Episode #445: Jeff Currie, Goldman Sachs – Why ESG May Make This Commodity Supercycle Different From Past Cycles
Guest: Jeff Currie is Goldman Sachs’ global head of Commodities Research.
Date Recorded: 9/16/2022 | Run-Time: 47:04
Summary: In today’s episode, Jeff shares why he called for a commodity supercycle almost two years ago and where we are within that cycle today. He touches on the underinvestment in supply, why ESG makes this cycle different from past cycles, and why the risk of a policy error could exacerbate the problems we have in the commodity markets today.
Be sure to stick around to hear Jeff’s price target for oil and a surprising call on the European energy markets.
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Links from the Episode:
- 0:38 – Sponsor: AcreTrader
- 1:53 – Intro
- 2:28 – Welcome to our guest, Jeff Currie
- 3:23 – Why Jeff believes we’re in a commodity supercycle
- 8:28 – Episode #431: Scott Reynolds Nelson; Oceans of Grain
- 13:11 – Episode #443: Kyle Bass
- 14:17 – A structural view of the commodities space
- 19:33 – Jeff’s view of the oil market
- 22:44 – Hitting critical stress levels in the European energy markets
- 25:20 – Some good and bad policy ideas
- 29:39 – How investors should think about commodities
- 34:19 – A commodity he’d pick that is currently in an interesting situation
- 41:46 – The most memorable moment from Jeff’s career
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Meb: Welcome podcast friends. We’ve got a huge show for you today. Our guest is Jeff Currie, Goldman Sachs’ global head of commodities research. In today’s episode, Jeff shares why he called for a commodity supercycle almost two years ago, and where we are now within that cycle. He touches on the underinvestment in supply, why ESG makes this cycle different from past cycles, and why the risk of a policy error could exacerbate the problems we have in the commodity markets today. Be sure to stick around to hear Jeff’s price target for oil and a surprising call on the European energy markets. Please enjoy this episode with Goldman Sachs, Jeff Currie… Jeff, welcome to the show.
Jeff: Great. Thanks for having me.
Meb: I was going to say this. It’s not just anyone I’ll get up at 6:00 in the morning for, but Jeff Currie, I said I’ll get up at 6:00 in the morning, watch the surfers out here. Where do we find you today?
Jeff: I’m in London. I’m about ready to finish my day as yours is beginning. But the battle with the Queen’s funeral, when we leave this building is lots of visitors in London right now.
Meb: Today’s topic is one. We actually talk a lot about on the show. We talk about natural resources and farming and commodities, but it’s a topic that I think many investors don’t think about until they kind of have to, or many citizens in the world, commodities, despite playing a daily role in everyone’s life, often are in the background. You’ve been thinking about commodities for a while, and they’re certainly in the foreground today, but I figured we’d start with sort of pandemic timeframe. You kind of started publishing research talking about a new supercycle on commodities. So, maybe you can start there and kind of walk through on your thesis, and then we’ll get to where we are today and what’s going on.
Jeff: Okay. We shifted to the supercycle thesis in…it was October 2020. And really at the core of it was COVID. COVID was the catalyst. Why? Because it shifted macroeconomic policy away from financial stability, following the financial crisis and towards social need. And once policy begins to focus on social need, particularly the disadvantaged groups, you create more commodity demand. The bottom line is when you look at the lower income groups, they consume the world’s lien share of food, fuel, and capital goods, all of which commodities represent the greatest share.
If I were just to get at this point, is that when we think about financial markets, the concept of volume does not enter in them. How do you quote inequity? Billions of dollars in market cap. In fact, even an economy, the concept of volume does not enter. But think about oil. How do we quote it? Hundred million barrels a day. How do you quote the bushels of corn? It’s always in volume. Now, why is this important? Is because when we think about income inequality, are there very many high-income people in this world? The answer is no. Very, very few. They control a lot of dollars, but they do not control any volume.
And when we think about the world’s low-income groups, they control all of the volume just by sheer numbers. So, if you have policy shift towards favoring lower income groups, you’re just going to get more volume metric demand. That’s what creates bull markets in commodities, that are what creates inflationary pressure. So, I like to point out, rich guys can’t create inflation. It’s impossible. There are simply not enough of them. Only the world’s low-income groups can do that because they have the volume.
