← The HC Commodities Podcast
The HC Commodities Podcast
Unearthing Alpha with a Metals Hedge Fund, with Matt Heap
00:50:24
Today we return to the subject of hedge funds in commodities, and metals and mining in particular. How have hedge funds evolved with respect to commodities? What do investors and allocators think about with respect to commodities exposure and the types of investments they want to make? How do hedge funds go about a lasting edge in the commodities sector? And then why commodities and why, in particular, metals and mining? Our guest is Matt Heap, founder and CIO of Forth Fund Management, a sector specialist hedge fund dedicated to metals and mining, launching in Switzerland. Matt has had a phenomenal career in metals trading, both in hedge funds at Orion Resource Partners, and then prior to that, at Louis Dreyfus, where he was global head of metals
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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 hedge funds and hedge funds in commodities and hedge funds in metals and mining in particular. How have hedge funds evolved with respect to commodities? What do investors and allocators think about with respect to commodities exposure and the types of investments they want to make? How do hedge funds go about building a book that can deliver a lasting edge in the commodities sector? And then why commodities and why in particular metals and mining? Our guest is Matt Heap, founder and CIO of Fourth Fund Management, a sector specialist hedge fund dedicated to metals and mining, launching in Switzerland in the next month or so. Matt has had a phenomenal career in metals trading, both in hedge funds at Orion Resource Partners and then prior to that as Louis Dreyfus, where he was global head of Metals Proprietary trading. As always, you can really support the show by leaving us a positive review on the platform you're listening on and I hope you enjoy the episode. Matt, welcome to the show.
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Thank you so, yeah, real pleasure to
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be here, Paul, Glad to have you on. And there's sort of a sad unrecorded episode of the HC Commodities podcast where we had you on a panel with Bloomberg Intelligence, which was a great discussion. We're taking little bits of that, but actually leaning a bit more into, into what you're currently doing and kind of real relevant information. And that is essentially talking about a being a hedge fund, a sector specialist in metals and mining. And so the first part of the discussion is going to be very much about setting up a hedge fund. What are they, the whys, the hows, challenges and opportunities in commodities. And then the second half is going to be talking about why metals and mining now and your thesis there, which I found fascinating at that panel. Let's just start with the basics, which is what do we mean by hedge fund? Is that now just a catch all and irrelevant term and no longer applies to what they originally set out to do? And what are the different types of funds that are now kind of swept up in that one umbrella?
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Sure. Well, yeah, I think a hedge fund is still a very relevant asset class, let's say. And really a hedge fund is simply a pool of private capital where the manager has authority and the investment mandate to manage that pool of capital. One way to also think about it is a focus on absolute return. So very often I present that our job is really to make money if markets are going up, down, left or sideways. And I'm often asked what our strategy is and really I answer, it's to make money and not lose it. Another way to think about the history of it, it goes back to just after the Second World War. You have a famous gentleman called Alfred Winslow Jones and he really started the first hedged fund. He also introduced the 20% performance fee. That's back in 1949. And for anyone who likes to read a good book certainly can recommend there's one called More Money than God which is a good view of the hedge fund industry. And then another seminal one is the reminiscence of a stock market operator which is over 100 years old now. And those two books really give you a good history into some of the origins of how the hedge fund market started.
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And critically my remembering they could go short as well as long. Right. And going short was quite the innovation back then.
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That's exactly right. That's really what was unlocked is how you can have both a long position as well as a short position. And in an ideal situation both legs make money and therefore you've effectively increased the return by reducing the risk. And that's really, that's really our job of risk adjusted return.
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B
Now that sort of, that that original start has proliferated into many different types of funds and anagrams and so forth. Can you just give us some, what are the big sort of buckets of different types of funds? I know we covered this up a couple three years ago now actually on the pod, but it's good to go through it again and how do they distinguish themselves from one another?
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So I broadly speak, let's say about the commodities sector and some of the words we use. So CTA is a common one, which is a commodity trade advisor. That's really now a catch all for the trend following community which is really an old strategy. We know some of the richest people in the world have really achieved that by riding some very long trends. And that's really what those strategies continue to do with some additional elegance these days. The systematic strategies that's really let's say a data driven and it's model based as an example, a super simple one of if inventory goes up, maybe it'll encourage it to have a bear bias, maybe with some mean reversion and it is trying to remove the human emotion from the trading. And then lastly the discretionary managers, which is what our strategy is, which is really combining, let's say the human brain is still A very powerful instrument. And combining that with technology to. Yeah. To help adjust and to see turns in the markets. The brain is still very good at consciousness and therefore. Yeah. It's to really adapt with the information.
