will go on forever. It's somehow a new paradigm and a new regime. And like you said, eventually, high prices do cure high prices. But the problem is all that time in the middle where investors can create a huge amount of value by appreciating where they are in the capital cycle. and appreciating how big and long it can last. Because we're all long-term investors or claim to be. But even a long-term investor, a 10 to 15-year cycle, that's investable. That's not a trade.

10:25 Okay. So then that sets up the scene for us gorgeously. Where are we now?

10:43 Well, as you might expect, since I'm vocal about this type of work, we are at the bottom of this super cycle, if you will.

10:52 Your words, not mine. This very large cycle, in my words.

10:56 I just know that you're going to keep saying the phrase super cycle over and over again for the remainder of this pod and then desperately correcting yourself. I think I've won the super cycle. I've won that argument.

11:05 I think you might have. I'll concede.

11:09 We're at the very, very beginning. And what we use to measure that, I mean, we use a couple of things, really. You know, you can look at CapEx trends across the industry. In many cases, like you take oil, for example, and we're spending about $ 500 billion a year upstream. First of all, I don't think that's anywhere near enough. But in real dollars, I mean, you're far off peaks. You're certainly not making new highs by any stretch, and you're not at the same level as you were in the last peak of the last cycle. However, the one metric that we think is incredibly, incredibly helpful is simply to look at the ratio of between commodity prices and stock prices. Now, on the surface, that sounds like just a straight valuation call.

11:56 But actually, it tells a little bit more. So the ratio is low and falling. What that's telling you, not only does it mean that stocks are doing better than commodities, but it likely means that capital is being sucked out of the extractive sectors. and obviously going to the broad indices, which we know today is dominated by tech. And vice versa, when commodities are far outpacing stocks, it's probably not a great time for stocks. It's certainly a good time to be a real asset investor, and it means that money's flowing in. So it's actually a good proxy for the capital cycle as well. And what's nice about that ratio is that it moves in a very predictable band. The highs are always around the same level, give or take,

12:35 and the lows are around the same level. And it paints this picture of And I have to admit, we stole the chart. We stole it from Jeffrey Gundlach, who in turn stole it from Tony Beck at BCA Research, we later found out. And Tony is a friend of ours and a friend of the firm. So we feel at least we're, now we're just borrowing it. We haven't really stolen it, borrowing it from a friend. But what we did that was a little bit different is most of those charts went back to 1970 and they showed a cycle and a half. And we extended it back to 1900, which was fairly easy to do actually, because commodity data goes backwards. in some cases, thousands of years, longer than stocks and bonds, that's for sure. And we

13:12 were able to see that the cycle repeats several times. And it has a very, very large amplitude, and its duration is always about 10 or 15 years. And based on that measure, the only time we've ever been cheaper was when commodities bottomed in 2020. But if you take that out, you still are not at the lowest low from any other cycle. And that's what's so exciting here, because this is very, very early.

13:34 So when... You talk about commodities. What are you talking about? You're talking about obviously precious metals. You're talking about industrial metals. You're talking about energy. Are we including agricultural commodities in there or do we look at those as a separate sector?

13:50 So if we think about our remit and our mandate, we include all of those. If you talk about the chart that I just described to you and your listeners, that ends up taking it's based on the GSCI commodity blended commodity index, which takes a essentially their version of a market cap weighted. So, of course, commodities don't have market caps, but they do have a size of the traded market. how much volume times the price and so they set that weight at a fixed level and they let that be the weights of the individual commodities so that's what's really really cheap and of course you're right every commodity within the commodity complex really has its own capital cycle and if you have a big investment boom

14:32 in lithium that has nothing to do with how much copper you're going to bring on or how much uranium you're going to bring on so you do have to look at it commodity by commodity now i will say that oftentimes what intrigues investors about commodities or what turns them off about commodities tends to be the fact that they benefit in volatile environments, the fact that they're perceived to be good inflation hedges, and they tend to work when other things don't. So we do see similarities across capital cycles. And what I mean by that is what's going to attract people to copper, iron ore, and oil, there's some similarity there. People want that real asset component.

