Pestiferous Policy Portfolio
“Two bubbles found they had rainbows on their curves. They flickered out saying: “It was worth being a bubble, just to have held that rainbow thirty seconds.” -- Carl Sandburg
Recent years have been marked by a growing number of increasingly large bubbles – an expensive stock market, crazy low credit spreads, accelerating housing costs, cryptocurrencies, NFTs, SPACs, central bank hubris, Elon Musk, money-losing tech companies, political divisiveness, authoritarianism, fraud, pronouns, fact checking, everything anti-Russian, cancel culture, and skullduggery (possibly the single best word in the English language) to name a few. Many of the most egregious investment-related bubbles have been flickering out since last November with even the “quality” bubbles getting mildly kneecapped.
Bubbles require an ever-increasing amount of money to keep expanding. The federal deficit this year is projected to be around $1 trillion. That’s a lot of money, but it’s down from $2.8 trillion in 2020 and $3.1 trillion in 2021. Whatever your view of deficit spending, a $2 trillion reduction in federal spending will leave a mark.
Then, of course, we have the major central bankers which have printed trillions in reserves and pushed investors to chase yield in increasingly risky securities. The Federal Reserve is currently attempting to slowly take the punch bowl away by raising short-term interest rates and shrinking their balance sheet (unprinting money). Between the Federal Reserve and the federal government, there’s a lot less money entering the system than the prior two years. It’s no wonder overvalued markets have been a bit manic.
I expect the Federal Reserve to pause and reverse course after they break something, and there’s no reason to suspect the government is about to adopt fiscal restraint. Expect more stimulus checks and spending once the economic slowdown becomes obvious to the insulated Washington crowd. If all your one-trick pony has is a hammer… Fortunately, our key portfolio positions are poised to continue benefiting from the errant short-sighted actions of global policy makers. I give you - our Pestiferous Policy Portfolio.
How U Doin?
The largest position in our Pestiferous Policy Portfolio is uranium. Policymakers have made a mess of energy policy for years, and the impact is being felt around the world currently. As a result, nuclear power is in the earliest innings of a renaissance. But first, a quick review of how our position in this space has evolved.
From “Here We Go” in January 2019:
The price of uranium moved up from about $22/pound last year to $29, but the stocks haven’t done much yet. I ultimately expect uranium to move up over $50 with the equities posting triple digit gains. This is a good example of the type of undervalued and unappreciated story I like to own. Nobody is talking about uranium. There is zero interest in this small sector. These names will likely sell-off with future market drops, and we’ll be looking to opportunistically boost our holding if they do.
From “Uranium: A Little Less Radioactive” in July 2019:
While most investors are still enamored with the grossly overvalued tech sector, money-losing private equity companies, negative-yielding debt, and scandal-ridden cryptocurrencies, the neglected and unloved uranium sector offers one of the best risk-return trade-offs I’ve seen in my career.
From “A Bullish Bear” in January 2020:
I’ve mentioned uranium in the past, and I’m more bullish today on that space than I’ve ever been. We’ve been slowly building our exposure as the industry searches for a bottom, and it’s now the second largest exposure in most accounts. I can’t time the exact bottom, but I can’t think of a better risk-reward proposition over the next 5 years.
From “Bull Market or Bull Trap?” in March 2020:
The long-term uranium outlook keeps getting better, despite the languishing equities. We were already running a large annual supply deficit, and now we have mines shutting down due to the coronavirus, hastening the depletion of existing inventories. As I’ve highlighted in the past, this entire industry is currently worth a paltry $7 billion. When the next uranium bull market kicks off, we’re going to see fireworks. In the meantime, the price of uranium itself has held up well during this downturn and actually increased nicely last week on the back of some mine shutdown news. We keep nibbling.
From “What Goes Up Must Come…Negative?” in April 2020:
Our other large energy bet is uranium, and the recent mining supply cuts there have finally shaken the industry out of a long slumber. …this undersupplied market is eventually going to need prices well in excess of $50 to encourage the development of adequate new uranium supplies in the years ahead. We've seen a big jump in the uranium stocks with this recent price move. Fortunately, we took advantage of the March fire sale to build out our full positions. Hopefully, this is the first leg higher of the multi-year uranium bull market I'm expecting.
From “The Anecdote Phase” in March 2021:
Our uranium holdings are now our largest position in most accounts, and uranium remains one of the most compelling opportunities I’ve seen in my career. We methodically built out our uranium holdings over the course of a year and a half, and our patience and diligence has recently been rewarded. There will be significant pullbacks along the way, but I expect a multi-year bull market in this space.
Our uranium position has played out almost to the letter so far, and I’m as bullish today on uranium’s prospects as I’ve ever been. We continue to have a supply deficit, the Russia/Ukraine conflict has highlighted the need for energy security, the green movement is finally coming back around to the benefits of zero carbon nuclear power, nuclear plants are having their lives extended, more countries are planning to build nuclear plants, and the U.S. is now officially supporting nuclear. Uranium prices already hit our initial $50/lb target, but that number will have to move meaningfully higher to encourage the development of uranium mines the world will need. If my optimism isn’t clear enough, I sold my mountain getaway last summer and rolled the proceeds into uranium securities, which was already my largest holding. So…yeah…bullish.