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B
Yeah. And just going back to the CTAs versus systematic. Are there CTAs out there that are using a systematic approach to deliver that trend following? What's the blurred lines between the two? And can you just talk about sort of why you alluded to them being sort of a bit old fashioned?
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Yes, I think it comes back to almost the commoditization of it that a pure trend following strategy is now, let's say quite commoditized and typically doesn't command a hedge fund fee. And the systematic strategy is probably leaning a little bit more on the quant side where there's a plethora of information and data science that's gone behind it to come up and utilize specific data sets to create models. And that's probably really the adaptation of the systematic side is into the quant space.
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And when we talk about trend following, are they doing it on different timescales or are we talking sort of. Generally they build on momentum in the course of a couple of hours. Just tell me how you understand that. I find it fascinating.
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A
Yeah. So without giving too much away of our secret sauce on the trend following side, one way I like to think about it is the short, medium and long term models. And the super high level way of looking at this for anyone who enjoys technical analysis is really looking at a daily chart, a weekly chart and a monthly chart. And that can often just give you that high level view of where the short models, the medium term models and the long term models may be active.
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B
Yeah. And then where do the sort of the high frequency traders and market makers and so forth sit in that kind of categorization that you're talking about?
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Yeah, great question. So the market makers and the high frequency traders, I remember let's say 10 years ago there was quite a lot of lamenting about the strategy. One of our views is everyone has a right to their strategy. It is a extremely short term strategy where really it's a technology race to be both co located and have speed of market. But ultimately the market makers are attempting to find short term fair value, taking liquidity or taking on the other side and warehousing risk, but then maybe using other markets through statistical arbitrage or even just playing with time zone timelines to try and exit that position. Liquidity.
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Yeah. So this is sort of, I don't know, dealing with. I'm getting this wrong, but Comex and the LME or something, right? Or London versus New York or trying to capture a localized bid ask spread just through the speed at which you can operate because of that reduced latency because of proximity and so forth.
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Yeah, that's right. There's a great book called Flashboys. Would recommend anyone to read it about the innovative thinking of trying to reduce latency. But yes, at the origins, indeed it's a mix of both warehousing risk and then having models that determine the fair value to exit it in an expedited timeline. It's the automation of what the bank desks or the floor has done for decades. But then that's also evolved into some statistical arbitrage where you may look at highly correlated instruments to so use the liquidity to exit.
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B
Yeah, okay, we're going to come on to how you went through your decision process with respect to metals and minerals and mining. But you've obviously been in and around funds for a long time and the leading forefront of innovating how funds operate in this space. Can you just give us a sweep of kind of what you've seen over the Last decade or 20 years in your career in this space? Just the key trends that you've seen, both I guess from a capturing opportunity standpoint, but also from an investor preference standpoint.
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Indeed. So yeah, over my career there's been three very distinct evolutions of the hedge fund world. I would say the style that hedge fund allocators are investing through. And I think we can define that as the pre global financial crisis. That was largely what we call a commingled master fund world. And the master fund is where you have one pool of capital which the manager owns and all investors are contributing to that. That master fund is cash. So if you win $100 million investment, someone will wire $100 million to your fund. Then the global financial crisis happened, but that also uncovered some leverage in the system and there's often no places to hide. And Mr. Bernie Madoff was uncovered and yes, approximately $40 billion plus was on inadvertent commas lost through Bernie Madoff's investment scheme. And that was because it was behind the curtain of where you could look of what he was doing. So that was actually quite a. It created a new phase of hedge fund investing where investors wanted transparency. And it was such a big blow up that there was a huge demand from institutional investors to really have higher degrees of transparency, potentially liquidity, insight and due diligence. So from 2010 until Covid was really the second phase where we have the emergence of managed accounts. And I define them as dedicated managed accounts. And these are really what we would explain as a fund of one, which means that actually the investor owns the vehicle and gives the power of attorney to the manager to trade. And they could then choose how much cash they put in that fund and control the leverage. And because they own the fund, they get the bank statement every day, they get to effectively see your trades and they have a much higher degree of transparency to solve that issue that occurred. And then more recently on the post Covid world, we really have the rise of SMAs separately managed accounts, which is an enhanced evolution where that one fund that the investor may create, instead of having just one manager trading it, they may allocate to say, 10 managers to trade that same pool. And if your strategy only requires say 25% initial margin to trade that strategy, the investor can leverage the vehicle and create their own volatility. And it's really a DIY multistrat. The multistrats use the same financial engineering to overallocate the capital. And the super sophisticated larger allocators enjoy the same business model as the multistrats. But really, rather than outsourcing it for the manager selection, they also do it themselves. And that model has become very popular in the post Covid world and it assists the speed to market too.