So, that’s point and center one. And when we think about the supply side of the equation, the supply side we call it the revenge of the old economy. Put bluntly, poor returns in the old economy so that capital redirected to the new economy. Another way to say it is investors favor Netflix over the Exxon’s of the world. And it is not the first time we’ve seen this. We saw this in the 1990s. It was the .com boom. And that’s where we coined the term the revenge of the old economy. And it was February 2002 because so much capital was being sucked out of the old economy going into the new economy.
You couldn’t grow the supply base and you had supply shortages And then you had this big surge in demand out of China and it exposes severity of it. This is the same story. You had this underinvestment due to this revenge of the old economy. This time instead of the .com boom, it was the fame boom taking all the capital from the Exxon’s of the world. And then you had underinvestment, then along came the COVID surge in demand and expose the severity of it.
One last point I want to emphasize, we’ve seen this before. What was the 1960s? It was the Nifty 50. It was the new economy then. In fact, I was just reading some French philosophers. They figured out this revenge of the old economy story 200 years ago. When interest rates are zero, you favor these long-duration tech growth-type stories and you ignore putting drill bits in the ground. And then when interest rates get really high, you go “Uh-oh, it’s time to put the drill bit back in the ground.” I don’t want to get into the ESG issues. 250 years ago, who knows what the…..and grains and things of that nature.
But these cycles, these investment cycles are very much tied to low-interest rates. Because what was the ’60s all about? LBJ made interest rates far too low. What was the event that triggered it all? It was the Great Society. He spent a lot, no investment, and kaboom. One last comparison between today and the 1970s, today, people want to blame the high commodity prices on Russia. Russia took advantage of the energy crisis, it did not create the energy crisis. Similarly, people like to say, ‘Oh, the 1970s was all about the OPEC oil embargo.
No. It took advantage of the situation in 1973 of a process that was well underway due to the Great Society and the revenge of the old economy long before the OPEC oil embargo. So, the similarities between the ’70s and today are quite striking. But really at its core, to answer your question about the supercycle, it was the COVID surge in demand that exposed the underinvestment in supply that I’m going to talk about this later. But what makes this investment cycle much different than one in the 2000s and one in the ’70s is the ESG overlay that makes it really difficult to get capital into this space.
Meb: There’s a lot in there and it’s great. I think anytime looking at investing, in general, we talk a ton about this. Like looking back towards history, you see many of the themes repeat, and you have sort of this story of boom and bust, but overinvestment, underinvestment, the story is old as time. And I love you talking about sort of the interest rates and how people think about the world. We had a great podcast recently with an author who put out a book on the history of wheat called “Oceans of Grain.” He’s a professor from Georgia, and he was talking about the arc of grain and how it kind of impacted history. But looking back, I think is such a useful exercise. We have talked about these supercycles before. When you think about supercycles, what does that mean to you? How long does it last, or is it a magnitude idea, or is it just sort of a fuzzy concept that you can define in retrospect?
Jeff: We know one existed between 1968. And by the way, the Great Society, the first big wave of spending was ’67, ’68. So, just started basically there. So, we’ll mark this one starting in the mid-2020 when that spending occurred. When we look at that one in the ’68, it ended in 1980 after 12 years of a huge investment cycle. Now, ironically, when did the one in the 2000 start? It started 2002 January when China was admitted to the WTO. It was the policy-driven story just like the one in the late ’60s and the one today. When it ended, it ended in 2014.
Ironically, both are 12 years. That’s all we know, is the two that we can have data for lasted 12 years. Why did it last 12 years? Because ultimately, you solved this problem through investment. By the way, you can hike rates all day long, it’s not going to solve this problem. It’ll make the commodity prices go down and the inflation go down temporarily. But there is only one solution to this, you got to debottleneck the system. It’s not rocket science. I like to point rate hikes cure this centum, which is inflation, but only investment can cure the underlying illness, which is a lack of production capacity.
The question then is how long does it take to do this investment cycle? And here’s what I picked up. And I know enough from the 2000s about what… So, bull market starts in ’02. From ’02 to ’05, prices of commodities went up, the equities did really well but no money came into the space. Wasn’t until 2005 that money started coming into the space. Why did it take so long? Because nobody believed the story. Everybody hated the space like they hate it today. A history of bad returns, wealth destruction.
In fact, I remember I was testifying for U.S. Congress in ’03 and I looked, it was the same gas story back in 2001, 2002 that we have in Europe today. In there, we had a table that showed the wealth destruction in the energy sector in the 1990s. By the way, … stored about 28 cents on every dollar. So, no wonder nobody wanted the space. And by the way, a lot of people trading this stuff, they can remember that. And now they know. You know what those numbers are today? Destroying 52 cents on every dollar. So, getting money into the space is difficult with that type of track record.
