← The HC Commodities Podcast
The HC Commodities Podcast
Equity Investing in Commodities with Matt Zabloski
00:45:52
Today, we return to the subject of investing in commodities, this time from an equities angle. How has the sector performed over the last couple of decades and how much diversification does it offer? How do you analyze and discover value in the sector? And are investors returning and how best to navigate investing in such a rapidly evolving sector? Our guest is Matt Zabloski, founder and chief investment officer of Delbrook Capital Advisors, a Vancouver-based fund manager, focused on alternative investment strategies in the metals and mining sector. Matt has had a long career investing in energy and natural resources including as a portfolio manager with Fidelity.
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Foreign.
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Welcome to the HC Commodities Podcast, a podcast dedicated to the commodities sector and the people within it. I'm your host, Paul Chapman. This podcast is produced by HC Group, a global search firm dedicated to the commodities sector. Today we return to the subject of investing in commodities. The this time from an equities angle. How has the sector performed? How is it dealing with the rapidly changing world? How do you analyze and discover value in the sector? Our guest is Matthew Zabloski, founder and Chief Investment Officer of Delbruck Capital Advisors, a Vancouver based fund manager focused on alternative investment strategies in the metals and mining sector. Matthew's had a long career investing in energy and natural resources, including as a portfolio manager with Fidelity. As always, you can really support the show by leaving us a positive review on the platform you're listening on. And as always, I hope you enjoy the episode. Matthew, welcome to the show.
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Thank you for having me.
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So well. I'm looking forward to having this discussion. We're talking about both investing in equities in the energy and natural resource sector and the why and the thesis behind that, which is obviously your focus and has been your career focus. And then leading into some of the theses that you have, some of the trends that you're following and some of the why behind some of the narratives that we're going to discuss. Let's start at the top, which is essentially why should investors in general, why does commodities now make up, should make up some portion of your portfolio and then we can go into the difference between investing directly in the commodities themselves versus equities.
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Sure, absolutely. And I'm sure most of your followers know the commodities space, but obviously looking at the commodities area as an asset isn't a new concept. But I think importantly, people look at diversification benefits of commodities as hard assets and can appreciate that they can be additive to the diversification of an overall portfolio. So that's really the crux of one of the reasons we spend a lot of time on the sector is there are definite diversification benefits and also high level longer term thematics that I think are at play right now, you know, in a much greater sense than they have been, you know, through the last decade or two.
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From that diversification standpoint. I mean, how discreet are the sort of basket of commodities equities, whatever it might be, you know, versus the broader market? How does that, where do you get that diversification from? And also obviously there's been a narrative out there about, you know, a protection against inflation. There's some question marks whether that's actually Real. But can you just help us understand a bit more about kind of the why that diversification piece and how it holds out over time?
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Yeah, it comes down to correlation returns, right? I mean, historically, commodities, and I say commodities, it's a very bold, broad statement. Commodities you can obviously drill down into individuals and that makes a huge difference between commodities such as metals, precious metals versus base metals versus bulks versus energy. So when you say commodities is a very broad statement, but for us it's all about the correlation of returns. And historically, empirically you can show that commodities as an asset class or as sub asset classes have a great diversification benefit just based on the correlation to things like bonds, fixed income and or equities. So for us, really, it starts as an additive diversification tool as it comes to inflation. I mean, obviously looking at certain subsectors, gold in particular, as a play on macro trends for inflationary times or stagflationary times, that's not an argument that is new to the broad market, but it's something that if you look at previous cycles, holds quite nicely. So we continue to look at the commodity space as not only under represented in most institutional portfolios, but something that can not only be added for the return profile, but also diversification as we go through, let's say, at best, some questionable times geopolitically and from a macro standpoint, globally.
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Yeah, yeah, we'll get onto that. And obviously that's been a big theme of this podcast. Okay, so I guess digging, digging in further, you know, you've got this choice between investing in the commodity itself or instruments around that versus investing in the companies that produce or process the commodities. Can you talk about why you've gone down the equity route in your career and kind of some of the differences there?
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Yeah, I mean, it's best put that we go down the route of the operating companies. You know, 80% of the time that will be within sort of the equity area, but we also look at credit within the space. And you know, what really attracts us to that is not only the ability to play some idiosyncratic differences in the equity valuations or the fundamentals of a company either being long one producer and short another, but also allowing the fund that we run to take advantage of some very interesting facts that you only find in operating companies, that being the financial leverage of the balance sheets and the operating leverage inherent within anybody who produces something. Take for example, a commodity that we have, let's say a bullish spin on. Bullish thoughts on prices are increasing. If you take A copper producer, for example, that copper goes from $4 to $5, and it's a nice 25% return on spot copper prices. But that gets amplified many, many times on an EBITDA basis in terms of cash flow generation for a producer. So we tend to like the operating leverage, the financial leverage within the companies that we follow.
