A Record Breaker and A Broken Record
“My friends, as I have discovered myself, there are no disasters, only opportunities. And, indeed, opportunities for fresh disasters.” -- Boris Johnson The financial history buffs out there (anyone…?) may be interested to learn that both stocks and long-term bonds have not fallen over 10% in the same year since the 1870s. That 150-year record stood strong…until last year. In 2022, the S&P 500 dropped 19%, the NASDAQ sank 33%, and investment-grade bonds were off 20%. We also saw international and emerging markets down 25-30%, and most commodity funds posted losses. Real estate prices started rolling over, and Real Estate Investment Trusts (REITS) were generally crushed. Near the top of the speculative pyramid stands Bitcoin which fell a nasty 65% last year, but that was better than most other cryptocurrencies fared. Even my complete set of collectible Ken dolls took a hit. KIDDING! Those gems are never losing money.
Fortunately, we had enough spritely cows to generate positive returns in all portfolios last year. We primarily owe this solid performance to our significant oil and gas position, with most holdings posting 30-50% gains. Of note, Exxon was up 80%, and Occidental Petroleum gained 117%. In addition, our largest security holding tracks the price of uranium, and that was up 6% last year. One of our other largest positions is a U.S. coal producer which returned 160% last year and is up more than sevenfold since our purchase less that two years ago. Finally, the increase in interest rates allowed us at long last to earn a little money with our short-term funds. Other positions tempered our large oil and gas gains. Precious metals were a modest drag overall with silver up a touch, gold about flat, and our mining stocks mostly lower. Although the price of uranium rose last year, our basket of uranium miners also dinged performance on an overall basis. As I often repeat, one year is a short time period given our investment style, but 2022 was a good short time period for us. But that was so last year...
What To Expect in 2023
Every December we get the “investment experts” rolling out their market predictions for the coming year, and every year they seem to predict about a 10% increase in the stock market. They might be anticipating a tactical nuclear war in Europe, global famine, a deadly strain of coronapoxingitis, an electromagnetic pulse that wipes out the electric grid, and a sudden acceleration of the sun’s death leading to the imminent incineration of the Earth…but “the S&P 500 should still end the year with about a 10% gain.”
I don’t know where the asset markets are going to end the year or the path they’ll travel to get there, but nothing changes on January 1 for us. My view of the stock market remains that it’s very expensive. The 2022 pullback simply brought the market back to the peak valuation levels that existed at the tops of the 1929 and 2000 bubbles. That’s still a pretty stiff headwind in my book.
While the market overall is still far from cheap, 2022 did see some progress in the stupidity-reduction arena (charts below). Venture capital and unprofitable tech stocks gave back all their gains since the Covid lows of March 2020. Many investor favorites like Amazon, Meta, and Tesla suffered huge losses. Cathie Wood is the poster child for stupidity this cycle (she had a lot of competition), and the decimation of her ARKK Innovation Fund last year managed to slightly increase my faith in humanity. Also, nonfungible tokens (NFT) all but disappeared, cryptocurrencies were knee-capped with more major frauds coming to light, and negative-yielding bonds vanished. Time will tell if these risk-off moves are the first leg of the Next Great Unraveling or a temporary pullback on the way to the Next Great Stupidity.
Thesis 1: The Homer Simpson Play
While the U.S. stock market still leaves a lot to be desired, I remain bullish on our core sector positions the largest of which remains uranium. We were comfortably early in building up this position in 2019 and 2020, and we’ve enjoyed sizeable gains since. 2022 was a year of consolidation for uranium which I believe sets the stage for the next move higher in this secular bull market.
While a couple European countries are continuing their virtue-signaling plans to close their safe, reliable, zero-carbon nuclear plants, far more are reviving, expanding, and initiating their nuclear plans. The long-lived, carbon-free, baseload power that these plants generate is winning converts with public perception becoming more positive around the globe. This shift has been happening much quicker than I expected and is largely owed to an increased focus on energy security, energy cost, and decarbonization.
Demand is solid and growing, but supply is another story. There simply isn’t enough of the stuff coming out of the ground to meet expected demand, and current prices still aren’t high enough to incentivize much new development. Prices need to move higher in the years ahead, and the mining equities stand to benefit. Institutional interest should continue to grow, providing a strong inflow of funds to the space.
As a reminder, this is a very small industry with few established players. Cameco (CCJ) is the largest company with a market value of $11 billion. For comparison, Best Buy has a market value of $19 billion, Campbell Soup is worth over $16 billion, Pinterest is worth $18 billion, and Bath and Body Works is valued at $10.6 billion. Uranium stocks have had powerful moves from their cycle lows, but the industry is still tiny, and it doesn’t take much to move these stocks in either direction.
Thesis 2: The Beverly Hillbillies Play
I tend to be early when I stake out a new play, especially if I’ve been rifling through the market’s trash bin. It’s exciting to find a hidden gem, but it’s still just garbage if there aren’t catalysts to get it moving well before we’re all dead. Patience to let catalysts unfold is one of our competitive advantages, and it paid off nicely with uranium after an 18-month build-out of our position. As for oil and gas, our required patience was measured in hours. We established our core positions in October of 2020 (see chart below), right before the stocks took off.