Okay. So, they came around too, finally. What was the requirement to get them to get the money in ’05? Three-year track record. You got to have a three-year track record before money is going to look at you. Then let’s say ’05 to 2008, they started spending money. What happens when you haven’t spent money in a sector for over a decade? Cost inflation because there’s nobody there. There are no engineers, there’s nobody. You know, in fact, I think somebody from Australia in here told me that they graduated something like 30 engineers in Australia last year, yet the demand for more … was like 300 for minerals and mining. You don’t have the people, you don’t have the equipment, you got to go build it. That takes time.
And what happens when you’re all sad and everybody wants to have a space? They throw money at it, and it creates a lot of cost inflation. And then the last five years, so you got three years to get the money, three years to cost inflation … then finally debottleneck it, it’s about five years to get capacity on place. And the prices come crashing back down as they did in the early ’80s and as they did in 2015. One last point on this is everybody says, “Oh, you know, the Volcker in ’79, ’80.” I want to point out, Volcker raised rates to 20% after a decade of a huge CapEx cycle. So, which one solved the inflation problem? Was it the investment or the rate hikes? I’d say it’s probably the investment.
Meb: Yeah. We just had Kyle Dawson on the podcast and he had a great phrase where he is talking about energy sector had just been pommelled then we got to the point where you remember energy’s future is trading negative, energy in the U.S., those percentages, the S&P got to like 2% from a high, I think in the ’70s, ’80s around 30%, just like a sector that had just kind of been forgotten, put out the pasture. And then, of course, the politicians come, get into play, and all of a sudden, they’re making so much money and they’re the bad guys. And people quickly forget how much of a struggle it was, and he says, “We need to stop fat shaming these companies.” He’s like, “You know.” Just because for this moment in time doing well. Anyway, we can come back to that in a minute, but…
Jeff: Oh, I heard a good one the other day. I think it was Raymond Lee. He had pointed out that the average return in refining is 17% over the last two or three decades. His point was he had never seen a 15% or 19% return ever in his entire career doing it, which is kind of your point about the boom bass. It just comes and it comes in a big wave.
Meb: Yeah. Okay. So, that kind of sets the stage for where we were in 2020. COVID obviously happens, the world is sort of awakening. Well, who knows what’s going on in China? And as you mentioned, we have a war going on. Let’s talk about today. So, how’s the world look to you today? Are we still in the thick of this? Is it the beginning or is it…when you say commodities, it means a lot of things. There’s probably, I don’t know, 50 you track at some point, but a couple that are more important than others. I hand the mic. Where do you want to begin?
Jeff: Well, let’s talk about the structural story, and then the tactical story. And the two are going separate directions. The structural story is getting more bullish by the day. But as those you follow, these markets’ prices go down by the day. And when we look at the structural story, I like to call it the political economy of inflation, meaning that once the inflation starts, the political reactions typically reinforce and get you married to it. Whereas the energy crisis here in Europe, the subsidies to consumers with the windfall profit taxes on the companies who then can’t invest. So, you lose the supply, you increase the demand through the subsidies.
You look at the Inflation Reduction Act in the U.S., that’s going to create a lot of demand for oil and metals to actually produce all this stuff. Well, it’s not till 2024 or beyond, but you get the point that it reinforces the demand for these underlying goods that are going to be important in terms of sustaining society. Particularly take energy in Europe where I think it’s crystal clear where you need to protect the lower-income groups, but by doing it, it prolongs the story. And that’s what we call the political economy of inflation. So, from a demand perspective, the situation is being reinforced by money of the policy decisions.
Now, when we look at the supply side, it is remarkably stronger than what it was three months ago, six months ago. We look at the investment recounts in the U.S., you get $95 a barrel right now, and they’re down in the last three weeks. So, they’re not spending. When we look at the situation with Russia, whether it’s the price cap or the EUN, they’re going to have to redirect another 3 million barrels per day of oil. And every time you redirect something, friction say you’re going to lose another. And so, we think you’ll lose another million barrels per day right there. You’re going to lose the SPR oil.
Iran deal has failed. Production capacity is at nearly 100% utilization. Nigeria is now a smaller oil producer than Angola. You get the point. I can go on down the list on the supply problems. Single-digit or negative supply growth in Latin America on copper due to a political environment that’s hostile to investments, grains, drought. You get the point. The supply pitcher is much stronger. So, why are prices going down? Prices are going down because the market is giving the Fed the credibility of solving this problem. You see break-even inflation going down.