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Just staying on that for a bit. There are some downsides, obviously. One is being caught up with broader macro impacts, all ships rising in the tide and so forth. The other one is, of course, and this has been a bit of a question mark out there, is a lot of producers, miners have typically not wanted to have significant trading operations, for example. This is kind of a key theme that's been going on the last four or five years in the commodity sector, because they wanted to give their investors exposure to that underlying commodity. Right. That's sort of the Exxon narrative, if you'd like. More recently, as markets have become more volatile, more challenging, you know, they are hedging much more of their production. They're actively trading it. How does that sit within that sort of ability to predict the impacts on free cash flow from increasing prices?
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So, I mean, in terms of the hedging side, with companies that we track, invest in and operate with, I mean, hedging really is nothing more for them than a diversifier of risk, given their individual characteristics. So, as an example, if we're working with a company to build a gold mine, for example, and they have a massive amount of capital that they need to deploy to make said mine come into production within a certain timeframe, the advice we generally give from an equity standpoint, from a shareholder standpoint, is to effectively diversify some of that risk through the hedging side. I think historically, investors within the operating companies have not wanted a hedge book in place. They haven't wanted active trading operations. But I think as we proceed in a much more volatile world, there's an acceptability from investors that cash flows are robust. Potentially mitigating some of the volatility is a smart thing to do. So I think you'll see a trend of increased hedging amongst some of the commodities producers that are out there. And that's not necessarily a bad thing. I think it shows a sign of maturity within a sector in something that from a cash flow standpoint, especially a company that has that operating and or financial risk that is in front of them in the midterm, taking a proactive approach to hedging to get over that hurdle is a very thoughtful thing to do for creditors. And, or for equity holders.
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Yeah, yeah, we're definitely seeing that trend. Right. There is an absolute, every, a large proportion of producers, miners, processors, the operating companies are starting to, they're not already strengthening existing commercial teams. Starting to think about it precisely because as you said, it's volatile times, you know, in marketplace as well as prices and you know, across the board. And it also seems as well that there's less of a discount or there's more, more understanding from equity investors about the, you know, the benefits of having a trading program, a hedge program, how you'd want to describe it. So it does seem that that sort of, that piece is starting to be unlocked.
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Yeah, I would agree with that. And I think it also comes down to the individual situation within these operating companies would obviously have a different view of a company hedging production for multiple years in the future. But if you're doing it on a rolling 3, 6, even 12 month basis to allow some certainty of cash flows, especially in commodity market, that is volatile, as we touched on, but also within certain commodities that we track, an area where potentially prices have somewhat in the short term unjustifiably risen because of uncertainty that may in the next few months dissipate and bring prices back to normal. Taking advantage of some of these things is not seen in our mind as being a poor decision. So long as it's managed within the context of the operations.
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Yeah. And sufficient risk controls and all the rest of it. Before we talk about sort of particular strategies and what you're looking at and how you see the world today, there's some sense that investing in equities in the commodities space, particularly in things like mining, is not for your average generalist like myself, you've obviously spent a career dedicated to this. What is it that makes it a unique sector to invest in? What are some of the challenges? Why is it relatively difficult for your more generalist equity investor to tackle?
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Well, I think you're just taking on a greater number of input risk in terms of building the models and understanding the inputs for the industry. Right. I mean, not only do we have to hit correctly on the analysis of the actual operations. So let's talk about margins, let's talk about cost pressures, let's talk about anything operationally that could potentially throw a wrench into any fundamental strategy or fundamental analysis of a company, but the overarching revenue line is affected by something that's very volatile, which is the global commodities market. Right. So I think you have a greater degree of overall industry volatility. You know, you Combine that with the fact that typically within the commodity space, you know, very capital intensive, you know, new projects. If you look at the mining sector, for example, the capital intensity is, you know, can be very extreme. We're talking about hundreds to billions of dollars to build, build operating mines. So I think it's not for the faint of heart, but I think when you find the right, the right group, the right that's focused on the sector and being able to analyze and identify the risks, mitigate them, the return and the reward on the other side of these can be very, very, very material. So you're correct and we see it in institutional allocations. It's been a sector that's been very difficult for institutions to invest in. But I think it's also from the combination there not being a lot of institutional fund managers that are solely focused on the space. So it's not for the faint of heart. It takes a great deal of expertise and a bit of an iron gut from time to time. But the rewards on the other side of the sector could be very robust. It's just about managing the risk and identifying those risks ahead of time.