15:12 And so there's a similarity to those cycles. But there's many times where you get sort of offsets or delays of one cycle versus another. And lithium, I think, was a great example in the bear market and commodities when everyone sold all their commodity exposure down to extremely low levels. There was a view because of ESG that lithium would be a growth area within commodities and it could be green.

15:36 So we saw people devote all their time and attention to lithium and lithium had a capex boom while everything else had a capex bust. And that's, I think, why lithium is performing so poorly now in what should be the beginnings of a good commodity cycle, because it had it several years ago.

15:53 All right.

15:53 Well, let's try and break it all down a little bit then. And I want to start, although I know you're not going to say what I want you to say, I want to start with precious metals, because a lot of our listeners are very keen precious metals investors, and we talk a lot about gold, and we talk a lot about silver. And obviously gold had that fantastic bull run and now things aren't going so well. In fact, down quite a lot year to date. Where are you on gold and silver?

16:17 I don't think that the gold bull market is over. I think that we're going to make new highs this cycle. And if you think that the commodity cycle started in 2020 and that it's been a little bit slow to take off with CapEx trends. So let's say it's 10 or 12 years from now, 15 or so years from the beginning. By 2035, if your listeners would like to hold their gold, I suspect they'll be very happy that they did so. But I do think that there'll be a better market. entry point before then. I think gold will move lower before it moves higher. And why do we think that? Well, a couple of things happened earlier this year that made us a little bit concerned. So when we talk about gold and we say, is gold

17:04 expensive or is gold cheap? The question, of course, is relative to what things you have to compare it to other asset classes relative to things. Gold looks expensive and relative to financial measures. Gold looks really cheap. So, okay, that's great. What on earth do you do with that? Well, if you're investing in a portfolio that can do, to simplify things a great deal, gold or oil, it means that oil will probably outperform. Indeed, the gold to oil ratio reached an all-time high back in January, where a single ounce of gold could buy 90 barrels of oil.

17:38 And historically, if it could buy as much as 30 barrels of oil, you wanted to move from gold into oil. Now it got bought in the 90s. It's unprecedented except for COVID when oil went negative and the ratio went to infinity.

17:49 That was one thing.

17:51 The second thing that concerned us a little bit was that we did start to see speculative accumulation of gold last year, particularly in the West, not so much in the gold stocks. You didn't see big inflows. They were strong performers, but not because lots of people rushed out to buy them. But gold bullion in the form of the GLD and these other ETFs, we did see quite a bit actually of investor interest.

18:16 And money flow into that.

18:17 And of course, Western investors are very often trend followers. And we said, well, that's a bit concerning because if gold falls, we could see massive liquidation. There could be a lot of gold for sale on the markets if the gold price falls. Because clearly, if the price falls, people want to sell. And if it rises, they want to buy, counter to what they might claim in private.

18:37 So that worried us. And then the third thing that really, really was our impetus, I think, for selling down a lot of our gold, because we had close to 30% of the portfolio in gold last year. And we took that down to 5%.

18:51 When you say in gold, you mean in gold mining stocks?

18:54 Gold mining stocks, yeah. That's what we focus on.

18:58 And the big kind of catalyst and trigger for us was the silver, what we call the silver catch-up ratio. And this was work done by my partner, Lee, which I think is really interesting and original. Most gold investors identify a strong silver price as the sign that you have a robust precious metals rally. So they'll say, for instance, every time you get these big gold rallies, these gold bull markets, silver outperforms gold.

19:27 Well, there's a little bit of.

19:28 A wrinkle to that because actually what happens is the gold bull market starts and silver lags for sometimes years. And the lag can be very, very big and can frustrate a.

19:40 Lot of people.

19:41 And then typically silver will stage this massive catch-up rally. So if you only focus on that catch-up rally, yeah, silver does much better than gold. If you zoom out a little bit, they actually tend to perform from the precious metals bottom. They tend to perform about the same. And there's another kind of corollary to that, which is when silver does stage its catch up rally. That is your great signal or indicator to maybe start to reduce your exposure to both because both tend to pull back after that.

