The Energy Report: In a recent Financial Sense Newshour interview, you were more bullish than you've been since the crash of 2008. Is the economy really improving?
Don Coxe: My biggest fear was that the whole system was going to collapse, not because of central bankers or politicians, but because of big, bad bailout bankers. I just finished reading Nassim Taleb's latest book, "Antifragile," and that is one of his points, too: We should fear the bankers more than the governments. Due to the crash, the bankers are being forced to rein in their stupidity and greed. That's my reason for being bullish.
TER: Do you think that the Federal Reserve's 2008 crisis management was the correct response after the crash?
DC: Yes, it was. I wish that they had imposed the Volcker rule. I wish that we didn't have an extra 3,000 lobbyists in Washington coming up with new rules to put into Dodd-Frank. The rules that constrain the banking system should be written in a few pages. Having such a large number of pages means that the bankers are going to do what JPMorgan did when it lost $6 billion, which was to claim that speculating was not speculation.
TER: What kind of stocks are the best bet in the current situation?
DC: When there is an upside surprise to the global economy, commodities can outperform other investment sectors, especially when inflation is low. Inflation is not a threat when commodity supplies rise to meet demand, and the money supply greases the transaction. But no matter how much demand exists, the central banks can only marginally increase the money supply. And commodities have limits. Think of commodities as runners who are capable of doing a 100-meter dash in less than 9.5 seconds. No matter how much you pay the runners, the number of people who can do it that fast will not increase dramatically. On the other hand, global economic growth correlates to increased commodity consumption, particularly if the growth is occurring in countries with lots of young people moving up from subsistence levels to middle-class levels.
TER: Where is the growth?
DC: China is number one in total foreign trade. That is free competition at work. That is a sign of how much we can expect demand to increase for commodities. There is a dramatic increase in the total volume of trade relative to the size of global gross domestic product, partly because tariffs on commodities crossing borders have fallen.
The U.S. got beaten up in the last five years or so because the capital-spending boom came a couple of years after the commodity boom. Then we had the bankers' crash, which slashed demand. Meanwhile, great big capital projects that take three to six years to complete were coming onstream and we witnessed the nightmare effect of commodity prices falling while the global economy was expanding.
Now that we are slowing down capital expenditures, we are finding a surprise on the upside as the GDP improves, bringing along commodity prices in its tailwind. Stock prices have not yet confirmed this trend, which means there is more value now in commodity stocks than there is in the rest of the Standard & Poor's.
TER: Growth in Asia is clearly expanding, as you indicated, but what about the West?
DC: The West has bad demographics. With the aging of the Baby Boomers, a disproportionate amount of all new resources will go into health care. That creates a demand for jobs in health care, but there is no economic multiplier to support that demand. Let me give an example: When Eisenhower built the interstate highway system, there was plenty of spin-off upside activity. But we don't get a multiplier effect from extending the Baby Boomer lifespan by 73 days. China does not have that problem.
TER: Growing economies demand increased energy use. What looks the most promising to you in terms of coal, uranium, natural gas or oil?
DC: As long as I have followed commodities, there was a global price for oil. Now, there is an astonishing spread in oil prices between Brent and West Texas Intermediate and an unprecedented gap in the price of crude in Alberta and the price of Louisiana crude. That is not due to tariffs. That is due to a failure to build the Keystone Pipeline and a variety of other problems. The good news is that the best performers within the energy group are pure refining stocks. That has almost never happened before. The pure refiners are insulated from the rest of the industry because they are not subject to exploration risk. The spread between what they are paying for crude and the price of gasoline is astonishing. It is a market distortion and it will not last forever. But in the meantime, it's fun to own the pure refiner stocks.
TER: What about the natural gas phenomenon, in which the increase in supply drives down the price and that drives down potential profits from exploration?
DC: The people drilling and producing natural gas are some of America's greatest heroes! They take big risks, fight off politicians and spend tons of effort and technology to produce a commodity that they have to sell at a virtual loss. The rich oil and chemical companies and utilities are benefiting from the explorer's pain. It is a bizarre situation. But Herb Stein's Law tells us that if something cannot go on forever, it will stop.
In the meantime, the U.S. has a built-in competitive advantage from advanced technology. And I am not talking about Silicon Valley. Every job created by fracking stays in the U.S. And every price reduction due to fracking stays in America.
TER: Will environmental concerns about global warming and fracking hold back the development of the energy sector?