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Yeah, and I guess in some ways the story we're about to tell is going to show how some of these risks have been amplified in a less stable global trading environment. De globalization also pressures from digitization and sustainability. The energy transition, which provides opportunities but as well as costs. Just talking about having that stomach of steel in some ways as well. Obviously it is cyclical by nature and a lot of investment that looked very good in 2012 no longer look very good in 2015. And that also washed out a lot of interest and investment in the sector which returned somewhere around 2019 onwards. So can you give us some sense of that cyclicality and how that impacts investors desire to have exposure? And then secondly, can you give us some sense of performance returns in general through that period as well?
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Yeah, if you look at typical institutional allocation to the sector, I think a lot of institutions were historically had an allocation, The S&P 500, for example, waiting within the global materials sector was always small, but it was never immaterial. I think you saw what is best termed as the super cycle, and we don't necessarily like that term here, but the super cycle in the 2000s and money chasing equities within the commodity space. And if you sort of dissect what was actually going on back then, it wasn't necessarily looking at any of the fundamentals of these companies. I think you had institutional allocators who were chasing nothing More than beta, if you will, or leverage to the commodity price. You saw that in the 2000s up to the financial crisis in 2008, when everything abruptly ended. Not because the commodity cycle blew itself up, but because global financial crisis blew everything up. And I think there were great losses on the back of that. If you look back at what happened though, and sort of dissect, I think through the early super cycle into 2008, you had a good number of operating companies deploying capital in suboptimal ways. You had billion dollar copper mines being built in Chile that didn't have economics at the time. But we're forecasting higher copper prices to justify construction. And I think that all came to a screeching halt in 2008, and that market turned pretty dormant for I'd say a good part of half a decade. Right. Those projects were either canceled or they were built, but not cash flow positive, they were not economic. So you had still a very sour taste in the mouths of most equity or credit investors who were in the space who they thought they were making the right decision because you couldn't go wrong in the sector. But in reality they were just chasing perceived higher commodity prices in perpetuity. That put a big stain on the industry for, like I said, at least half a decade, if not longer. And then you sort of got into a greater dispersion of commodity returns in the 2014, 15, 16, into that range there things like precious metals were bumpy, things like copper were bumpy. Energy worked pretty well. So I think you saw the bifurcation and I think a lot of the specialty analysts within the commodity equity space or operating company space had exited and the sector was basically just left neutral of any fundamental ability to be analyzed. We obviously got into the COVID situation and as happened to most of the global economies, they were slammed at first and then inflated with free money. And that stayed within the commodity sector as well. So you had a great deal of rampant sort of speculation again in the early 2000s, 2000s. Then things sort of petered out. The macro picture emerged that we had inflation and that obviously war on the US dollar supported some commodities over others. But I think if anything, we're now sitting in a situation within the global commodities space, especially within the metals and mining space, where we're paying a great price and will pay a great price in the future for the lack of capital investment that we've had in the sector since the end of the super cycle and the great financial crisis. So I think it's a great Time to be looking at the sector, but it hasn't been without its volatility in the last couple decades.
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The energy and resources sector is experiencing unprecedented change.
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To help navigate this change and capture.
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Its opportunities, HC Group launched Enco Insights, a global advisory network dedicated to the sector, providing senior advisors and software subject matter experts to investment and infrastructure funds, law firms and corporates. Enco Insights leverages HC Group's 20 years of connections in energy and commodities to give clients the expertise they need when the stakes are high and insight matters. Learn more@encoinsights.com Talking of super cycles, we've had Jeff Curry on a few times who talks about that revenge of the old economy and that we really aren't seeing sufficient inflows of capital into things like copper. If you actually look at the future consumption predictions. But also yeah, you had that sort of as you said, you had inflation, but then you had this massive tightening of the money supply in 2013, in 2023 and onwards. That's sort of taken some of the narrative out of that super cycle. But yeah, we sort of land where you do on. It's not a particularly useful term in general.