Real interest rates have gone from -50 basis points to 1 basis or 100 basis points. That’s 150 basis points swing in underlying real interest rates. Whether or not that’s justified, we’ll find out soon. But it’s taken the liquidity out of the system and sucking commodity prices down. Here’s the way I like to think about it. It’s a race between, will the Fed get demand low enough before we run out of commodities? Or will the ECB? So, policy is trying to slow this thing down. Call it slowdown recession or whatever you want to call it, but your inventories are still declining.
If they can get this thing completely shut down before you run out of commodities, you’ll at least be safe in the near term. And I think that’s the bet that markets are taking. In fact, you look at the coalition, oil/dollar, or copper/dollar, all of these prices are going down. Now, let me ask you. What happens we run out of all those stuff long before we get the big slowdown in demand and you can’t rebalance? Then you have to rebalance through prices. And that’s where they got high and spiky again.
Meb: I was going to say, how good of a track record do we have on the politicians and policymakers being able to thread that needle on being able to get the timing right on this? It seems like a pretty tough equation to solve.
Jeff: I like to go out and this out. Las, hiking period was late 04 through 06. Late 06, the market was convinced we were in a recession, yield curve inverted just like it is today, oil sold off, commodities sold off tremendously, oil went from $77 a barrel all the down to $45. Guess what, we all know when the recession actually happened. Didn’t come until ’08. What do oil prices turn around and do? Well, from $45 to $147. You’re out of it. By March of ’08, I remember we were out of wheat, lowest inventory level since 1948 or something like that. That’s a similar dynamic this time around. The other time the market tried to price in a recession was after the rate hikes in ’94,’95. Yield curve inverted, commodities went on to rally for another 80% because it takes a while before or actually the system really begins to shut down.
Meb: As we look to the fall here, what sort of are your outlook? I figured we could start with oil. I live in Los Angeles, and so there was a period where it was not out of the question that we were going to see a double-digit price per gallon, right? Like they don’t have enough digits on the gasoline signs. But they’ve come down. And so, I want to hear a little bit about your thoughts on oil. What’s been the big influence or impact is the drawing down of the strategic petroleum? Does that make a difference? What’s going on? Where are we? Talk to me.
Jeff: I mean, obviously, you added a million barrels per day of oil back into the market over the last what’s been 6+ months. It’s had a material impact to help get gasoline prices down. But again, it’s not a permanent solution. There’s not…in fact, if anything, it crowded out investments. Part of the reason why the rig counts are down. Obviously, they came out with some noise that they subsequently said it’s not true that they were going to buy back the SPR oil, $80 a barrel, putting a put on the market for the producers to go out and invest, but they denied that.
So, you don’t have that payback advantage for the producers. The bottom line is they crowded out the investment. So, they got it down. The timing of this with SPR ends in early to mid-October. Coincidence, before the election in early November. Actually, Clinton did the exact same thing in the October election. But I think the key point is that in no way has the underlying core problem been addressed, which is underinvestment. And we learned this summer is the underinvestment is not only in the oil production but also in the refineries themselves.
When we look at the ability to solve the problem during the summer is you can use SPR, but it doesn’t solve everything. And the SPR did not solve the refining problem in the middle of July. And that’s how prices got us high there. But I want to emphasize, and this is the revenge of the old economy story, is we’re out of refining capacity, power generation capacity, oil production, copper mines, you name it. We haven’t invested in any of these core old economy production capacities, and that serves as the constraints we’re running into. Again, the only way we’re going to fix this problem, well, it’s either one, increase supply and the ability to produce this stuff. And by the way, one way they did try to solve this was adding more ethanol into the gasoline stream, which is food. And what surprised the upside in the CPI? The food numbers.
You’re robbing Peter to pay Paul. I do think gasoline has a bigger impact on inflation expectations than food. So, was it a good trade-off for them? Probably so. But it illustrates the fact that food really dominated this most recent CPI that you can’t rob Peter and pay Paul every time. You’re going to actually have to deal with the underlying problem. I know a lot of listeners probably will, “Hey, what about demand and taking down demand? Can’t you solve it that way?” You could, but we have no mechanisms in place to create the efficiency, there’s no carbon tax. No anything like that that’s going to slow the bank go down other than higher prices, or running out of supply. If we’re going to address this on the demand side, again, you got to do something.