20:10 So whereas everyone says.

20:11 You need silver for a robust gold bull market, I say, and my partner Lee says, when you see the silver catch-up rally, that's when you want to look for higher ground and maybe rotate. So we definitely had that in January after lagging for three or four years, silver caught it all up. And so I think we're now in this period of a gold retracement within a broader bull market.

20:30 And we also had a slight pullback in central bank buying, didn't we? Because that was one of the big drivers of the early part of this gold bull market was that there was a huge new buyer in town and it was the world's central bank. So we've now pulled back from that a bit.

20:43 You're absolutely right. There was really two central bank changes that occurred around that time. The first was, as you said, there's a little bit of a buyer's pause in central bank buying and they've come back and there's maybe a bit more volatility. But I don't think actually that that trend is over. I think all the motivations for central banks to want to diversify on the margin away from the dollar remain. I don't think that the geopolitics have become calmer since January, certainly. But I think that the big change that happened around then was the fact that with Warsh coming in as the Fed chairman, the last kind of rise in gold, that last blow off rise, was really driven by the view that Warsh was going

21:29 to deliver two to three cuts. And finally, President Trump was going to get his cuts that Powell kept away from him for however many years. And that I would argue that that was already priced into gold.

21:43 In fact, we had this debate.

21:44 We said, I bet if you were to get a rate cut tomorrow, gold would sell off because so many people had bought in anticipation of exactly that. And we had this view and we wrote about it, actually.

21:55 So we're in print. You can go and see.

21:57 In January, we said... I bet we get hikes later this year. And everyone said, well, why on earth would you think that? And our extremely sophisticated analysis was simply this. When everyone is expecting cuts, more often than not, the market does what punishes the greatest number of people. And so we said, what's not being priced in a hike? Now, of course, because of the Strait of Hormuz and persistent inflation, We've had those. So we're in a rate hike cycle right now. We're at the beginning of that. And the question to gold investors that I would posit is, do you feel that gold has sold off enough that it's already priced in two to three hikes? We've had one, maybe we get two or three more from here. Has

22:40 that already priced in? If Warsh came out tomorrow and announced a surprise hike, would gold rally? Would people have shorted gold into it and now cover on that news? I think the answer is no. And in fact, when Warsh did deliver his first hike, gold did sell off quite sharply. So I don't think that's priced in yet.

22:58 And I suspect when you look at what a normal retracement of gold after the silver sell signal comes in, et cetera, you typically will move down anywhere from 20 was the most mild pullback to 45%. And on average, it lasts about two years. And so now we're sort of nine months and 20-ish percent into it. And so for gold to bottom here, it's possible, but it would be tied for the shallowest retracement we've ever seen since 1971 when gold free floated. And I suspect it has lower to go.

23:32 I mean, I suppose it's some slight pushback to that view would be that at the moment, some people look at gold as protection against financial repression, which seems to be one of the few ways that we'll be able to deal with that. high levels of public debt. And if you're in Europe, you're looking at potential fiscal crisis in, say, France or the UK. You might want to keep gold in your portfolio as insurance against all that.

23:57 Well, and I have a very difficult time arguing against that. For people, like I said, that are looking for gold as a ballast that's going to stay in their portfolio for the next 10 or 15 years, I suspect that you'll be very happy that you did so. However, given that we're still in this rate hike cycle, given that A lot of goods and services, notably oil for us, because that's one of the big decisions we have to make, is essentially at record cheapness relative to gold. And given the fact that there's still a lot of metal in the ETF and it's now shedding, the question is really a probability one. Do you think that those factors point to the shallowest contraction within a bull market ever? I would say not. But if you're willing to take another

24:43 down 20 before you double... from the old high. So let's say we think gold eventually goes to $ 10, 000 an ounce. If you're willing to take a down 20 or 25 before you get the double from that 5,000.

24:58 Then keep it.