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It's also now complicated the last six months by heightened geopolitical tensions and uncertainty and decisions that have to be made globally based headlines without substance being followed up. So the uncertainty factor and thus the volatility in the last six months is that much higher. So if you take one step further from that in terms of making large capital allocation decisions in the capital intensive industries such as commodities, it's obviously a more difficult place to be sitting in the boardroom saying you know what, we're happy to greenlight a $5 billion copper expansion for this company because it's very difficult to discern I think some of the shorter term price movements within commodities that are fundamentally demand supply driven or maybe short term influence by headlines or geopolitical risk that's come up. I think the world's just become that much more complicated. But for us that's where we find the opportunity. That's the key for us being able to be in the operating companies. Both long and the key short is really where the opportunity is.
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As you say, it's very hard to make decisions when you've got sort of this magnified political risk. And actually there you're not talking about what price, you're talking about can the commodity flow. Right, which definitely makes everyone pause but I guess let's get into that. So can you give us some. I guess you run a multi commodity strategy. Can you help us understand some of the themes that you've been focused on over the last six months or in general and what you see out there?
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Yeah, I think from a high level for us, just speaking thematically and we can get into the individual spots, it's been a continued de dollarization theme. I don't think that surprises many folks. I think that's accelerated in the last, call it a couple months here. So that de dollarization theme, not necessarily that quintessential end of US Exceptionalism, but more just a weaker dollar, its impact on commodities. I think we're very cautious globally on growth. I think internally we discuss maybe a mild recession in the Western Hemisphere. Whether that happens or not continues to sort of bounce around, but we're planning for slower economic growth in the United States and then really, really focusing on the risk in Asia, the general commodity consumption economies, what's going to come out of China. So I'd say we're cautiously optimistic, you know, in the medium term, but I think in the short term we need to be very cognizant that there could be some, you know, some bumps along the way. What does that mean for us? I mean we've been, we've been very focused on the precious metals trade in the last six months. I point to, obviously everyone knows the gold, gold prices moved quite materially. But you know, the operating companies within the world that we follow for gold producers, primary gold producers, are still very inexpensive on a cash flow basis and need to catch up to the commodity prices. I think generally we look across the board there and see some of the gold producing companies still pricing in anywhere from 24 to $2,500 gold in a $3,300 an ounce environment. So to the degree we go back to the beginning of this conversation and having some of those operating companies maybe in the short term hedge some production to take advantage of this increased margin, backfill with a bit of cash flow and even look at things like dividends and buying back stocks. I mean it's a pretty interesting time to be a fundamental analyst in this space. From there I go back to looking into China. We're long term believers. I think that because of decarbonization initiatives and electrification initiatives and AI, there's opportunities in some of the base metals for sure. But I think in the intermediate term here, call it through the end of this year into 2026, we're still looking at copper more as a Dr. Copper sentiment indicator of global growth as opposed to anything else you've had a Huge bifurcation in commodity prices, copper prices that have been a result of the tariffs and the uncertainty that's going on in the U.S. u.S. COMEX copper prices versus European copper prices. How can we take advantage of that from an operating company standpoint? Can we find a producer who can take advantage of Chicago based prices, sell at a premium versus the guy who's selling for less into Europe? So there's really an opportunity, I think, to take advantage of this noise and this bifurcation. And you know, it's something that as a hedge fund we quite enjoy analyzing and getting in the weeds. And because we do this nonstop all day, we're quite unique globally. So I think, you know, we're at the front of the information curve, if you will, on it. So you know, those are sort of where we're sitting from a high level thought process at the moment.
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Just out of interest, how do you get on the front foot in terms of information? Like how do you build that capability up? I don't want this to be sort of an obsequious question, but it seems to me, whereas five, ten years ago you could have some traders who really understood the commodities, they'd have decent networks. Today you need to have so much more of a political lens, a geopolitical understanding. I mean, there's just so much going on that any good idea could be railroaded by a tweet or by a response. It just seems tough.
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So I think that comes down to risk mitigation, risk management. But I think for us it's the team we employ here. We're on the west coast of North America. We have the advantage of information flow from Asia still relatively early in the evening, have the advantage of working the entire North American market. So the team spends a lot of time outside traditional equity market hours analyzing. It seems like an incrementally higher number of factors, geopolitical, macro, etc. But for us, the process really just starts from the top down and just looking at the macro trends that are out there and then discerning how that makes fundamental analysis of individual commodities applicable and then looking at the operating company. The coverage universe we have is global, so that takes some time. But generally we've been at this going on 20 years now. So it's leading onto the process and leading on to embracing some of the volatility for the opportunities and understanding that in a market like this, some of the noise will be amplified and will have greater than historic impact on what occurs in the markets that we cover.