Meb: This rebuilding sort of timeframe, that’s not something that really gets turned on in a week or a month, that normally takes years. The cycle where we are kind of right now. And if you think of energy, in particular, and you guys are much closer too, with everything that’s going on in Europe. I would love to hear a little more about how the rest of this year and potentially the winter plays out, but it’s not something that really is as easy as just flipping a switch.
Jeff: That is the real critical point here, which is why they turn to the SPR because that’s oil put in storage for an emergency, and you can drain it out quickly. Building a refinery takes 5+ years, a copper mine, 7+ years. The oil shell can do six months in the Houston area. But if you have to build infrastructure, add on two to three years to that. Your average oil field is somewhere around, call it three to five years outside of the U.S. The shell is fast cycle. So, you know, it does have that advantage. But I think the key message there, it takes a long time. And so, a lot of people think those tie this into Europe. The U.S. can export natural gas to Europe to solve this problem. It cannot, it takes time. You got to build those liquefaction terminals in the U.S. to liquefy that gas, and then, in turn, send it to Europe.
Now, on Europe, has anybody ever seen a forecasted crisis actually materialize? No, you haven’t. It’s like, you know, has anybody ever been hit by the train they see coming? No. I’ve been doing this 30 years and I’ve never seen one of these train wrecks ever actually price out in the end. The market is just. Prices went up this summer and readjusted the industrial demand. I like to point out in as in 2001 and 2002, the price came just crashing back down in the U.S. because you ended up killing off an industrial demand. And so, the crisis will likely be averted. In fact, our target right now is that European gas goes sub €100 of megawatt hour in January and February during that time period just because everybody has turned down the thermostats, everybody has made the adjustments.
You squeaked out every supply you possibly can out of the system. You adjust the governments. In fact, I would say, if anything, the bigger risk is that the policy here using price caps and things like that can end up creating a problem than the actual underlying crisis itself. Actually, it was Paul Krugman. He titled the recent article in New York Times. Europe is going to party like it’s 1979 when the Americans did pretty much the same thing, created the gas lines and everything like that. So, the policy is now what I’d be more worried about than the energy crisis itself.
Meb: So, as we think about…you just mentioned policy. I’ve heard you mention the carbon tax, you briefly referenced CSG at the beginning. What are some of the good ideas? What are some of the bad ideas when we talk about policy and what the future looks like?
Jeff: We all in our Econ 101 courses in college learned about the negative externality in economics and how you have to impose attacks on it to get the behavioral shifts. ESG and the rest of these simply do not address that problem. And by the way, it’s in our DNA, we know what to do. We have solved the war on acid rain in the ’60s and the ’70s. And we did it through sulfur market. You had to have compliance, you have to have rules and regulations. You can’t be turning the coal plants back on in Germany because it’s a difficult environment. You need to get fined or put in jail or something like that. I know I’m talking about a difficult situation in Europe, and I’m not trying to make light of it. But the reality is you’re only going to solve this problem if you have real rule and regulations put in place that create real compliance. And that’s what we did in the ’70s and the ’80s with that war on acid rain.
I’m going to go back to Econ 101, we learned about this. It’s just you pollute, you pay. And it really needs to start with that so that that behavior changes and we’re not ordering 13 boxes to our house in a very inefficient way. And the only way you’re going to achieve that is through a carbon price or a carbon tax. Now, how do you get to the point where we solved the acid rain problem in the ’60s and the ’70s? I like to call it the Lake Erie moment. Lake Erie was on fire in 1969, and by 1970, it was Richard Nixon who signed into law, the Clean Air Act Amendment, created the EPA, and so forth. By the way, on that point, I like to emphasize, whether you want to call them labor, Democrats, so forth, is they’ve really never, ever created environmental policy. If you look at the word conservative, comes from the conservation of resources.
Actually, history has shown it was really the Republicans, the Conservative, whatever you want to call them, that ended up focused on these issues. I’m not trying to make a value judgment on the politics or anything here, but think about who solved the climate change problem. It was Nixon. He was the biggest environmental president we’ve ever seen. And then it was Reagan and Thatcher that put the nail in the coffin on the acid rain problem. And then it finally was George Bush Sr. that got the sulfur market.
And by the way, on that sulfur market, once you created a functioning sulfur market, it created all the mechanisms to solve these problems. I’m sure there was a guy like me in 1965 going, “It’s going to cost trillions and trillions of dollars to solve the sulfur problem or the acid rain problem. But once they head off functioning markets and made taxes were put in place and the compliance rules, it was just a fraction of what anybody ever thought to solve it. Why? Because BASF invented the catalytic converter and all these other things that were generated over that time period.