24:58 And I think for a lot of individual investors and even some institutions for whom gold is a constant weight in the portfolio, I can't argue with that at all. For someone that has a two-year tactical view, I'm not talking a 30-day tactical view, a two-year tactical view, I think the probability suggests that you'll have a better entry point.

25:18 So, I mean, the key point here is that you're running an active commodity equity fund and other people are running long-term retail portfolios of their own. So, it's a slightly different priority. So, excellent. That's very clear. So let's move on then to oil, because we're all getting a bit confused. What's going on in the oil market?

25:47 Oh, nothing. It's quiet and calm as can be.

25:50 And we now hear, of course, I mean, interesting news from various sources that the exports from the Middle East are now pretty much back to where they were, give or take a few percentage points here or there, before this conflict began. So the bottleneck is no longer pure exports from the Middle East. It's more refining capacity and distribution.

26:08 So- Let's get into it, shall we? Let's again take a sort of shorter-term view and a longer-term view. So on a longer-term view, the important thing that's happening in the energy markets today is that the shales have slowed down, and they're essentially no longer growing. And if you go all the way back, really to the beginning of the age of oil, we've had three moments where the main driver of growth from supply, I'm talking, up until that point was suffers challenges and it stops growing. Now, I should point out, you know, that's very much a Hubbard's peak style view. And we believe in a lot of the work that King Hubbard did over the years. But I do think that those views get a little bit distorted sometimes. And people think that it's sort of this

26:55 doomsday call that we're running out of oil.

26:57 Not everybody will know about Hubbard and the peak oil idea. So maybe can we have a couple of sentences on that?

27:03 Absolutely.

27:03 Thank you.

27:04 King Hubbert was a shell geologist. He worked for the Shell Oil Company in the 1940s and 1950s. And he put forward these views that essentially, I mean, they seem so simple on their surface, but they're highly controversial.

27:19 He said that any.

27:21 Oil field that you look at, whether it's a well or a field, let's talk about a field or a basin, will exhibit a moment where it doesn't produce anything. It'll then ramp up and production will grow and grow and grow and grow. And then eventually you'll run out of that oil. And so production, if you've run out, has to fall and it essentially has to fall quite sharply.

27:41 And so you can then appreciate that there's a moment there that has peak production. And the question is, how does the size of the field, the oil in the ground, how does the size of that field correspond to where you get the peak and how big the peak is? Because, of course, everyone appreciates that if you have a finite resource, it doesn't produce forever. I think that's the definition of a finite resource.

28:04 So the point is.

28:05 That at some point, there is a moment of peak oil across the board and the supply of oil declines from there.

28:12 That's right.

28:13 And when you say across the board, he's really talking basin by basin. He never made claims that you would hit a global peak because you could bring on new basins. But every basin would exhibit this curve that ramps up, peaks, plateaus, and rolls over. And what he sort of added to the literature was trying to make estimates by looking at how big he thought each field was and making a prediction as to when that field would roll over. And it turns out that there's a very, very strong connection, as you would expect. You know, if you found a little pool of oil in your backyard, you wouldn't produce at 10 million barrels a day for six minutes and then it would go away. You would produce at 10 barrels a day for X number of years. And if

28:51 you found something that was a billion barrels, it would hit a higher peak and ultimately produce more. And so the size of the field corresponds to how and when you peak that out. And so he made a prediction in 1955 that 1971, the US, which had only ever grown its production year on year, would roll over and begin a period of decline.

29:10 And it did that. And so for 15 years, people debated it.

29:13 Then it happened and he was vindicated. And that brought on the first oil crisis that essentially took oil prices up 15 fold. Now, I should point out on a global basis, In the 1970s, we continued to produce more oil. We didn't run out of oil as a civilization, but the single biggest driver suffered a challenge. And that's all it takes to tip the scales in the favor of the bulls in the oil markets. So then what happened? Well, in classic capital cycle investing, it created a huge oil exploration boom. We brought on the North Sea and the Gulf of Mexico in the 1980s, and oil prices collapsed all the way back down to $ 11 by 1999. My partner, Lee, in the early 2000s made an estimate at when the North Sea and Cantarelle might roll over. And what's so

30:00 interesting about commodity markets is that the cycles are so long. And you brought this up at the beginning. It was such an insightful comment. There's very few people that remember the last cycle. If the cycle was five years, you'd have more institutional memory. But because it can be 20 years from peak to peak, you ultimately lose that connectivity with the prior generation. They're long gone. And usually they don't have quiet retirements. They have big blowups and they're fired.

