Base Metal Bull Thesis
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Preface
For this week’s edition, we’re going to try something a little different. I have recently become very big on the long-term commodity bull thesis, in particular base metals. These base metals, specifically copper, cobalt, and nickel, will be needed in an ever-increasing quantity for many years to come, while at the same time, it seems as if supply may become more and more constrained. I believe this presents a great opportunity to get in on the development of the whole globe and its infrastructure, with the added bonus of acting as an inflation hedge. That said, I have not figured out a company, or companies, that I want to express this view through. Rather than discussing a specific company, for this week we’ll go through a high level overview of the thesis.
Overview
Over the medium-term, say 2-4 years give or take, base metal spot prices will more than likely stay relatively stable, or around historical norms. Of course, this is up for debate and volatility is all but guaranteed. More critical to understand is the dynamics that bring legitimacy to this shot-in-the-dark prediction in the face of a significant expected increase in demand. This is because miners are leaning more heavily into extracting these base metals and drawing down reserves to meet today’s demand. As nearly all free-market products are, commodity prices are determined purely by supply and demand. The key difference between producing commodities and these other free-market products is that the commodity businesses own an inherently depleting asset. This means that the more the miners produce now, the less they will be able to produce later. Even today, the start of this trend is becoming more evident as global inventories are drawn to help meet the increase in demand. On top of this, the mines that are mined earlier are of course the most cheap and easy to operate mines. Summarized, these dynamics have set up a major pull-forward by the supply side in order to meet short and medium-term demand, creating an issue, or opportunity, depending on who you ask. Over the long-term, 5+ years, as the world becomes more populous, more rich, and more electric, the demand side will only need more and more of these base metals, while at the same time, the miners will have less capacity, which will be both harder and more expensive to produce.
More Populous
Today, the world’s population is approximately 7.9B. While some of the more developed nations are beginning to see slowdowns or even shrinkage, this will be more than offset by population growth in other parts of the world. While today the United States is the third most populous nation in the world, behind only China and India, some estimates have it slipping as far as sixth by 2050- despite a continuously increasing population. An aside for those that are wondering; The other three nations in contention to surpass the United States in population are Nigeria, Indonesia, and Pakistan. By most estimates, the world population in 2050 will be approximately 9.7B, an increase of nearly 2B people. The buck doesn’t stop here though, the world’s population is expected to continue to grow, reaching more than 11B by 2100 according to some estimates.
More Rich
Just as important as population growth is that the population, as a whole, will become continuously more wealthy. As many undeveloped parts of the world join the developed world, their attention, and spending, will shift from basic necessities to increasingly more aspirational goods as the ability to spend on discretionary items increases. With this, comes the need for more and more base metals. Everything from cars, planes, houses, infrastructure, telecommunications, and electronic devices will be in higher demand as the world continues on its trajectory of increasing wealth.
More Electric
Jumping on the back of the more rich theme is more electric. I don’t want to harp on this point too much as it is the most apparent to most people. For example, while no one knows who will win the electric vehicle race (no matter how confidently some people say they do), it is pretty clear that we are heading in the direction of the world’s fleet being fully electric (at some point). Maybe the biggest contributor to this though will be something that most do not think of, though ironically it seems to be top of mind for everyone- AI (and no, not Allen Iverson). Though AI is operated as software, it is supported by massive data centers that require massive amounts of base metals in just about everything in them. It is also important to keep in mind that the infrastructure needed for this is far greater than traditional compute, meaning that even more of these data centers will be needed then if they were built for traditional computing. Amongst other things, the clear path towards increases in the application and adoption of AI will generate almost unfathomable demand for base metals.
Base Metals
Sometime down the line I plan on exploring each of these metals in a much more extensive manner (something may or may not already be in the works), though for today we will discuss the base metals at an (extremely) high level. The goal is to simply get an overview of some of the main uses (certainly not all) of these metals in order to understand part of their role in the more populous, more rich, more electric bull thesis.
Copper
Batteries
Power transmission and generation
Wiring
Telecommunications (cable)
Consumer electronics
Nickel
Batteries
Stainless steel
Heat-resistant steel
Cobalt
Batteries
Magnets
Catalyst for chemicals and petroleum
Paint and ink drying
How to Play It
There are many ways to play this thesis. While there is no “right answer,” I am a strong believer that “investing” in assets that do not have the promise of producing anything, typically cash flows, is simply speculation. I think it goes without saying that I do not believe in simply buying the assets directly. Instead, I believe that the potential upside will be best captured by investing in companies. As always, this is easier said than done- particularly in the commodities space. Again, I am yet to pick a company, or companies, but I believe the best way to get exposure to the underlying commodities is through mining royalty companies. Though there are nuances, such as the difference between royalties and streams, at a scale royalty companies operate very high quality businesses. Given that it is largely just a financing business, all a company needs (other than finances) is a building and a few employees- none of the heavy costs that come with actually operating a mine. This gives the businesses operating leverage in the best ways. The numbers truly speak for themselves here. For an at-scale royalty company, with producing mines you can conservatively (!!!) underwrite a 60% operating cash flow margin, with the potential for far greater in a bull cycle.
Summary
Base metals seem to be set for a multi-decade “higher for longer” environment. In a macro sense, the writing is very clearly on the wall for the various trends that support this thesis. Finding a way to represent this view is always more difficult, though should you be able to do it, the results should be quite satisfactory.