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B
So doesn't that sound like a bit of a recipe's disaster in the sense that you're. If I'm hearing you correctly, I've got 100 bucks in my account, dollars, not millions or billions, but someone's using that same 20 bucks in it to be the margin for 20 different trades or something. So that's the leverage. Isn't that quite risky in that sense?
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Well, it's really solving an unencumbered cash situation. Whereas if we had 100 units and only 20 is going to be used for initial margin, you're sitting on 80% cash, which is a drag to the vehicle, actually a drag to returns. And so one of the elegances is to utilise that cash more actively and to allocate it to another manager.
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But cash is used twice.
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No, no chunk of cash is used twice.
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Right, okay, okay. But every chunk of cash in the entire account is used as opposed to just sort of. Yeah, understood. Okay.
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It's used a little less conservatively, but ultimately it's being sent to the clearinghouse, and the clearinghouse is still calling the margin. And these are largely sophisticated conservative counterparties. But yes, it's an elegance of the current strategy.
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And are the big multi strats that we all know of now offering similar products to their large investors?
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So it's actually the same model as a multistrat. They're collecting assets from investors and then they're leveraging it up with all of their knowledge on risk management and allocating to talent and.
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But I mean, do I get a separately managed account? I can get to see sort of, you know, in that sense I'm not exposed to a.
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If you're a portfolio manager at a large multi strat, you effectively have a portfolio you're managing and that almost is an account. However, the multistrats are now also allocating externally through separately managed accounts the same way the investors are.
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Yes. They're sending it off to another, you know, a couple of guys want to set up a fund. The multistrat can invest in that.
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Exactly.
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Yeah. Okay. And then so that's kind of the, I guess how the money is managed. You spoke earlier about those different types of funds. Is there, is there a vogue on for a particular element of that or is it kind of all morphing into one of you won that combined, you know, human consciousness, the brilliance of the human mind, plus all the technological tools, you know, or is there still quite distinct. You'll sit in front of whomever and there'll still be quite a distinct strategy play.
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A
Yeah. So I think as a discretionary manager, our job is to be constantly curious, it's to constantly evolve, it's to be humble, reflect on our job as being the greatest entrepreneur because we're wrong a lot and we have to rebuild ourselves and have confidence that we're going to continue to be successful. So I think it's the greatest entrepreneurial pursuit is to be a trader, a particular discretionary trader. And then secondly, I often think we're engineers, make very good traders because your natural skill is to convert logic or research like a physicist would create and put it into practice. You're really taking theory and putting it into the real world.
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B
And this comes back to sort of scale. Right. I want to come to the lens of the allocator at this point. Right. Or the investor. The sort of the question out there and you know, it's become ever more sort of prevalent is 20 years ago you would kind of invest in this amazing trader. Right. And I think, I think we could all agree that there are sort of this weird sort of 5% of traders who are just unbelievable risk managers, great traders who can kind of. They kind of seem to make money come what may. That might be an unfair percentage and it might be bigger than that. But you know, generally speaking and the rest live in some kind of are great at using an aspect of a system, an aspect of a company or whatever, you know, that that enhances their capabilities. They, they're very good at managing X in Y environment. Investors today, if they've had enough of the big multi strats, tell them that you need to have a bank of quants and you need to have the best in class technology and you need to have X, Y, Z. And we heard Seb Barak on stage talking about the edge and the competitive advantage Citadel had built over time through their analytics. And I'm mentioning candidly that, you know, they've got to keep innov because widely available subscription services are now catching up with some of the tools that they built a decade ago. Just kind of keen to get your thoughts on that. Is this still that unique human pursuit or do you need to be able to demonstrate to have best in class technology and all the costs and the challenges that brings with it as well?
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A
Yeah, absolutely. So it's very important. It really comes down to investment. And I think the question is also about research. Research driven investment processes are typically very strong strategies. So high levels of investment into research and then research is now with the advance of AI, becoming almost deflationary in the sense of access to research and access to manipulating that research in the way of data science. But the human element, which may technology and computers may be soon on the horizon, I think is still process. So research driven investment processes are still very, very successful ones. Whether investment process can compute, can challenge investment process. That's where the systematic and the quant shops have been effective. And then the human element is still, I would maybe imagine the psychology of markets and of the world, the consciousness. And then one of the hardest things which is still, let's say a touch or an art, is the turning points of markets. That's still maybe a human element, but indeed we can all philosophize when AI will come for our jobs. And indeed it's making tremendous headways into trading too.