30:26 And so nobody bothered to look at a Hubbard style. Hubbard was relegated to the dustbin. But we did an analysis and we said that the North Sea and Cantarelle were going to do the same thing. that the US did in 71.

30:39 And they did.

30:40 And I would argue that was a big reason. You talk about China. Yes, China was a big growth driver. But the slowdown in those two large sources of growth, they represented about 70% of all the growth in the decade prior. The slowdown of those fields was enough to tip the market into deficit. And all of a sudden, prices were at 145.

30:58 What did that do?

31:00 Another spending boom, this time the shales. The shales brought on the equivalent of two and a half Saudi Arabias in a country with good rules of law and deep capital markets. It was an unbelievable bonanza, probably the most important energy find. Probably it'll go down in history. And nobody, nobody, nobody ever bothered to ask, will they run out too?

31:22 And that's what we started to study in 2019, 2020. We built a big neural network before everyone had one.

31:29 We had one before they were cool.

31:31 And we used our neural network, which we trained ourselves, to just study a very narrow topic, which was oil productivity in the shales. And we concluded that the shales would still grow. but that the growth would begin to slow. So every year we would grow, but we would grow less. That hadn't happened so far from the shales to 2020.

31:51 Every year grew more than the year before. And for the first time, we said on a sustained basis, growth is going to slow. And that's exactly what has been happening from 2020 to 2026. And now we're actually flirting with negative on a year-on-year basis. Okay.

32:06 So you think shale has peaked?

32:08 Shale has peaked.

32:10 It's possible always that you could get another small bit of growth. It's possible that if you had a real energy crisis and a spike in prices for six or eight or 12 months, you could have production grow again. But look what happened in the 70s. Oil went up 15-fold and the US lost 30% of its production. It wasn't for a lack of trying. All the energy companies had a bonanza. They had a great time of it.

32:36 They went out and They drilled four times as many wells through the 1970s than they were drilling at the beginning, but it wasn't enough to arrest the declines. I think that's what we're facing with the shales.

32:46 Okay, so long-term, that's very interesting. So we're hitting another one of these peaks, and that could be the trigger for this long-term bull market in oil.

32:56 I think that's exactly right.

32:58 Even with the endless conversation about the energy transition and decline in demand for oil, etc., none of which has actually happened, but which conceivably could happen.

33:08 The full cycle energy efficiency is horrible. And that's why countries are having a very difficult time. apart from virtue signaling or outright subsidizations. So outside of that, we're starting to see a little bit of a hitting of a wall with straight EV penetration outside of China. China has a very different goal. China is looking to get off of its dependence on imported crude. So I don't see that as a long-term problem. And of course, it's not showing up in the numbers, right? Crude oil demand growth has been fairly steady at about a million barrels a day, year on year. And that's pretty much the long-term run rate as well.

33:41 Let's look short term then. What is going on short term?

33:45 Short term is all about the Strait of Hormuz, as we all know.

33:48 And so when the Strait of Hormuz closed on March the 1st, you know, we were one of the first to come out and try to quantify its impact.

33:55 And we were maybe.

33:56 Naive and we said, let's say it stays shut for 100 days and we lose 10 million barrels per day. And when I say lose 10 million barrels per day, I mean the fields have to be shut off because there's nowhere to put and move the oil.

34:09 Right.

34:10 And that's what happened. We lost 10 million barrels, except it wasn't 100 days. It's 215 days or so and counting. But we said on 100 days at 10 million barrels, that's a billion barrels lost. And we don't have a billion extra barrels sitting in inventory to make that up. And as a result, we're going to have a major problem.