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You mentioned precious metals. Can we Just go back to that. You mentioned sort of that bifurcation of east versus West. Obviously in the short term that's changing how we're seeing the flow of metals. That's primarily in response to expectations around tariffs and positioning for those. What does that look like long term? Does that mean actually that you're going to have less efficient markets? You're going to have, you know, having. There's this fascinating challenge out there that if every, if every nation now wants to sort of French or you go into that kind of Balkanization blockatization, I think we've had it called on this podcast before, of different supply chains, in the end that means you're going to, you know, operating companies, presumably with government support or not, you know, some level of government support are going to have to be operating less efficient mines from a security standpoint. Right. We recently saw Richard Holtom say, you know, look, if Nerstar in Australia that wants to stay open, it needs, you know, there needs to be some government support. So how do you manage that east west bifurcation? How do you manage that sort of those supply chains getting sort of essentially decoupled? And what does that mean for operating?
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Well, look, in the short term there's a short term response which is that it increases volatility and uncertainty. And I think you're correct in the assertion that longer term you're going to need to have either much differentiated pricing based on local operations. But at the moment we're not there. I mean, the best we've seen in terms of pricing bifurcation has been the copper example that I gave. But I think in the long term you're definitely seeing local economies, local governments support their own industry. You've already seen the use of commodities as a currency, especially out of the BRICs. You continue to see commodity purchases backfill central bank balance sheets. And I don't think that trend is something that is started and or ends quickly. Right. I mean, the fact of the matter is there's been an insatiable demand from Asian economies and China and also Southeast Asia for physical bullion. Right? Not paper bullion, but physical bullion being brought back and stored in vaults locally. We can talk about why that is, but the fact of the matter is central banks are and continue to be at the leading edge of seeing commodities as a central bank key holding. I think that probably accelerates into other commodities, but we've seen the front of it being within bullion, obviously, given its historic use as a central bank asset. If you look at what the Europeans hold in terms of physical bullion versus what China holds. I mean China still has a lot of gold to buy to catch up to them. And look, we're not gold bugs here. I'm not preaching the benefits of gold as a central bank asset in and of itself, but it's certainly interesting to see those trends and the fact that regardless of the price, eighteen hundred dollar bullion versus three thousand three hundred dollars bullion, purchasing really hasn't slowed down.
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And just to get your thesis on why, is this just a response to obviously sanctions, increasing sort of weaponization of the dollar by the US government and confiscation of funds, potentially Russia's 300 billion over all that piece?
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Yeah, I think it's a little bit of column A, a little bit of column B and column C being that there doesn't seem to be a slowdown in deficit spending in the U.S. right. Like, I mean we have the big beautiful bill that is being touted to.
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Go through Congress to add more debt.
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Whether it happens or not is anyone's guess. But if you combine a bit of a dumpster fire of a balance sheet with the US with greater uncertainty being led from the top and threats being made to other economies, you can pretty easily get to the fact that potentially you don't want to have a U.S. treasury basket as your primary holding of central bank assets. And you know, it's not to say that I think this is going to go to zero or anything, but you've seen it in the flows. You've seen the trade flows out of Treasuries, you've seen yield curve adjust accordingly. You know, you've seen people question how future deficits, 2, 3, 4 trillion dollars over the next few years are going to be funded. And it's very simple economics. There's more supply than there is demand. Well, you know, the yield has to go up. So you know, I think it's a slow moving sh. I think the last, call it month or two since we've seen the 10 year sort of spike up to over 5 maybe that's a little bit of a more volatile than the equity markets certainly want. They've told you that. But at the end of the day I think this is a shift that is not just something that is in the short term, it's not just a tactical move. I think it's a systematic global slow reallocation, even to a small degree of central bank assets. And it seems to me if you touch on those three baskets we just talked about to be entirely justified. And I think you see it play out over the coming years.
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Historically, putting it into context, 5% is kind of the average, right?
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Yes, I think it's a matter. Right, but it's a matter in which we got there the levers that were pulled or the arguments that were made on April 2 and presented to the world that got us to go A S and P tanking and yield spiking. I mean, the writing's on the wall pretty quick, but the markets are efficient. They're going to tell you what they think pretty quick.
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Yeah, I'm not particularly bullish. That's fascinating. So just in terms of that, geographically speaking, where are there certain regions, certain countries where you feel more comfortable to invest in those particular domiciled operating companies?