So, my point here is voluntary markets just do not work here. When we think about ESG, ESG is another form of a voluntary market. There’s no compliance, and what you’re trying to do is allocate capital based upon some type of score. And that’s why we’re generating a misallocation of capital here. If you had a carbon price or some type of measure there that you can allocate capital on, you end up with a much more efficient way to allocate capital. Why I go back to the importance of having a carbon price or a carbon tax.
One last point about ESG is that it is not economically sound. And when we look at where the free cash flow yields that these companies are trading, they’re trading in that…some of them are 30%. By the way, the coal guys are trading 75%-100%. For those who don’t follow this, what does that mean? You can buy the company out in one year. So, if it’s trading at 75%, you buy the company out, take it private and you own 75% of it one year. What does that mean? These companies will end up going private and go completely out of the purview of ESG, which is why it’s not a sustainable solution here. Again, I’m going to go back to the sustainable solution. You got to have fines, jail time, cost. You have to have a cost to make a market work. Without cost, there is no market. And I think that’s the key message here.
Meb: As we turn our lens from policy to sort of implementation, you mentioned Australia in the beginning. Outside my Aussie and Canadian friends, I think most investors don’t think that much about commodities. I mean, they may think about them, but they don’t really think about them as investments. Sometimes they do. They do after they’ve gone up a lot. And so, we do polls on Twitter a lot. And one of which was, do you invest in commodities at all? A third said they don’t. Or commodity-related natural resources. A third said no, another third said essentially zero to 10% or something. So, most people don’t really do any. How should we think about it? Investors. So, both professional, individual, and of the complex. Any particular ones that are standing out to you as either opportunities or things to really avoid in this world?
Jeff: I’m going to address the question of why people shy away from the space. Now, it goes back to this whole point where you’re about financial markets versus physical markets. I’m going to talk of one’s volume metric, the other one is dollar base. When we think about the following statement, I really realize this is true with the ESG factors driving investment in oil companies. Nobody in this world has to buy a financial product. You can live without it. Somebody has to buy food and fuel. And as a result, you have a forced buyer. And the key point here, though, is that the physical markets are driven by real supply and demand. They’re relatively e…in fact, they’re very easy to model because, ultimately, they’re driven by very simple needs and weather shocks and things of that nature.
However, very short term, they’re hard to forecast because it’s weather. Things like that driving wheat prices and stuff like that. When you think about the economics and those easy models on commodities, longer term, they’re relatively easy to forecast because outside once the weather shocks go away, what’s left is supply and technological trends, which are relatively easy to forecast. So, if you want to invest in commodities, you got to go for the long run. You can’t do the short run.
Now, here is the problem. What’s the situation with financial markets? They’re exact opposite. They’re easier to forecast near-term but impossible to forecast long-term. And they’re impossible to model because they’re driven by expectations. All you have to do is get where expectations are going. You got a pretty good chance where financial markets are going to go. And the problem is they’re driven by momentum, short-term momentum. And as a result, people take what they’ve learned from financial markets and try to apply it to physical markets, and then they get railroaded by the volatility and they say, “I’m never going back again.”
And so, my advice to anyone listening to this, if you’re going to trade commodities, you got to take the long view. As a result, you got to buy and hold and go through the volatility like we’re going through the summer on oil and copper. By the way, most people have bailed. The link in these markets has collapsed. People don’t believe in the story. But it’s only been two and a half, three months of real pain here. If you’re going to trade the space, you either have to be like the pro who knows what the volatility flows are going to be. And by the way, I can tell you I know a lot of people who know the space and they got caught on the wrong side of this down move here. But I’m comfortable this down move is temporary and we’ll go back up again. And that holding through that type of volatility is key.
That said, what are the key markets that I’d be focused on? Oil. Oil is key to everything. It’s the key macro driver. In fact, it’s the best hedge against inflation, and it’s the one that you need in society to keep the lights on. And at the margin, it’s pricey in a lot of those other different types of fuels. When we look at the commodities and the one that we have the real shortages on, I would argue, on a longer-term basis are oil. So, we really like oil from here. We see it’s still going up to $130 a barrel. I know at $95, that looks like a really far distance. But let me remind everybody in here, how many times have we round trip between $95 and $125 this year? Twice. So, it wouldn’t be that shocking, it sounds crazy right now.