34:29 And we cautioned people that we could hit tank bottoms, meaning we run out of inventories sometime throughout the summer. And JP Morgan said the same. So we weren't alone in saying that. And the numbers were fairly straightforward. And now here we are, the big question and the big mystery in everyone's mind. is after 215 days, we haven't hit tank bottoms twice as long as we had expected this to last.

34:54 What's going on?

34:55 And I think the bears will say it proves that the oil market was in a huge surplus at the outset of this crisis. It shows that we were more resilient, right?

35:06 We had more.

35:07 Supply sloshing around than anyone expected for us to be able to withstand that. And I'm not so sure that's true. I think we are in the midst of a crisis as we speak. I think that crisis is getting worse. It's just not happening in an area of the market that anyone has much visibility into.

35:26 And I'll tell you what I mean by that.

35:28 So if you kind of read the headline numbers, The reason this 10 million barrel a day of shut in productive capacity hasn't resulted in a crisis is because demand apparently has fallen by 6 million barrels per day. So, yes, inventories have fallen and that makes up the rest of it. But six out of the 10 million lost barrels was made up for by demand that has been destroyed. Now, I don't think that's true. Six million barrels a day is massive. That's worse than what we lost in the GFC.

36:02 That's on par with what we lost during COVID when the whole world shut its mobility. And yes, people are worried about a recession and economic hardships, but for the time being, GDP prints are positive pretty much everywhere in the world. And I certainly don't think anyone feels that the true underlying industrial and productive economy today is as bad as it was during the GFC, nor do I think that anyone thinks that from a transportation basis, were as restricted today as we were during COVID. So why would we think that oil demand is down 6 million barrels per day? And this might shock your listeners, but nobody.

36:41 They're unshockable, Adam. They're not.

36:44 I'll try.

36:45 I'll show my readers.

36:46 I'll try. Nobody measures oil demand. It's not a measured number.

36:54 Nobody goes and looks at how much gasoline is going into gas tanks and jet planes and etc. What they do instead is they model it. And the biggest source of their model is refinery inputs. So it's much easier to look at the massive crude intake pipeline going into a refinery than it is to count the millions of cars that consume the product coming out the other side.

37:20 And look, for the.

37:21 Most part, that is a completely reasonable way of going about things because refineries really are not in the business of running crude that no one needs, right?

37:32 They don't speculate. maybe a little bit, they.

37:34 Have trading desks, but in general, right, they run what the market is demanding. And so if there's a lot of demand, they ask for more crude. If there's no demand, they ask for less crude. They collect the crack spread or the spread between the diesel price, the gasoline price, and the crude oil barrel is their margin in the middle.

37:51 So if you think about what's happened to refining since the war started, we have lost, surprise, surprise, precisely 6 million barrels of refining capacity around the world. Two of that is in Russia, where it was destroyed by Ukraine. Two of that is in the Persian Gulf itself. And then the final 2 million barrels has taken place in China.

38:14 And that was a policy decision. It had to do with the fact that they wanted to cap the gasoline and diesel price for domestic consumers. So we lost 6 million barrels of refining, and that's why people think we've lost 6 million barrels of demand. But I don't think the consumption of those refined products has gone down It's just the refinery runs have gone down.

38:35 OK, so this all makes sense. The demand for oil is down, but that is only because refining capacity is down. So the supply out of the refiners is down. And that is why the price of diesel and petrol is rising, diesel in particular, obviously. So it's a falling demand for oil because of refinery capacity and therefore a limited supply of the finished product coming out the other end. So how are you investing then at the moment? What equities are you buying to be in this part of the market?

39:16 So I think at this point in the cycle, and look, I'll be completely upfront. We ought to have been in the refiners since the beginning of this crisis.

39:25 We were not.

39:25 We've been, we ultimately figured that the companies that will benefit the most will be the crude oil producers themselves. Because look, eventually we have a crude oil problem. We shut off 10 million barrels of crude production. That's the problem. And so eventually the crude oil price will lift. It's being masked now by what I would call this logistics in the middle. We didn't appreciate how long and how severe that could be. So we're in the upstream molecule.