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You know, we spend a lot of time doing political risk analysis, geopolitical risk analysis. Because it's a very important question. I'll start just with the statement that obviously commodity production globally in terms of global reserves is in a constant decline. Right. Just in terms of a reserve decline, you're pumping oil out of a reservoir that doesn't regenerate it, you're mining gold out of a mine that doesn't regenerate, etc. Etc. So, you know, that is to say that the remaining reserves globally are probably in less stable jurisdictions than they were 10 or 20 years ago. I mean, that's a fact. So we need to appreciate what the risks in these jurisdictions are and understand and decide if those risks justify an investment. So increasingly over the last decade, let's say that risk assessment has become an increasingly more important part of the investment process. Right. Don't have to point much further than continents such as Africa where things are materially different between countries. You know, the importance of understanding the local risk within those countries is very important. So for us, you know, is there a no go place anywhere in the world? Of course there is, but it's because we've risked any potential return out of the equation. Right. We said the risk is too high to justify any capital there because even if we tripled our money, the risk is too high for us. We tend to look at, you know, Western hemisphere, you know, North, South America, we do some work in West Africa, we do some work in Australia, you know, we're not doing a ton of work in mainland China, for example, just given disclosure requirements of operating companies and given security of asset, etc. So for us, you know, it's about the reporting the company's bringing out. It's about the stability. I'd say there's certain great opportunities in Africa. But to say that Africa is all the same is obviously a mistake. So we tend to stick to certain areas that have good mining codes to them or extraction codes that are multiple decades old. Where we don't pick up, we can't identify the risk as being a severe. In other jurisdictions, obviously Canada is a great place to invest. The United States continues to be attractive. Central South America and Australia sort of, you know, where we spend a lot of our time. Hello, I'm David Hunt, founder and managing director at Hyperion Search. Founded over a decade ago, Hyperion Search has helped organizations from major utilities to startups recruit their leadership teams and key individual contributors to accelerate both their growth and the energy transition. Our three main verticals are renewable power, energy storage and the mobility. The energy transition and the talent that delivers. It has been our passion since day one. To find out more, visit hyperionsearch.com or listen to my Leaders in Clean Tech podcast, available on all platforms.
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Let's move. Let's talk rare earths and more broadly, critical minerals. It's been a key topic on this podcast this year and historically. Where do you, where, you know, what's the thesis around that?
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Well, look, I mean the thesis is, you know, the majority of supply, actual mine site or extraction supply, comes from China. There's a distinct competitive advantage there because labor generally isn't compensated and the environmental liabilities are ignored. So, you know, the play for us has been identifying, you know, whether it's the NDPR mining, whether it's antimony, gallium, et cetera, very difficult to find an ore extraction operation globally that can compete with what's coming out of China. Even though China has curtailed to a certain degree some of the exports of NDPR and almost entirely things like gallium and antimony. So, you know, we found opportunities to a certain degree. Those are generally byproducts from primary mining of other natural resources. But the real spot that I think we can focus on here, that's a core to our place within the rare earth world. The critical minerals world is within the processing and refinement, you know, the separation of materials, the refining into oxides, etc. You know, there's some western based companies that do a great job of that and I think really will be the place to put your money in the mid to short term here before we can focus on primary or extraction outside of China. That will take obviously building a mine will take years. Even with government support, the operating costs of those mines in the current environment are nowhere competitive to what China can Manufacture for. So in terms of primary mining and ore extraction within the rare earth market, and I talk specifically to NDPR or heavy light rare earths, you're going to need some incentive pricing from the government, you're going to need a floor price put in or you're going to need the global markets to very much bifurcate on Western supply versus eastern supply. And you haven't seen that yet. I know there's some folks in the US especially some operating companies, who say that's beginning to happen. I haven't seen any of that. So for the time being, we've taken ourselves away from the actual mining operations or extraction operations and look more at the refining model and how we can invest in companies that are profiting from throughput, not from our extraction. Yeah.
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There is somewhat of a sense that actually, whilst these things are rare, it is actually ultimately the processing bit. That's, that's rare.
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Yes.
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And you know, there are significant opportunities to be gained from modernizing some of those processes. You know, some of them are decades old. Right. I mean, and as you say, there's no incentive in China to really do that because you don't have the same environmental liabilities, same, you know, other impacts. It would seem to see that that would make sense.