As with uranium, this is largely a supply/demand play. The populations of China and India aspire to the level of development that we take for granted. While we’re busily attributing brutal cold spells to global warming and bellyaching about Netflix price increases, there are a couple billion people in the world who would be thrilled with indoor plumbing, refrigeration, clean water, a 1982 Datsun, and a TV/VCR combo. Energy is integrally linked to education, transportation, healthcare, heating and cooling, agriculture, sanitation...just about every facet of life. Energy density, infrastructure, transmission, economics, and efficiency all matter. Suggesting that developing countries intentionally limit their development for a fraction of a Celsius is unserious. Not only will oil and gas be around for decades, I expect demand for both to slowly churn higher for some time still even as renewables expand.
Future supply is more uncertain. Technology has been a big driver of increased supply for many years. Large “elephant” oil discoveries are very rare now, so the ability to extract more from existing fields has become increasingly important. Fracking and horizontal drilling have been key in boosting U.S. production, but the fields that have benefitted most from this appear to be near peak production. At the same time, the fossil fuel industry has been demonized and threatened with increased regulation, punitive “temporary” taxes, and reduced land access. Whatever your view on fossil fuels, it should be clear these policies don’t encourage the industry to pour billions of dollars into long-lived exploration and development projects, even if they can find the needed labor and supplies.
Oil companies managed to have a stellar year in 2022 and oil prices held strong despite a drawdown of 180 million barrels from our Strategic Petroleum Reserves (SPR) and economic weakness in China, due in part to Covid lockdown. Now, the SPR drain is behind us, and China is ending lockdown. Global inventories have been draining for the last couple of years, and Russian production could certainly suffer in the years to come from underinvestment and reduced access to end markets and oilfield technology. Companies are running their businesses with a focus on prudent investment and returning excess cash to shareholders (see chart above). The biggest risk to oil prices this year is recession risk as economic downturns temporarily reduce demand. Given our bullish multi-year outlook, we’ll be ready to take advantage of any exaggerated sell-off.
Thesis 3: The Scrooge McDuck Play
I’ve talked about gold and silver a lot over the years, and there isn’t much to add. 2022 was a quiet year for the metals, which is somewhat impressive given the strength of the dollar and rising interest rates. Gold continued to flow from the West to the East. I imagine our adversaries and neutral countries have noted the asset confiscation and sanctions we’ve leveled against Russia. The idea of keeping a bit more of their sovereign reserves in gold and on their own soil is probably looking more attractive.
The big moves in the metals and mining stocks tend to be spurred by U.S. demand. We’ve seen a nice rebound in the space since November, and that’s come without much U.S. interest. If gold can break out and hold above new highs on this current move, the technical and momentum traders should perk up. We’ve pared back one of our core gold mining stocks recently after a fairly quick 45% jump, and we’ll pare further in the space should Western appetites return. In the meantime, gold and silver act as a currency diversifier and an insurance policy against the unending cycles of monetary malfeasance.
Thesis 4: The Treasury Island Play
Remember the good ole days when we could earn a perfectly safe mid-single-digit return with CDs, Treasury bills, money market accounts, and even savings accounts? Well, they’re back…sort of. We’re finally seeing rates of 3-5% in short-term, safe assets after a long hiatus (chart below). Inflation fears and the Federal Reserve’s policy tightening are mainly to thank for these higher yields, and those are the two factors which will largely determine whether they’ve peaked and how long it’ll be before they head back down. Recently, there had been over $18 trillion globally in negative-yielding bonds, so this has been a dramatic swing in interest rates here and abroad.
A dive into inflation, the Federal Reserve, the debt and deficit, and international demand for the U.S. dollar and Treasury securities is beyond the scope of this quick review. Suffice it to say, I expect the Federal Reserve will yet again be forced back into its lender of last resort role and will yet again be buying Treasury debt at the “first next” or “next first” sign of trouble, and the odds of trouble increase the further and longer the Fed tightens. There’s just too much dollar debt and not enough dollars currently to service it all without something breaking, and the Fed is outstanding at breaking things. In the meantime, it’s nice to get a little safe yield with our cash, especially in more conservative accounts.
The Long and The Short of It
We methodically increased our exposure to yield (dividends and interest) in more conservative portfolios over the last half of 2022. We’ve laddered Treasuries out over the next couple of years and selectively added duration and yield with corporate bonds, preferred stocks, and high-dividend equities. We continue to keep some liquid assets in cash, money market, and stable value accounts. Our more aggressive portfolios hold fewer bills and bonds and are more weighted toward the uranium, oil and gas, and precious metals sectors. We’ll continue to pare back positions as they approach our targets and add on pullbacks as long as our investment theses hold, and we’ll keep searching for new green pastures and sparkly objects during our market dumpster dives.
As this goes to press, I see that Cathie Wood is predicting global oil demand will collapse to 70 million barrels a day within 5 years from its current level of 101 million barrels. I don’t think we own enough oil and oil stocks…
Ken Bell, CFA, MBA, Stock Wildcatter
Aspera Financial, LLC
The Market Rubbernecker is associated with Aspera Financial, LLC, an investment management and financial advisory firm based in the Cary, Raleigh, and Durham region of North Carolina. This and all Market Rubbernecker missives and musings are subject to the disclaimers, disavowals, and hindquarter-coverings found at www.asperafinancial.com/aboutrubbernecker.