39:53 Certainly today, even if you were smart enough to have bought the refiners, today I think what you should be doing... is rotating from the refiners into the upstream companies. Because I think you asked what happens in the next six months. $ 200 diesel, maybe that stays there, comes down a little bit.

40:10 But the big thing that's going to move is $ 100 crude is going to come up to match that. There should be a $ 20 gap between those. You're now at $ 100 gap. That's $ 80 of crude price rise that would happen if those refiners turned back on. I think that's the path forward. And in that environment, who benefits? It's the oil producing companies and particularly the pure play companies with long reserve life. So we really like the oil sands.

40:37 Suncor and CNQ are two big holdings of ours. I think those are very, very well run companies that have 100 year assets, essentially.

40:45 They almost never decline.

40:47 The capital has all been spent And they will be the biggest beneficiaries from a rise in the crude price.

40:52 What about your shells and your BPs?

40:55 You have to be a little bit more careful.

40:56 You know, some of those companies are obviously most of them are all integrated, meaning they have pipelines and refining businesses as well. So I don't think they will participate quite properly.

41:06 Quite as much.

41:07 I think their prices have rallied a little bit more already because of the refining. And I think, you know, if the crude price rises sharply, they're going to make a lot more money upstream and they're going to earn a lot less money in their refining. And that's going to somewhat net out a little bit. So you have to be a little cautious there. I think that owning a large integrated oil company here, if oil goes from 100 to 200, you'll probably do well. The question, I suppose, is could you do better in a name that's a little bit more of what we would call a pure play on oil?

41:35 Let's look at some of the other metals. You talked about there being separate markets for these. So lithium, obviously not participating in this in the same way. What are the interesting metals, for example, to look at at the moment?

41:48 Well, I think the most interesting and we can debate whether we call it a metal or whether it's an energy source. I mean, it's obviously both. But uranium, I think, is going to continue to move much higher. And to give a little bit of context, we started our uranium odyssey this cycle. We've been investors in the past, but this cycle, we got it right.

42:06 At the bottom.

42:07 It was $ 18 a pound. It's just going to be, I think, continuously steady up and to the right. is punctuated by these moments of retail and hedge fund euphoria and massive pessimism. And we've seen a couple of these cycles already. We've seen there's a huge Twitter and Reddit group devoted to uranium, and the hedge funds love to play it on the long side and on the short side.

42:30 And so the way I like to think about it is you have this trend that's up and to the right. And in a lot of ways, it's probably the easiest to understand commodity market that we have. It takes a long time to bring on supply, a long time to bring on demand. You have good, clear visibility, and it's going to be a tight market. However, it's punctuated by these moments of unbelievable euphoria and then pessimism. And so you're going to get these oscillations around an upward trend.

42:59 So you can either try to hold on and just stomach that volatility. You can try to trade it. The problem is, of course, they don't ever ring the bell at the top and the bottom of those mini cycles.

43:11 So we just like to hold it.

43:12 And when you hold it in as an equity, what are you holding?

43:16 Well, that's an interesting question because there's not a lot of companies that are producing today in any real size. We own Cameco, which is the big bellwether up in Canada. We own Kazatomprom, although much smaller. That's the Kazakh uranium producer. We've been comfortable with that governance and country risk for a long time. But there's a few things that are giving us a little pause there right now. There's been some changes to the tax regime that's not the right direction.

43:44 There has been, obviously, Kazakh uranium has become a little bit more of a hot button issue between the Russians and the Americans. It sits right in the middle of the East and West to some degree. And then the third thing, which is probably the most important, is that the geology of their assets has actually started to deteriorate quite sharply. And so I don't think they have quite the exceptional assets they did five years ago.

44:09 So you can own those.

44:10 Then you have to move into the development companies, the next-gen denizens. They don't produce anything yet, but they'll be probably the first to do so. There's a few smaller companies in the U.S. that have some really interesting projects, but they're smaller and more speculative. And then you have the SMR companies or the small modular reactor companies. These are the companies that are going to build the next generation of nuclear reactors.