DC: The development of the gas sector will move ahead. The odds favor the politicians finding a pious reason for killing Keystone. But the fact remains that, unlike other commodities, there is no scrap gas or oil. We burn 87 million barrels per day of oil. But for commodities such as copper, zinc or iron, roughly one-third of what gets used each year comes from scrap material that's been reprocessed from earlier economic cycles. The hydrocarbon business does not compete with stockpiled commodities. The law of depletion declares that every barrel we draw is gone for good. In the long term, the value of huge reserves, like in the Alberta oil sands, will be realized, but in the near term, when oil from Alberta sells at a $35 per barrel discount to oil delivered in Louisiana, this is a terrible thing for industry. Alberta oil is extremely expensive to produce.
TER: What about the alternative energy space? Do you see any growth potential there?
DC: What I see is an absolute coincidence between stock prices and politics. Ever since the election, the top-performing stock group week after week after week as measured by Investor's Business Daily on the basis of six-month performance is solar energy. Solar stocks are doing better than any other of the 197 groups covered in the U.S. And this is an industry that has required billions and billions of dollars of government subsidies and made no real money. But owning the solar stocks is a good deal.
TER: Last time we talked, you mentioned an agricultural boom due to people in emerging countries moving to more protein-rich diets. What does that mean for energy inputs to food, fertilizer and transportation fuel?
DC: U.S.-based fertilizer companies producing nitrogen fertilizers have been tremendous performers. Their profits rose spectacularly as the cost of their biggest raw material, natural gas, fell. Plus, the price of fertilizer has risen because farmers are using more nitrogen to grow more corn. Not many industries are enjoying that kind of experience, so it's a good place to be as an investor. The fertilizer industry is helping to make life better for billions of people. The industry did not make much money in the past few decades, so there is not a multiplicity of companies now. The companies that came through those drab years are reaping their just rewards. Fertilizer firms are amazing investments.
TER: You've identified a few sectors where investors should look—refiners, alternative energy and fertilizer. Which other sectors do you favor?
DC: When there is a surprise on the upside, base metals stocks benefit. After the crash, they were hammered hard and the companies wrote off the excesses of the last boom. These stocks are selling at low multiples of earnings, and they are not priced at the true value of possessing decades of reserves. The reserves are the equivalent of farmland. Farmland doesn't sell purely on the basis of what it returns each year, but on the basis of future return. When you buy farmland, you usually plan to own it virtually forever. Oddly enough, this doesn't apply to something that is even more rare—base metals.
There is lots of farmland in the world, but there are not that many great ore bodies, resources that can last into the next century. In that sense, the ore fields are treasures that are going unnoticed because people choose to value base metal companies only on the basis of the current earnings. Any pension fund or investor with a long-term view should be buying companies with huge ore bodies, even though that money will be earned in the future.
TER: Where are some of these ore bodies you're referring to?
DC: I look for ore prospects in countries that can be politically trusted: the U.S., Canada, the solid countries of Latin America, or Australia. We do not want to invest in firms with ore mines in countries that are wracked by civil wars or that expropriate properties without paying anything. There are only a few such base metal mining treasures around. As long as we're going to have reasonable economic growth, it is a good idea to buy assets that will last until late in the century. In the meantime, investors receive earnings and dividends that justify owning assets that will become worth more over time.
TER: Which base metals do you particularly think are going to be the most lucrative?
DC: Iron ore is the top. Number two is copper, which has many uses. As economies strengthen, there are big run-ups for nickel and zinc. Aluminum is by itself: I do not see a great future with aluminum, as it is not priced on the value of ore in the ground. It is priced based on the cost of the energy to refine it, the Hall process. Aluminum can be described as congealed electricity. With better energy prices, aluminum will stay cheap.
TER: Thanks for your time.
DC: I enjoyed it.
Don Coxe has 40 years of institutional investment experience in Canada and the U.S. As a strategist and investor, he has been engaged at the senior level in global capital markets through every recession and boom since the onset of stagflation in 1972. He has worked on the buy side and the sell side in many capacities and has managed both bond and equity portfolios and served as CEO, CIO and research director. From his office in Chicago, Coxe heads up the Global Commodity Strategy investment management team, a collaboration of Coxe Advisors and BMO Global Asset Management. He is advisor to the Coxe Commodity Strategy Fund and the Coxe Global Agribusiness Income Fund in Canada, and to the Virtus Global Commodities Stock Fund in the U.S. Coxe has consistently been named as a top portfolio strategist by Brendan Wood International; in 2011, he was awarded a lifetime achievement award and was ranked number one in the 2007, 2008 and 2009 surveys.
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1) 1) Peter Byrne conducted this interview for The Energy Report and provides services to The Energy Report as an employee or as an independent contractor. He or his family own shares of the following companies mentioned in this interview: None.
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