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When the animal spirits kick in, you need a human to recognize them. And you're the perfect person to ask this in some ways because you sat absence a large trading house platform. And one of the biggest challenges of is kind of going back to that 5% is kind of making that switch from a high physical, highly physical merchant into a trading seat. That's absent all of that, how are you going to and how have you maintained an informational edge or some kind of that edge in the absence of all of those, that physical flow that you get from a merchant, the deep insight that ultimately is kind of the raison d' etre of those guys being successful.
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Yeah. This is an Allaquita favorite question. I'm very fortunate because I started my formative years in a physical trading house, which was a wonderful experience. Fantastic places to learn how the world works and how physical trading works. I moved away from that in 2015 and then have spent the last 10 years in the hedge fund industry. Indeed. I actually didn't find my job too different. I was a prop trader in that physical trading house. The physical information is very rich indeed, but really the skill is in the processing of it and understanding what's relevant, what are financial markets sensitive to, and then it's really about again, it's back down to process. And with regards to access to information, fast forwarding 10 plus years, a lot of information is now available through third parties or research services, so the access is no longer the problem. There's still a host of proprietary information in many businesses, but it's whether there's a process that's actually utilizing it. By the way, the analogy I think of is a chef where we could put all of the ingredients on a table, but it still takes skill and artistry and experience to make a Michelin meal or whatever equivalent. So actually the access to the ingredients is there for everybody, but the, the knowledge of what to look for and how to put it together is really what our careers, I think are about. And that comes back to the process.
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B
Yeah, yeah, interesting. And then I'm a, an investor, an allocator, and I've got the choice between a, you know, and I, and we're going to come onto it in a moment. I'm sort of burying the lead intentionally here, but you know, I recognize the need to have commodities exposure. And you're going to tell us why in a couple of minutes. There seems to me to be quite a difference between a fund that is a multi strat and has commodities, you know, POD or whatever. It might be that focusing on commodities versus a dedicated commodities fund because it trades so distinctly as an asset class and has different requirements in terms of capital at periods, margin calls at periods, you know, is that an old trope? Is that a fair assumption? And why go down the route of being a dedicated sector specialist versus being part of a broader group?
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A
Indeed. So there are many great ways and seats to have in the industry and I think it's almost to think a little about maybe the commoditization or the freedom and access to set your own path within a multistrat. There certainly have built extremely impressive businesses with fantastic diversification effects where almost like a bingo scorecard, if you can fill up every different sector and have a super high quality individual each one of those sectors of the market, you're going to achieve fantastic diversification. And the risk management of those businesses is extremely impressive because they also run on leverage, as we mentioned, for commodities. I think there is maybe a bit of a truth that it doesn't always fit the mould. That's because we do have cycles, we can have boom bust cycles. But also some of the fantastic opportunities can be in the asymmetry and in warehousing risk. And that's where I think maybe sometimes the single managers have set up their businesses in a way that they can warehouse some of those, the risks and the larger opportunities. And then ultimately I think it is the same job of being a sector specialist. Often you're able to invest to create resources. I think we can maybe do that as a different scale in a single sector specialist manager where the job of our management fee is to reinvest in our team and our research. So we may have a different resource than a role at a multi strat. But then it's also the flexibility of structure that if you were to think of a physical trader versus a hedge fund, a pure hedge fund is chasing, let's say the same liquid alpha. Whereas a physical commodity trader has various entities all over the world and they have access to China onshore and they have lots of trade financing lines and the structure actually gives you optionality and that comes with a cost and it comes with investment. So you mentioned Citadel. They've done a lot of that work and they have fantastic elegance in their structure as to trade houses. And I think being a single manager, you can also make those investments into the structure of your business to give yourself optionality for some of the opportunities that come your way.
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B
Yeah, whereas. And so sort of the layman's view of what you just mentioned there is that you're sharing those resources in a multi strat and then secondarily or more importantly potentially when those opportunities come along again, you don't have the same capacity to sort of accept the big warehousing of risk that might be required to support that. You know, those long term views and we all see that in the current volatilities and so forth. Is that sort of a fair assessment?
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A
Yeah, I think that's one of the many reasons. Indeed.
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B
Yeah. Okay, let's talk about then. You're in front of an allocator nearly 20 years ago. Right. Again, it was a period when talking about commodities probably fell on quite soft ears when it was about why you should have exposure to commodities in your portfolio. It would seem that's been the case at least that sort of the COVID era up until 2024, let's say, when actually results have been declining a bit. But beyond that sort of like cyclical trend in your mind, when you're talking to investors, to allocators, like, what is the clear compelling case for why outside of absentee, so the cyclical nature of the market, why you need exposure to commodities in today's world?