The oil and gas markets have also benefitted from policymaker shortsightedness, and this runs much deeper than Putin. The push to demonize carbon and push wind and solar has led to decreased energy security and reliability, a huge underinvestment in the industry, and higher energy costs. Germany is perhaps the best example of what not to do. They decommissioned three nuclear plants, built out their wind/solar capabilities, and turned increasingly to Russia for natural gas. The result has been soaring energy prices, energy insecurity, and a recent increase in coal burning. They’ve done everything 180 degrees wrong and serve as a warning sign for the globe. Another quick walk down memory lane:
From “Death of Oil” in April 2020:
Oil at $20-30 is already discounting a lot of bad news, but with inventory continuing to build and storage likely to fill globally, there is a very real possibility that oil prices haven’t seen their lows. Regardless, the stage is being gradually set for a huge oil bull market once we bottom. Conventional oil fields are being depleted, there are very few new giant oil fields being found, and shale is about to fall off a cliff. The Saudis like to suggest that they have the ability to significantly ramp their production, but that’s unlikely for any extended period without damaging their wells. At some point, we’re going to see oil north of $100 again. The issue, as always, is timing.
From “What Goes Up Must Come Negative” in April 2020:
I haven't forgotten that I wrote only two weeks ago that I eventually expect oil to hit $100/barrel again. I don't expect that in 2020, but I do expect it in the next few years. This isn't because of the OPEC+ production cut, and it definitely isn't on the hopes that Trump follows through on his rumored plan to pay U.S. producers to not pump their oil out of the ground. That's right. We're actually talking about paying oil companies to not work. Econ 101 is going to fix this market in time. Many producers are losing money hand-over-fist and have already started to shut-in (curtail) production. The Saudis and Russians need higher oil prices for their budgets to work. Today's terrible oil market is setting the stage for an explosive oil bull market in the years ahead.
From “The Anecdote Phase” in March 2021:
Our third largest position is in oil and gas producers and pipelines. We established this position primarily between late September and the end of October last year when the sector was hated and oil prices were under $40/barrel. I started my career as an energy analyst but had never owned Exxon (XOM) until September when we bought it for $35/share. There may not have been a more hated name in the market at that time, but it had a 10% dividend yield, and I felt confident that demand growth and supply destruction would drive oil prices much higher. A couple of our more speculative energy names are up 150-200% since late October. So far, so good on our oil/gas producers.
We built our oil/gas holdings at just about the lows of the cycle – a little bit smart and a little bit lucky. A recession would certainly dent demand, but there is a structural supply/demand imbalance that is going to take years to fix (just like with uranium). Green energy won’t be supplanting oil any time soon, and few people seem to appreciate just how pervasive oil is in our lives. OPEC is close to maxed out on what they can produce, shale oil plays in the U.S. are similarly taxed, and oil inventory is low and falling. In addition, the U.S. is draining the Strategic Petroleum Reserves for non-strategic purposes, and that oil will have to be bought back in the future.
Importantly, oil and gas companies are finally allocating capital to the benefit of shareholders, and I expect that to continue. For example, we’re earning 17% from dividends on our initial Devon Energy shares. Our other holdings are also paying healthy dividends and/or buying back shares. Energy stocks are still broadly unloved by the investment community, but I expect strong cash flow and healthy dividend yields to attract more investors in the quarters ahead. Bold prediction: Oil and gas companies will eventually be considered ESG compliant to allow more institutional investors to buy shares. The ESG label is a marketing ploy that has been and will be made to fit the needs of the investment powerhouses.
We wants it, we needs it. Must have the precious.
We continue to have a significant position in gold, silver, and the mining equities. We’ve had a gold position for many years…thanks primarily to pestiferous policymaking. As long as our government leaders and the Federal Reserve are going to mismanage economic and financial policy, we’ll want to own some of this time-tested store of value.
I first bought gold personally in 2002 when it was trading at $250-275 and ounce, and I’ve held it since. It’s been a terrific holding for 20 years, but it hasn’t been straight up. We’ve had multi-year significant pullbacks, but gold has ultimately powered on to new highs. We recently had another decent pullback, setting the stage for another leg higher. Sentiment is abysmal and futures traders are very bearish – both terrific contrarian indicators. Once investors understand that the Fed will return to QE and lower interest rates again, the spark should be lit for a move to new highs.
Brand New Addition
In more conservative accounts, we’ve added…Treasury notes. I feel dirty typing it. For so long, we’ve been paid essentially nothing for having cash in our portfolios. Inflation concerns and the Fed pushing up the federal funds rate have given us a chance to actually earn a little something with our liquid funds. We’ve laddered out Treasuries over the next few years with an average yield of 2.5-3.0% and no risk.
While yields can always go higher, I expect moderating inflation, increasing recessionary signals, and a pivoting Fed to eventually take these yields back down to their lows. If I’m wrong and yields move higher, we’ll roll the ladder out when a bond matures (take the proceeds from the maturing note and buy a new Treasury that matures 2-3 years out).
The Long and Short Of It
Hopefully, this update gave a sense of where we’ve been, where we are, and how we’re positioned going forward. As a reminder, we’re positioned looking out 2-5 years and not for the next quarter or even the next year. I expect our portfolios to continue performing well, but we will absolutely have pullbacks along the way. They’re part of a healthy bull market, and they tend to shake out the weak hands who chase momentum and don’t really understand company and industry fundamentals. These shakeouts are what form the support for the next move higher. We’ll continue to pare back on positions when they rally strongly, as we’ve been doing with our energy holdings. Conversely, we’ll continue to add to core holdings when they get unduly sullied.
When you find yourself getting frustrated with the state of the world and the actions of our policymakers, remind yourself that they’re self-serving shortsightedness is helping your portfolio.
Ken Bell, CFA, CFP, Leader of Team Curmudgeon
Aspera Financial, LLC
The Market Rubbernecker is associated with Aspera Financial, LLC, an investment management and financial planning firm based in the Cary, Raleigh, and Durham region of North Carolina. This and all Market Rubbernecker missives and musings (written, oral, or mimed) are subject to the disclaimers, disavowals, and hindquarter-coverings found at www.asperafinancial.com/aboutrubbernecker.