What I'm Positioning For

Inflation.  And more of the unhappy kind (stagflation), rather than the happy kind (growth).

Long term I see inflation spikes this decade.  Not hyperinflation, just spikes of 5-10% some years with a 'normal' rate 2-4% for others.  Like the 40's or the 70s.  If you haven't already done so, you really have to read Lyn Alden's two pieces on why:

• A Century of Fiscal and Monetary Policy: Inflation vs Deflation
• The Ultimate Guide to Inflation

Investing in this kind of environment is really tough.  In real terms, expect a sideways market that treads water for ten years.  Its not like the last decade, where ever-falling rates boosted asset prices.  Its the opposite, when ever-rising wages reduce profit margins.  Asking whats a good investment during this is an oxymoron.  For the last decade investors had the wind in their sails.  This decade we'll be pushing boulders uphill.

To make it worse you can't hold cash.  Your cash is melting at 3-10% a year.  Learn to love the boulder.

Market Outlook

In 2-3 years, I think energy prices will rise enough to cause a recession.  Brent around $110 to 120-ish for 6 months should do it.  When that happens, the Fed can't fix it, and spraying all the liquidity they can will only make it worse.  It'll be our first real recession that can't be fixed by the Fed, it will feel more like 2008 than 2020.  Gold would be my hedge for this, but thats not here-and-now.

Before this, I think:

• Energy is a getting overbought now.  I think after Winter it sinks to a more reasonable (though still elevated) level.
• The Inflation trade is now becoming consensus.  ZeroHedge is running an inflation article every few days.
• Can't see any sign of a correction now, maybe in 2Q 2022.  Especially if the Fed tightens then.  Think it'll be a short, sharp one like Dec 2018, as the Fed reverses course and starts spraying with a fire hose.

How am I positioned?

To prepare for higher inflation, I'm moving more into commodity producers.  Anything that cant be printed:

The trouble with commodity producers is that they are really tough to invest in:

• Mines collapse and flood all the time, even in first world countries.  
• Developed countries have extracted all their easy-to-reach resources, so companies at the lower end of the cost curve are in developing countries.
• Who commonly change the rules and raise taxes.  Here, here, and here.
• Meanwhile companies in first world countries face ESG pressures.

So its a lot of small 2% positions, spreading out the operational & political risk.  Out of the 17%: 5% is Malaysian palm oil (United Plantations),  6% is in Russia (oil, gas and fertilisers at 2% each), 4% Kazatomprom, and 2% copper.

My REITS should be fine.  Hard, scarce assets plus debt.  Only half their properties are in Singapore.

Energy pipelines should be ok.  Costly assets with low maintenance costs, and high debts paid off in tomorrow's dollars.

I want to get rid of Netlink Trust, but for now its a cash/bond proxy, paying 4% while I wait for the correction/recession.

What do I want more of?  Copper, aluminium and battery metal producers.  Oil producers.  Its tough to find companies to buy, especially with sustainable dividends.  Maybe stock exchanges in commodity producing countries.

No banks or bonds.  US debt is so high, interest rates need to be held down.  Negative real rates deflate the debt.

I'm slightly over leveraged, at 104% invested.  Will stop buying and get my leverage back down.  Waiting for the next correction.

Canadian Natural Resources (CNQ)

I'm interested in energy producers because I think we're in for a decade of inflation and currency devaluation.  I want companies that are producing crude, without much refining, paying sustainable dividends, and with manageable geo-political and ESG risk.

Extracting flammable materials from deep down is a risky business.  I want to spread the risk by taking many small 2% positions.

An oil producer's job is to extract oil & gas, sell it at a profit, then use some of the profits to replenish or build-up their reserves.  Usually I just take a cursory look at a company's reserves, profits/cashflow, debt, position on the cost curve, and political risk.

I'm looking at the 2nd largest Canadian oil producer CNQ.  I traded it years ago, first got the idea from Hedgeye (who no longer cover it).

Operations and political risk

80% of their 1H21 revenue is from Canadian oil sands, with the remainder from the North Sea and Africa.

There are two main political risks with Canadian oil production:

• Oil production from Oil Sands is considered environmentally unfriendly.  Theres a risk of ESG pressure or environmental regulation.
• Canadian oil has no pipeline to a port.  They must rely on the Keystone to the US, whose expansion was cancelled.  Canadian producers sell their oil at WCS prices, at a discount to WTI.

Apart from the above, Canada is a low risk country.  Unlike most other energy producing regions, it does not have political risk (nationalising resources or levying taxes).  And it will never be a war zone.

Reserves

Canadian oil sands require high fixed investment, but once set up have low or no decline.  Their reserves are effectively infinite.  

Finances

Simple to understand, they have fixed costs, and are operationally leveraged to oil prices.  Their 1H results from 2020 and 2021 illustrate this perfectly:

Debt at CAD 19b is a bit higher than I'd like.  They expect to reduce it to 15b by end of 2021.

A Morningstar report from last year estimates their cash breakeven costs at USD 35-40 (WTI).

The quarterly dividend is CAD 0.47.  They did not say they plan to increase it, but will engage in buybacks instead.  After they reach 15bn debt, half the company's free cash flow is targeted to buy back shares (pp11-12).

Conclusion

A (mostly) safe company, without the political or confiscation risk in many parts of the world.  High fixed costs.  Good leveraged play on oil prices.