I mean, this goes to that point why people don’t like the space is that volatility. We also really like copper because the inventories are quite low and it’s critical to the decarbonization story. By the way, I want to make sure everybody understands. While I’m negative on ESG, I think the carbonization problem is really serious. It needs to be dealt with. And the only thing we’re going to is electrification and sort of like education to it. Significant degree and copper is the only thing that can conduct electricity. So, we think copper really is a excellent opportunity here on a longer-term basis as well. It’s also had a lot of headwinds driven partially by the dollar, but we see more upside there.
Meb: We’ve only got you for a little bit longer. You got to take your pick on the commodity, and there’s a lot of wonky ones. You can take a pick on anyone where you think it’s an interesting situation. It could be orange juice, it could be wheat, it could be rubber, it could be soybeans. Anything that you’re like, “You know what? This is kind of a interesting situation here, or I’m really bearish or nervous.” Anything come to mind?
Jeff: I love the aluminum. I guess I’m on the Atlantic, the aluminum story. I definitely like the grains, particularly corn. But let’s focus on the aluminum story. And what makes it really interesting is what we call the climate paradox. You need it to solve climate change but it creates more missions than any of the other commodities. Ether is the electrolysis process to create it and it melts more so than even steel. And as a result, with the energy crisis in Europe, you’ve turned off smelters in Europe, you’ve had problems in China. And so, they struggle between, you know, the shortage in energy, which is power the cars by decarbonization, then creating higher prices that forces you to shut down the aluminum plants, which are being also shut down for decarbonization reasons.
So, you have that killing off supply, but guess what? Aluminum is the lightest metals out there. You need it to solve the climate change problem. And as a result, we get a lot of demand in alley driven, not only by the decarbonization story but more recently due to industry uses as well as in the construction, which obviously is cooled more. And by the way, construction is cooled, but it’s still above 2019 levels. We just cooled them toward a base that we had seen going back in 2021. So, bottom line, you have no inventory like copper, like oil, and you have no supply. I’m beginning to think that, you know, this climate paradox associated with alley may make it the strongest in the entire complex.
I’m going to take a step back and talk about the carbon cycle because it sheds a lot of light on really at the core of the problem that we’re dealing with. When we think about food, I want to remind everybody, what do we call food? It’s called a carbohydrate. What do we call fuel? A hydrocarbon. What is the difference between a carbohydrate and a hydrocarbon? One oxygen. And by way, the problem with our cars is just like our bodies. We eat carbohydrates, and we emit stuff out the back end, just like the cows do, just like the cars do. And it’s all the same stuff. It’s some form of a carbon. In fact, if you want to fly to Mars, you got to figure out how to bring the same fuel to put in your body that you put into the rocket booster. So, you got to take that oxygen in and out the hydrocarbon and in the carbohydrate so you can stay alive. Plus the rocket booster can go on for years.
That said, when we look at the issue in terms of food, more recently we call it the 3Cs, climate, conflict and carbon. So, when you start to underinvest in fossil fuels, you’re having a profound impact also on the grain markets as well. To understand that linkage is when we think about energy. What is food? Food is energy for our bodies. A lot of that food, you can burn it in power plants and do whatever you want. That’s why it’s a carbon. And it creates emissions just like the oil. Now, the oil…well, the fossil fuels, it’s a little bit more intense emissions.
But when we think about those two carbon cycles, the short carbon cycle, which is food and wood and things involved in that, is that the carbon is emitted. Let’s say you burn the wood, you emit the carbon, the carbon goes up in the atmosphere, but then it gets reabsorbed back into the photosynthesis process and then put back down into the roots into the ground. That’s how you cycle. That’s how you take the carbon out of the atmosphere. When we think about the long cycle, that’s where the fossil fuels are.
It’s kind of the same thing where the plants rot and then the oxygen falls off of that carbohydrate, and then it’s a hydrocarbon sitting down after a couple of hundred thousand years and we extract that fuel up and we burn it, then we emit that, and then that carbon goes up in the atmosphere. That carbon takes…this sort of, you know, like wood or like 50 years, this thing takes thousands and thousands of years to get that plankton or whatever it is back down under the earth. And you can think about what we did with food. Nitrogen is a hydrocarbon. Comes from fossil fuels. Nitrogen is what we use to speed up that short carbon cycle. I like to point out, 4.5 billion people today are alive because of nitrogen and ammonia.