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A
It's a great question and a big question.
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B
Yeah, yeah. I mean it's the fundamental question of this entire 300 episodes of the podcast. But yeah, have a crack.
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A
So I think diversification is a great starting point. Most allocators, or some allocators get to a size where they are seeking uncorrelated returns. Commodities can often be a very interesting addition to a portfolio because of when their cycles are happening. They're often, for example, in boom times, in late economic cycles. And then they're often great buying opportunities into the rollover of a cycle. And I think there's been a great evolution as well into the style of trading. So again, pre financial crisis, there were some fantastically large hedge funds with extremely impressive returns that also did it on quite high volatility. So investors got used to commodities being a high volume asset class because the returns of those funds were also quite punchy in both directions. After 2008 we also hit zero interest rates which compressed volatility globally. And that also from the macro community made a hard decade and the same for commodities where we moved into a much lower volume environment and we were forced to be much more nimble in our trading strategies. Those trading strategies are what trading houses have been doing for decades, if not centuries, which is why there are some trading houses that are as old as they are. And so I think now we've got to almost a graduation where there's a skill set of people who can be nimble and trade a lot of relative value as well as the directional strategies. And I think investors memories have kind of got over those super high volume businesses and are now looking for more accretive consistent returns, which is really the job of the hedge fund community to institutional allocators.
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B
Yes. Okay, so the thesis there would be. Okay, so you've got that classic portfolio theory diversification but in a larger talent pool of people who've been trained up in a world of as you say, trading relative value of actually being good risk managers in, you know, coming from the physical merchant world you can start to overlay some of the objectives of a. Of the investors by not having kind of the, the wild sort of ups and downs of the mid 2000s and some very famous blow ups and so forth in natural gas because you've got sort of a more sophisticated approach and so you can kind of draw those Venn diagrams together both. It has that portfolio theory effect alongside sort of more stable returns. Is that the analysis?
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A
Yeah, I think we always like to be humble that we. It's an evolution I think and I think investors are seeking good risk adjusted.
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B
Isn't that a bit tepid? I mean like sure, it offers diversification. Maybe this is my own naivety. Is there not kind of a screaming compelling case of like we're way beyond portfolio theory here. We're actually saying that there are key trends in place we believe over the next decade, two decades where actually two things are happening. One is you've got a sort of structural shift up in value of think hard things and maybe I've been drinking too much Jeff Curry Kool Aid. But at the same time you've got an entire sort of technological revolution going on that means that some a suite of commodities and we're about to argue that's definitely metals, you know, have a, a rising value in the economy, a core role to play a com. A global competition around them. At the same time oil is, you know, hydrocarbons are going through a, a challenging, a more volatile period as those markets degrade. Or is that just. You can append any kind of thought piece to a reason why you should allocate to commodities. It doesn't really matter. You need exposure and the portfolio effect to kick in.
- [29:21]
A
This is about cycles as well. So there's many ways to answer this. One thing that comes to mind is really alpha versus beta. So as a hedge fund, as I mentioned, our job is to make money, not lose it. And it's a very hard place to be because you have to be perfect. You have to have high returns or moderate good volatility and have managed drawdowns if at all and catch those good moves. So directional strategies. The most meat on the bone is in the type of market that we're foreseeing, which is where we do have strong tailwinds behind a sector where there is a good Argument for meaningful repricing over a meaningful time period. And that gives us more meat on the bone for directional strategies. But actually that has to be balanced with posting performance every month and wanting it to be positive. And the alpha generation where we have to be in the trenches and grafting on the relative value side as well to generate positive returns. So if investors want to have long term exposure, there are probably other products for that. And that's really back to the history. It's mutual funds versus hedge funds. And also there's a liquidity thing here where my prior business was also a private equity business, where if you want to invest into having meaningful exposure to the asset side with the potential liquidity constraints that a private equity vehicle gives you, but that also gives you the staying power to be in a trend. And as we mentioned, one of the best ways people have got rich is to stay in trends for meaningful amounts of time. So then, yeah, there's really a product selection assessment there, I think.
- [31:07]
B
So in your conviction, or let's say my conviction, that commodities are going to have a period where the cyclical nature is going to probably be more within intra commodities rather than inter commodities and other asset classes because of what's going on. That conviction is expressed by how much the percentage you allocate to commodities as part of your overall portfolio. Is that how it's expressed? And therefore are we seeing increases in percentage allocated commodities? In general?