44:33 And the problem with them is- We're.

44:34 All very, very excited about those. Don't be too pessimistic because we try to be excited about those.

44:39 Well, I think that the technology is excellent.

44:41 I undertook a very big research project a number of years ago to really go and spend a lot of time in the labs of all these companies. And some of the work that's being done by some of them is extreme. That will be our next generation of nuclear reactor. Others are a little bit more of hype and hope.

45:00 And the problem with the publicly listed ones right now is that they're awfully expensive on sort of the promise of revenue sometime in the 2030s. So I would stay clear of them for the time being. You will have some winners. My personal belief is that the company that will win and dominate that cycle is.

45:19 Actually not publicly traded right now. It's Bill Gates' TerraPower. Back to the company, it's still private.

45:25 So we don't invest in the SMRs, not by a mandate or rule, but just for the time being, I don't think they're attractive. Yeah.

45:32 Is there anything you're invested in that has projects across the board? A generalized commodity company, you can say, do you know what, if you just want to have a one hit company that'll cover you for the commodity super cycle, what would it be?

45:46 Well, two different questions. The first answer is no, we don't.

45:49 And the reason we don't is that we've always found there to be more value in going into a little bit more targeted pure play companies, right?

45:55 BHP, Rio, Glencore.

45:58 The way that they manage commodity volatility is to have 20 different product lines. And if I had to create a private company for my kids and grandkids, that would be a really good way to do it. But it's never going to give you the upside capture if you get that oil call right or the copper call or the uranium or whatever it's going to be. Typically, we stay away from those. I would suspect for investors not looking to invest in a resource equities fund where someone is going to actually go and do the work to find those, and for someone who's not unduly passionate about the space, you'll enjoy good returns still owning a collection of those super majors. I just think there's probably better targeted ways to get exposure, and that's what we focus on.

46:44 Fair enough. And inside a portfolio, this is not necessarily a question that you'll have a ready answer to, given that for you, of course, the portfolio is all commodities. But in an ordinary retail portfolio, In a cycle like this, what kind of percentage of the portfolio would you say should be in commodities one way or another? And we often ask this question about gold and we get told anything from, you know, 4% up to 15% of a portfolio should be in gold. So we still don't really know the answer. But for commodities as a whole, what would you say?

47:15 Look, I think there's been a lot of work that's been done on what the optimal commodity allocation has been. Now, the problem with that, of course, is that commodities move in these massive, massive cycles, so it very much depends if your look-back window is in the bear market or the bull market.

47:31 If it's in the bull market, it'll tell 25%. If it's in the bear market, it'll say 5%.

47:35 Let's split the difference and call it probably 10% to 15% across the entire cycle. At the bottom of a bear market, like what I think we're still at right now, could you argue for a little higher? You could, but the thing that everyone needs to remember is that the reason that this is such a shied away from area and the reason that it creates these, what you can only call our inefficiencies over decades, is because it's very volatile.

48:08 It's very, very volatile. People often don't like that. I would size it not to the opportunity, I would size it to the risk tolerance. I suspect for most investors, 10% or 15% is okay. If you're comfortable with the volatility and you appreciate that we're at the bottom of a cycle, and somebody told me they had 20% to 25%, just be prepared for those drawdowns.

48:29 But you probably will end the decade happy you have that.

48:32 There we go. Brilliant. That's what we want. We want to end this decade happy. Adam, thank you so much for joining us today. I really appreciate it.

48:39 Thank you so much.

48:40 This is great.

48:44 Thanks for listening to this week's Merrin Talks Money. If you like our show, rate, review, and subscribe wherever you listen to your podcasts. And keep sending your questions or comments to merrinmoney at bloomberg.net. You can also follow me and John on X. I'm Merrin SW, and John is John underscore Stepak. This episode was hosted by me, Merrin Somerset Webb. It was produced by Sam Asadi and Moses Andam.

49:05 Sound design by Blake Naples. And special thanks, of course, to Adam Rosenzweig.