Possible Deflation and New Positions
This has been a tough year for metals and miners, which means a tough year for you the client. Unfortunately a lot of the macro research I am reading also points to lower metal prices going forward. So we will have to be patient during this time, since this is our largest position in our active portfolio. We did sell out of our Freeport position earlier in the year when Copper prices hit an all time high of five dollars a pound. We didn’t sell because we thought this was a temporary high in the copper price, but sold because Freeport looked overvalued when considering the historical cash flows. Selling at the high was just a lucky coincidence and this type of opportunity is not normal for us. But it was our third largest position and has helped with stabilizing performance during a down year in commodities. After the sell of Freeport we had a large cash position for most of the year until a couple of months ago when we got excited about Allstate and allocated our cash position towards this company. We have made a nice return here in the last couple of months and this will help in our performance for the year, but we are still trailing the performance on the SP 500. We also added Carrefour to our active portfolio, but on a smaller size, so this has only added minimally towards our performance.
With metal prices going down and our three main positions of RIO, BHP and PICK underperforming this year we want to take advantage of these lower prices. Unfortunately I don’t feel comfortable adding more to these companies since your portfolio is already heavily weighted towards them. So we have started to allocate money towards Anglo American during this down market. Although Anglo doesn’t have as high of returns on capital, they are going through a reorganization and will be spinning off their diamond, platinum, nickel and steel making coal business. This might create some above average value for shareholders going forward.
We are also starting to get excited about the fertilizer market. We have seen a large sell off in the previous two years and valuations are starting to get attractive. We also like the macro economic outlook of this market. We are starting to accumulate a position in Nutrien, which has a 20% market share of the global potash market and a 22% share of the total US fertilizer market. The return on total assets are not great for this company at mid single digits, but they have a very attractive dividend of ~4.5% and produces a lot of cash relative to there stock price. Selling at 12x their ten year average net free cash flow.
The last position we started to accumulate last week is Goodyear Tires. I would consider this a speculative investment since the company doesn’t have positive earnings or a dividend. But on occasion we do toe the line with speculation when the risk/reward ratio looks to be in our favor. This is not an original idea of mine, my mentor and friend Steve introduced me to this. I will not regurgitate his research here, but the speculation is based off a European legislation on deforestation that will take into effect at the end of this year. And on the demand side the heavier EV cars might also speed up the use cycle of tires and the auto depreciation cycle is also near an all time high. The combination of these three variables make this an interesting place to allocate your money. I also like that Goodyear is the third largest player in the tire market. Which gives me confidence that they will be around for a while even if the supply demand outlook doesn’t play out like we think. I am thankful to have Steve as my friend/mentor and have access to his brilliant research. He has a long track record and is one of the best when it comes to commodity and macro economic research.
In conclusion, the market for commodities looks soft right now so short term returns might not be great. But this is giving us an opportunity to find well run companies at good valuations. We don’t know how long this deflation cycle will last but we feel confident that the companies we are investing in will be around many years from now and hopefully selling at a higher valuation. In the mean time we feel comfortable collecting some nice dividends.