- [31:36]
A
Yes. The one way we think about this in our strategy is there's really three modes of investing in my mind, or three modes of markets. There's directional opportunities, which is probably the more glorified way of trading and investing. And there we think about our net notional exposure as a strategy. And we're certainly not shy to take some directional bets. But then when direction isn't an opportunity, we may be looking at mean reversion, which is typically the relative value strategy. And we have to duck and dive and adapt to recognize if we're in a mean reversion period. And then thirdly, value investing, which is often considered, let's say, at the bottom of the cost curve or something that's meaningfully mispriced against a forward expectation, we typically find those in the troughs of markets. And I think what we can identify about 2025 was it was such a fantastic trading environment because you had extremely strong direction opportunities. With the trade war and geopolitical situation. The relative value opportunities were extremely high. And then we had some real laggards where the value was very clear because there were leading Indicators of other commodities where you could see a laggard was presenting opportunity and value. So it was a very, very high opportunity set as a year.
- [32:55]
B
I guess you're talking about from a metals perspective there.
- [32:59]
A
That's correct, yes. As a metals sector, the themes were extremely strong and we believe will continue to be strong really because of the geopolitical environment. And we can maybe touch on that.
- [33:13]
B
Yeah. Just to nail it down though, going back to that portfolio theory, it used to be 5% would be in commodities in general on average from a serious investor. Has that now crept up at all? Are you seeing, are they now talking more like 15% because of kind of these megatrends and kind of the understanding of the ructions the world economy is going through?
- [33:34]
A
No, I would say that commodities is still an extremely under allocated sector. I think something about a bear market is it often thins out talent as well. So there's a thinning out of the talent pool which often has decreased. There's a supply and demand imbalance of commodity traders because there hasn't been. Well, your industry knows better than any but the pool of talent coming through the ranks. So there's one, there's a supplant demand imbalance of talent and then two, there's two types we've seen the GCSI or other large indexes, they peaked in 2007, I believe. And indeed that has not kept up proportionally to passive investment as an industry. It's very under allocated.
- [34:21]
B
Yeah. And you can see that if you just. Yeah, I mean it looks great the last five years, but if you click sort of the all tab on your stock market chart, it's a bit more of a depressing picture for commodities. And as you say, you've got the tyranny of the S&P 500 to beat, which has done exceptionally well over the last decade in a period of free money. And we had Edward Chancellor on talking about that and people should go search that episode. Well, those two episodes on what that did to economies and the carry trade and all the rest of it. Right, okay. You make your compelling case to. The investor understands that they need some exposure to commodities, they might be under allocated to it. There is absolutely that talent gap, a missing generation in commodities. So there's few firms out there, few individuals out there, money managers, you know, investors, traders out there who kind of have the track record that convinces them that this is the right place to put their money. Both of us would argue you're one of them. And that's proven the case. Time and time again, what is the case for metals to your mind now to say actually do what you want on the hydrocarbon side, but when we talk commodities, we need to talk intra commodities. And here's the compelling case for metals.
- [35:31]
A
So I think there's two ways to answer this. One is commodity markets have a natural elasticity and that's really the speed of the cycles. So one way I like to think about it is back to first principles. And if we think of the state of matter, you have solids, liquids and gases. And we can actually define the commodities industry by those states of matters. And they have different speeds or velocity of cycle. So gas cycles, as we saw in 2022, where the prices ended up lower within one year of the energy crisis, was a very fast cycle. Liquids, which were probably in just now with the current energy shock, typically liquids have, let's say a two year cycle. And solids, which are metals. We could also use the analogy of coffee and cocoa. If you have a frost in Brazil and we lose the coffee crop, it takes five, six years plus for a tree to grow and to have a new fruit. And we've seen coffee and cocoa prices over the last couple 12 to 18 months. And metals is very much the same. It just takes time to bring on new supply relative to price. It takes six to 10 years to build new mines. It's kind of common statistics now. They're just very large infrastructure projects and regardless of price, you can't necessarily solve these. So I think it's a very kind of first principles answer of why cycles exist in commodities and metals. We're certainly coming to that part of the cycle.
- [37:13]
B
Yeah. Historically in your comment there on actually the Robert Friedland there's no NPV on a mine. Right. Just the maths don't work and there's no amount of price signals that you can give effectively in a short term that changes that equation. So it takes a lot of belief to do these mines and then it takes a lot of time to build them. Historically, you know, your return on oil production, you know, is somewhere sort of irr of whatever. It's typically been double that of getting into mining in general, on average, etc. It's always been a richer space than the metals and mining space. Is that a dynamic you see as well? That's always been a challenging competition there. Do you see that dynamic changing at all?
