Contrarian Commodity Opportunities & Where Risk is Most Present Today
Turning over stones in an already hated commodity complex + Where we see the largest pockets of risk today
Introduction
As allocators be it in our own personal accounts or on behalf of our clients two questions that cannot be ignored are where should capital be deployed and where should I avoid?
While these are questions all of us in the investment business wrestle with how we determine what is attractive and what is risky is a mosaic and, in our view, does not have a single “correct” answer.
When it comes to where we at TDC want to deploy capital it is in businesses trading for significant discounts to replacement cost, with no known catalyst for a turn in the underlying business. This typically manifests itself by getting involved with companies that are losing money, potentially overleveraged, or just recently emerging from a bankruptcy.
This process guides what we invest in but not where we hunt for ideas. What I mean by that is we let the opportunity set drive where we hunt for value, not a mandated sector or industry for the sake of it. Our process since 2019 has led us to the tangible world focused on commodity/industrial businesses that have underearned their asset base for a long period of time with many losing money and losing investor attention entirely.
In 2019 we identified industries like oil services as attractive places to deploy capital and watched the majority of the industry go through Chapter 11 over the next two years. During that time, we got excited.
The question we ask ourselves is not what is hated today, but what is being totally ignored. By definition, the investment wins of tomorrow are not being identified by the masses today for if they were, prices of the underlying equity would be substantially higher.
The goal of this piece is to lay out three completely ignored/ forgotten about industries that we are finding value in today that are off the radar of even the value commodity people we speak with regularly.
This is not going to be a piece on oil related equities as we feel the shift in the narrative has already begun and while the equities are still dirt cheap, most folks have already formed opinions on oil. In addition, this will not be focused on Gold, Copper, or Silver as again, plenty of investor attention has been spent on these industries.
What we will instead point you two are three industries that have all of the attributes you want in an investment opportunity which include, cheap entry prices, consolidating industry, consolidating capacity to right size supply with demand and a critical product that is not able be substituted.
The next part of this thesis will be focused on where we see the biggest pockets of risk in the market today. Areas of the market where capital has flocked too for far too long that will end in tears, as all of these things do.
It is important to note that when we point out risk in the market/industry we are not saying there are no businesses or pockets of the larger asset class that will not perform well - what we are simply saying is the risk is high and a simple appeal to the base rate leads us to believe that mean reverting activity will destroy a lot of investor capital in the next decade.
The themes that were tailwinds for a number of these risk exposed asset classes are beginning to reverse, and a significant amount of capital has been misallocated predicated on backward looking projections of a changing world that is shaping up to look much different tomorrow than it does today.
We think there are major political incentivizes to keep this current cycle going with no president in recent memory being interested at all in growing actual GDP. The last time we saw real GDP growth in this country was 2022 and inflationary pressures were high, stocks were pounded and commodities went gangbusters.
It seems obvious to us that the only way to get back to a more normalized environment in equity markets is going to have to come from a shock in the global system - coupled with investors being slow to adjust to the reality of what happens on the other side of this crack in the foundation.
When we talk about a shock, we are aware that there have been shocks to the system post 2008. These include things like interest rate hikes in 2022-2023, Russia/Ukraine War, Covid-19, Israel & Gaza, US & Israel v Iran today etc. The difference we are pointing out is that when these events occurred the prevailing narrative is that these are events to be “faded”.
If oil spikes, we fade it because it will be temporary, if inflation spikes, we fade it because it will be transitory, and if it isn’t we will just inject liquidity and backstop the system to make it so. We think this has sucked a lot of people including very thoughtful market analysts into assuming a back stop to nearly any event that moves us from the norm which is, low inflation coupled with large cap outperformance and passive flows dominating the market.
We believe that a structural shift is underway and what asset classes are attractive today and which have the greatest downside risk is an exercise we think is value add to our readers. With that said, lets dig in.
The Unloved Among the Unloved