- [34:25]
A
Yeah. I mean, you look at monocyte separation, for example. Right. Monocyte separation in the United States, you know, there is some capacity. There's not a ton. It comes with a great deal of environmental liabilities and oversight because, you know, the extraction process does generate some radioactive byproducts. You know, that has to be handled. You know, the cracking and leaching of rares is not for the faint of heart. I mean, there's great regulatory oversight in that as well, given the radioactive properties of some of the, some of the byproducts. But I think at the end of the day, you do not in the Western Hemisphere have a supply chain that can go from primary or extraction through separation, through processing to end oxide production. That infrastructure is not there. And I think, you know, if you speak to most folks who are in the know within the US Government, you know, in Washington, that's there's a great deal of concern that that supply chain needs to be addressed immediately and in a very rapid fashion. So. So the reading we're getting is that there's a great deal of interest in how to accelerate development of that entire supply chain in the West. But I mean, we're talking about, you know, hundreds of billions of dollars of capital that need to be found, invested, et cetera so this isn't something that changes overnight. So in the interim, I think you look at the folks in the Western hemisphere who have the technology and that's the big thing. I mean, the ore extraction, you're digging stuff out of the ground. It's the processing where the IP really comes in, where I think the great deal of margin is.
- [35:49]
B
Yeah, yeah. I mean, one challenge there is, obviously they have been, this has been on their radar. We've just had Ashley somewhat Forbes talking about this, who's the Deputy Secretary for the U.S. of Energy of critical minerals. There has been a lot of looking at this going on, but not really that much action. Right. I mean, and one of the challenges, of course, is that you've just got layers of regulation and process required to get through the state, federal, you know, actually doing stuff is challenging. But what about uranium? What about the nuclear storage? Does that figure into the intent of your thesis at the moment?
- [36:20]
A
Yeah, I mean, the nuclear story hits on exactly what we just spoke about with rare earths. Right. It's been one of these hurry up and wait opportunities. Right. The idea that there's a nuclear renaissance and, you know, we need to be involved in all these uranium extraction companies or small module reactor companies. Fair enough. I mean, it's very much a spin and a marketing ploy in our opinion. Look, I mean, everyone loves the idea of nuclear power. I mean, most intelligent people get it with the fact that it's clean, it's long lasting, there's a great deal of fuel supply in safe jurisdictions. But the next step from a psychological standpoint is nobody wants a reactor in their backyard. Right. Because there's still this, this overarching view that nuclear power is dangerous. So do we agree with the merits of nuclear power? We absolutely do. Have we invested in uranium companies in the past? Absolutely, we have. But if you look at the sector right now, I think a lot of what you've seen within the equity universe, within uranium in the last couple months is a lot of it's been headlines. The perceived ability to tear down the regulatory burden of putting a power plant in, being able to fast track this as base fuel, sort of base power load, you know, source. Look, I just think, you know, it's a bit of a cart before the horse thing. It sounds great, but once again, I mean, the last real nuclear power station built in the United States, I believe it's built in South Carolina and bankrupt in Westinghouse. So, you know, it's, it's something that, you know, I think the intelligent investors will take A bit of a wait and see here. I think there's a lot of speculation going into some of the actual uranium mining companies. It's a very small investable universe, right. It's not. There's less than, I can count the number of investable companies on one hand. So it's a difficult place for capital to flow into efficiently. And when you have any amount, reasonable amount of capital, trying to chase that small of a base market cap, you can have great influence on valuation. So it's something that I think people need to be aware of and maybe pause to see if any of the regulatory changes are actually sticking within some of these, these jurisdictions. Because just remember we had, you know, not so long ago in Germany talk about bringing on nuclear reactors that were previously being mothballed in Germany, right. And people got excited about that and then the news cycle died down and we didn't really pay attention to it for a while. So I think you need to be a little cautious of sort of. And discerning between headline talk that the market gets excited about and the reality of what's going to happen.
- [38:56]
B
Part of the great thing is, of course, for both of us being in the commodities sector is it's back on the front page of the Wall Street Journal every now and again, whereas it really wasn't five, six years ago. On the flip side, as you say, you just take the rare earth discussion we just had. There are very few public companies in the US that has anything to do with it. And so much sentiment driving price as opposed to underlying realities. Right. And I think we had on the nuclear story, there's very exciting things happening with the next generation, but the SMR story, I mean, they typically just keep getting bigger and bigger and end up just being like normal nuclear power stations that are just very expensive to run, Right. So it's a lot of hype if you step back. So, yeah, there's, there's opportunities today and it's this using the same old tools and rigor and understanding and that requirement for being a specialist in the sector, given it's kind of playing on hard mode. When you look over the next three to five years, we kind of touched on one, which is the US debt is a big potential overhang. What else sort of outside, you know, what do you think the next, the big risk factors are over the next three to five years. And I'd love to get your take on China because that seems like that's, you know, they've got some significant problems there as well.