- [37:54]
A
Yes, I think we really think about cost inputs and then the nature of deflationary assets. And commodities are historically deflationary assets because we have technological advance. Capitalism is an Amazing thing. It's like water. It will find the path of least resistance. So we all innovate in times of crisis and we find ways to produce more efficiently, whether it's crop yields, oil production, or even metals. But then I think we're moving into an inflationary world any way we cut it and we can maybe talk about it, but all of that's being undone from a deflationary cost input perspective. And we're moving into structural inflationary kind of from a macro perspective. We've got an amazing confluence of a few megatrends. And inflation is certainly one of them. Where from a timing of the market, this is likely to be running at a higher margin than history. And if we think of gold now, gold miners are probably 150% margin businesses pulling gold out the ground for $200 an ounce, $2,000 an ounce, and selling it for $5,000 an ounce.
- [39:10]
B
So that shift there, what is the megatrend behind that shift? I get the point of elasticity and so forth, but can you sort of tease apart for us from your perspective? I'm conscious I don't sort of frame this too much. Like do you see that structural shift up in the value of these mined assets over a period? And if so, why?
- [39:32]
A
If we think about megatrends and if you were to think about industrial revolutions, you can typically break it down into three big megatrends. So you have a step change in communication, transportation and power. So if we think of the first industrial revolution for communication, maybe you have print and the telegraph and transportation, you maybe have steam and then power, coal and the steam engine, steam power. And then for this one we're really for communication. We've got AI transportation, it's autonomous vehicles and electric cars and power. We've got renewables and batteries. And each of those sectors are all. Now the raw inputs is the metals sector, whereas historically the raw input has been fossil fuel based hydrocarbons. So that's one big step change that the world is shifting to.
- [40:24]
B
Yeah, the way I've sort of been thinking about it is, and I've forgotten who told me to think of it this way, but like the this, we're shifting from a fuel to technologies. Right. The renewable power, whatever it might be. Right. Sort of the, the fuel for the, for this future age is going to be sort of in time is whether it's going to be nuclear, whether it's going to be renewables, whether it's going to be. Obviously there'll be transitions, but over time you're moving to more technologies than you are fuels. And those technologies all consume ultimately metals as their sort of in quotes, fuel rather than hydrocarbons. And once you sort of turn them on, then actually they're very efficient at producing. In the case of they might produce low cost power, whatever it might be. But in that electrified age, whether it's, you know, at some point the cloud is just someone else's computer. All of it requires is hardware which is just going to consume a hell of a lot of these metals. And then you throw in the megatrend of de globalization. So everyone's going to want their own computer. It's going to be, you know, we're talking about a step change in certainly a suite of metals and minerals as demand requirements.
- [41:32]
A
Absolutely. It's about zero marginal cost. If we put solar panels on our houses and batteries in the basement. If you're fortunate enough to have that set up, then you have a zero marginal cost. And if you have an electric car again integrated, it's a zero marginal cost. Whereas the typical, it's almost molecules to electrons. The molecules you have to keep feeding and you have to keep consuming. So I think just the margins of the electron world are just far more efficient.
- [42:05]
B
And so exposure to all of those different metals and their different relative values is going to be directionally valuable as well as relative value be valuable. I guess the one challenge back to you would be this is all really great, assuming the world continues to kind of operate just about on the edge of being a global sort of market and all the rest of it and government intervention is kept at a minimum. The problem is obviously at the moment, the de rigueur in every polity around the world is security of supply is critical, minerals is all this kind of stuff and suddenly metals is ground zero for government stockpiling, for government intervention, for export bans and all the rest of it. Is that a good thing or is that a really challenging thing or is it both?
- [42:51]
A
That's why commodities are so interesting, because it's the real world, it's real things and it's constantly changing. With geopolitics. The geopolitical shift is very significant that we've experienced recently. I think we've closed a chapter and opened a new one. And you mentioned Edward Chancellor and his podcast and his book the Price of Time. And it's a fantastic read because it's all about interest rates and ultimately inflation. And I think that's really the answer here, that we're moving into an inflationary world where the government stockpiling is inefficient it's not inefficient but it's taking more material out of supply chains. We're losing the just in time nature and also adding inventory whether it's in supply chains, whether it's at the government level. We also have a touch of de globalization which is also supply chain linked. We have fracturing, we have higher inventory at consumers because of that maybe movement of people. And then I think a really under discussed one is the defense dividend. So we've probably spent two decades plus of governments being able to reduce their spending and reduce their deficits during peace times and all of that's being undone and that's also inflationary to government deficits. It creates a challenge because the last number of decades they've been able to cut that defence spending and put it into social programs. So that's all being undone as well.