When we think about just taking away these fuels and you’re underinvesting them, there’s a profound impact on the ability to produce … through the fertilizers and the nitrogen, in particular, it enhances the yields and supports enormous number of people on this planet earth. And so, when we think about the problems that the agriculture markets face is due to the underinvestment in energy and the more recent conflict crisis that we have going on in central Europe. As a result, we’re short of fertilizer that we need to enhance the yields. It’s raising the cost and creating problems there. Then you multiply that on top of climate because, hey, whether you want to cause, whatever you want to debate on what the cause of climate change may be, but the reality is we’re going through global warming and it’s creating problems with agriculture yields. They’ve had a profound impact on yields of wheat and other types of commodities over the course of the last year.
Multiply those two dynamics together. We’re ending up with significant shortages on your key grains. And then we multiply that with the revenge of the old economy, the underinvestment in the grains themselves, these shortages, I’ve talked to professionals who have been in this market since the ’60s. Never seen anything like this before. And so, when we think about the opportunity set in corn, soybeans, and some of these other commodities, I think it’s tremendous. But I think one of the key messages to really leave you with is to remember that food is a hydrocarbon, it’s part of the energy source and part of carbon. And I want to point out that carbon is historically the best hedge against inflation. And that goes back for millennia of many different societies.
Meb: We talk about this in the book I had penned where I say one of my favorite asset allocation portfolios, which by the way, is really hard to beat by most of these institutions was influenced by the Talmud Portfolio, which is 2000 years old, but there’s a quote where it said, “Let every man invest a third in business, a third in land, and a third, keep in reserve.” So, I interpret that as a third, stocks, a third, natural resources, commodities. Real assets can be real estate too. And a third in bonds and cash. And you model that out over any period, and it’s really hard to beat. 2022, great example because investors have very little real assets, whether it’s commodities, etc. And the only thing up this year, there’s nothing in stocks and bonds.
This surprises people, but it often happens in history. It hasn’t happened a lot lately, but stocks and bonds down at the same time. What’s saving your bacon here in 2022? Well, it’s commodities, but everyone’s forgotten them. Jeff, I got to let you go here in a second, but real quick, last question. We usually ask investors, what is your most memorable investment? So, you can choose to answer that question if you want, but given your background and expertise, you can frame it another way. It’s up to you. The second way we can frame it is what is your most memorable commodity-related moment in time in your career? Could be when you’re sitting around covering some commodity and some far-flung lookout, whatever it may be. You can take this question whichever direction you want.
Jeff: I can tell you real quickly which one it was, it was short U.S. natural gas in January 2001. During the power and energy crisis in the United States looks identical to what Europe is going through right now.
Meb: The interesting part about this is is, on one hand, you’re saying, look, we think certain things like oil and others can go up a lot, but natural gas, you’re feeling like it’s gone too far one way.
Jeff: Not in the U.S., but in Europe. And the moral of the story is you have a crisis, that inertia rally in U.S. natural gas prices, and it was a similar point in time is right now and 2000. We went from $2 in MMBTO all the way up to $10. That’s the first time I’d ever seen anything like that before.
Meb: You killed out so much industrial demand. By the way, where did all that industrial demand go to 20 years ago?
Jeff: Went to Europe. I guess where it’s coming back to. Now Europe is going through the same that the U.S. went through. But the reason why natural gas prices collapsed in the U.S. is you went into the winters by the fact it was cold because you lost 2.5 million manufacturing jobs that went to Europe and Asia. Europe is going to go through precisely the exact same thing. In fact, it’s already happening. A lot of the very energy-intensive industries are moving back to the U.S. So, it’s exactly the same industries that got offshored to Europe 20 years ago are going to get reshored back into the United States as you go through a very similar dynamic. And that was a big…my first big bear market that I cut my teeth on. And I remember it like it yesterday. And my conviction we’re going to see something similar to Europe this winter is pretty high.
Meb: Well, Jeff, we’ll definitely have to check back in with you in the coming months. Good luck in the coming days and weeks, by the way. I was going to joke when the birth of my son happened. We even did a podcast from the hospital because I was there like three days. Not all I can do, right? I can change the diaper, I can hang out, but like a lot of downtime. So, we have a memorable podcast from one of the poorly lit waiting rooms. So…
Jeff: Well, I’ll be at Chelsea and Westminister on the 22nd next week with a similar a lot of downtime, so…
Meb: Well, best of luck to you. Thank you so much for joining us today.
Jeff: Great. Thanks for having me. It’s a pleasure.
Meb: Podcast listeners, we’ll post show notes to today’s conversation at mebfaber.com/podcast. If you love the show, if you hate it, shoot us feedback at the firstname.lastname@example.org. We love to read the reviews. Please review us on iTunes and subscribe to the show anywhere good podcasts are found. Thanks for listening friends, and good investing.