- [40:09]
A
I mean, China is obviously the elephant in the room when it comes to commodity, and you know what that means, especially within the base metals area. You know, for us, the Chinese economy has continued to decline over the last, call it half decade. Right. Or, you know, for sure, the last half decade. In our mind, it's cautiously optimistic that, that, that there's a light at the end of that tunnel. You know, we're not making any large bets on that to any certain degree, but I think, you know, the resiliency and the commitment that the Chinese government has to ensuring consumption there is something, you know, that we anticipate they'll pull up a lever on in the next, you know, six to 12 months. And by that I mean potentially stimulating consumption once again to an even greater degree. That plays into the commodity sector, maybe not in the way historically it has. I think it's more based on consumer consumption as opposed to infrastructure stimulation. So I don't think you'll see huge infrastructure projects as the manner under which China stimulates. You know, they've built enough of the cities.
- [41:17]
B
Yeah, I think they think they've exhausted that particular angle.
- [41:19]
A
Exactly, exactly. So I think it's going to be consumer focused, you know, as it pertains to commodities. You know, we track things like Chinese electric vehicle sales, which for most would know that China is the largest electric vehicle market in the world. And Chinese electric vehicle sales have actually not been that bad. They actually surpassed expectations in the last year. So there are those green shoots out there, I suppose. But as an export economy and with your largest partner on the export side basically shutting your economy down, there's obviously a great deal of concern. And I think that should lead to. It's attempting to stimulate internal consumption to a greater degree.
- [42:03]
B
Anything else on the horizon that's just worth thinking about for potential investors?
- [42:08]
A
I think there's some relative value within the sectors that we cover just in terms of the dispersion of equity valuations within subsectors that we look at. I think that's a very interesting thing that's amplified by some of the volatility that's out there right now. I think some of the energy metals are generally troughing right now and they'll have some great opportunities in six to 12 months. And, you know, the ultimate contrarian play on that right now is something like lithium that has been just completely sent out to the woodshed and $10,000 a.
- [42:41]
B
Ton versus $80,000 a ton a couple years ago.
- [42:44]
A
Yeah, I mean, someone was mentioning, my analyst was mentioned to me that spodge means trading at $600 today and 6 or 800, it almost doesn't matter. But when we look at the sector touched on the EV sales of China, those are doing all right. And I'm by no means becoming a bull on this, but I think I am definitely becoming much more neutral. I think you're one or two large supply cuts away from the market, probably flipping and becoming more positive, even if in the initial stages, that's on speculation. I think you're well, well into the cost curve and I think that always sort of perks my ears up to follow something a bit more closely when you're that far into the cost curve. So for us that's interesting thematically. We still look at some of the minor metals, tin for example. Tin for us is a very interesting place to be right now still. There's been supply disruptions coming out of Southeast Asia. Tin as an input in the AI revolution and microchips I think continues to be an interesting story on a demand supply basis. We talk about earnings out of Nvidia or any of the microchip companies that continue to surprise quite nicely. It's going to require a greater amount of some of the metals that go into those microchips. So tin as a minor metal that I'm sure not many people follow still looks very interesting for us. And the operating companies that we look at there are making some, you know, very material cash flows.
- [44:11]
B
Yeah, Cornish tin is making a comeback after the Bronze Age.
- [44:17]
A
Exactly, exactly.
- [44:19]
B
I could go on all day, I'm enjoying this. But it would be great before we let you go, to understand a bit more about Delbruck, what actually you guys offer and what returns have been and you know, how do people find you and so forth.
- [44:31]
A
Yeah, I mean, so Delbruck Capital, we're based in Vancouver, Canada, the west coast of Canada. You know, a team of six of us here have a master fund sitting in the Cayman Islands, open globally. I'm a former portfolio manager for Boston with a large mutual fund company out of Boston. Really for us, as we started the conversation off with we cover everything global materials, anything from the steel sector, chemicals, fertilizers, metals, mining, etc. So that's, that's generally the focus I've had for the last 20 years. Returns for us have been in the high, high teens compounded since we started in 20, 2018, our master fund offshore, you know, and continue to see great opportunity in the sector. Run long, short books, both relative value and event driven. And yeah, we're based in Vancouver, our website is delbritcapital.com Excellent.
- [45:20]
B
I'll put that in. Put links to that in the show notes. And yeah, look, Matt, love to have you back on in a year or so and, you know, pick the story back up and, you know, a lot of crossover in what we've covered on the podcast is.
- [45:32]
A
Well, it's been great talking to you. Thank you very much.
- [45:36]
B
Thank you for listening. To find out more about HC Group, our global offices and our expertise in search within the commodities sector, please visit www.hcgroup.global.