- [44:22]
B
Yeah, there's going to be some tougher, tough choices ahead globally on that element. But it's certainly yet it all points to whilst the markets become more volatile as a result of policy. But in general it's all going to be inflationary which in general commodities are, you know, a solver for or at least you know, in part a solver for. You know, talk about sort of the megatrends and so forth. We talk as, you know. So that decarbonization, which essentially is a proxy for the energy transition, that move to a technology from a. The marginal cost production of energy goes to pretty much zero sort of deglobalization which is that, which is the fracturing, the nature of the world we're talking about. You mentioned earlier on digitization, is that sort of the, you know, is that the other piece of the thesis in AI and so forth or is there something, when you're talking to investors and to allocators, is there something some other bit that we sort of missed in general that supports the metals thesis over perhaps other commodities?
- [45:15]
A
Yeah, I think there's one, maybe one thing we think about and look for. And again this is back to process. We look for formulas and in trading I often describe that our process is like a child at school. You're taught in a science experiment to come up with a hypothesis, look for the method, analyze the data, find results and come up to a conclusion. And that's really trading. We're just doing that iteratively all day long. And then the other thing we look for in process and formula is if we look back at the big, let's say successful repricings in markets which can get named a Super cycle, really there's three core ingredients into a super cycle and arguably these are starting to be ticked for a forward looking view. And number one thing you look for is commodity. Guys, we love fundamentals, so we look for supply and demand. So we spoke about the emelasticity of supply, but we've also spoken about the megatrends and thematics for demand. So you need a new step change in demand. And I think that the market's broadly aligned, recognizing we were having a step change in demand on a forward looking basis. So the next part is new investment flows. As we mentioned back in the China super cycle. I think an underappreciated element of it is the self fulfilling nature of investment flows. And the passive indexes went from 15 billion in 2003 to 200 billion in 2008. And that's the investor flow. And I think we're starting to see that again now. Whether it's the mining equity space which has probably doubled from 1 trillion to 2 trillion in the last number of years, but also the rise of ETFs. We've got the uranium ETF, we've seen cobalt and nickel and copper ETFs coming back. So I think the access to investors is another thing. And then the third missing piece is the macro side which is really a bare US dollar environment. And this becomes self perpetuating, which is really. Most emerging market economies are natural exporters of commodities and as the dollar weakens they get more, as commodity prices rise, they get more dollars for their exports. That stimulates the local economy, then that allows them to service their debt better, that boosts their trade and their balance of payments. And then you get the investment community searching for yields where there's typically a higher interest rate as well as a tailwind behind their currency. And you get the self perpetuating kind of petrodollar emerging market commodity led US dollar tailwind. And I think that's arguably something that we'll start to see as commodity prices continue to rise as well.
- [48:08]
B
Yeah, invest in Brazil, you know, far enough away and all the commodities. Right. It seems to me. But fascinating. Well, it'd be great to just hear a little bit on fourth fund and what stage you're at with it and kind of the, the thesis of. And then, you know, who should, who and when should give you a call.
- [48:29]
A
Sure, that's very kind. So as a hedge fund we're not allowed to advertise but certainly happy to mention what we're doing and how we're doing it. So we are hoping to launch in about a month's time with close to a year of planning. We've recently received our Swiss regulatory approval, which is a very big milestone. And we have some fantastic LPs lined up to participate in our business to support us, which we're very excited to work with. And really the strategy is a sector specialist. Metals and mining is what we know and what we do. We have a very broad mandate, which is really to look at anything that's a metal or mined, if you dig it out the ground, unless it's on the periodic table. Our job is to really have a view and to be monitoring the market. And yes, ambition is to build a strong research team, to have sector specialists within the business too, and to provide our limited partners, our investors, with some fantastic returns. And we're really looking to be a consistent product. That's really our job.
- [49:41]
B
Yeah. Well, I wish you all the best and obviously we know you're very, very highly thought of by the metals community and hopefully we can have you back on in a year or so and improve a lot of what we've been discussing here about the way the markets are both trending, but also trading. So, Matt, it's always a pleasure to catch up and thanks for your time on the show.
- [50:03]
A
Likewise, Paul. It's been a real pleasure. Thank you so much.
- [50:08]
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. Com.