Investment Outlook

Commodities expert Hugh Mulcahy sees a bright future for base metals, and possibly Bitcoin too, due to the two trends of currency debasement and decarbonisation

The future looks bright for base metals and Bitcoin, helped by currency debasement and the electrification trend

The economic shut-down in 2020 was accompanied by all-time highs in the US stock market and in other financial assets. The markets rally was due to central banks, led by the US Federal reserve, injecting vast amounts of ‘ liquidity’ into the markets.

The amount of new money injected into the system will lead to inflationary pressures once people are allowed go about their normal business again. And while prior to 2020 there might have been some pretence that central banks would ‘unwind’ their huge bond positions, the sheer size means that this option is no longer realistic.

This increased demand from central banks for bonds has been met with a corresponding increase in supply from public and private sectors. US sovereign debt increased by c.$4 trillion in 2020, which corresponds nicely to the increase in the Fed balance sheet.

It is not just governments that are borrowing like crazy. The private sector is likewise indebting itself, in some instances because it has to cope with pandemic impacts but in other instances, corporates are taking advantage of ultra-low borrowing rates to issue debt and buy back their own equity.

The household sector is also highly levered. Overall in advanced countries, it is estimated that total debt is 430% of GDP. However, so far household incomes and finances have held up, and economies have already recovered faster than the direst predictions in March 2020. It’s unlikely there will be heightened default risk to an extent that causes systemic financial risk.

The rollout of the vaccine means that an end to various restrictions is at least in sight. So overall there’s a good argument that growth will rebound, real rates remain low and the debt overhang won’t become too much of a burden.

Assuming that this debt must eventually be dealt with, there are two paths to dealing with it. The first is to grow your way economically out of the problem. If you manage to keep debt constant and grow GDP at a higher rate, this will eventually bring down debt/GDP to a more manageable level. The problem of course is growth. In the past decade, the true measure of growth, productivity, has been decreasing.

According to the OECD, across France, Germany and the United Kingdom, the three sectors with the largest employment gains between 2010 and 2017 accounted for one third of total job creation but paid below average wages. Moreover, in Belgium, Finland, Italy and Spain, industries with above average labour productivity levels saw net job losses. In other words, new jobs created (Deliveroo drivers) are of lower quality than the jobs they replaced (factory workers).

There is also a view that we could be on the cusp of a growth surge. Think of the rapid development of the Pfizer/BioNTech vaccine, the first to use mRNA technology that could eventually lead to vaccination for other diseases. There are many industries that in the 2010s made piecemeal progress but could be on the verge of a breakthrough, like labgrown meat, artificial intelligence, self-driving cars and virtual reality.

Despite significant liquidity provision by central banks, there is limited evidence of inflation in the traditional sense. Normal measures of inflation reference a consumer price index of standard everyday items. These staples have not increased much in nominal price terms, but on a wider view it’s clear that inflation has been very evident for some asset types, especially property. In this sense, inflation is in the eye of the beholder.

This also speaks to who has benefited from the financial policies employed since the GFC. The owners of capital have enjoyed a disproportionate benefit while labour’s share of overall income has decreased. It’s not unreasonable to link these economic effects to the emergence of populist politics. The net result is more government borrowing and spending with a simultaneous need to reduce the burden of debt through inflation.

On the other hand, it’s not clear that governments and central banks can ‘inflate away’ debt. High inflation in the 1970s was a self-fulfilling prophecy, where wages and prices rose in expectation of wage and price rises tomorrow. After 40 years of low inflation, it’s much harder to reset those expectations. Governments also can’t reverse the secular trends of excess global savings, ageing societies and rising inequality that have meant insufficient demand for productive investments that in former decades (and centuries) would have overheated the economy.

If you’re bullish on inflation, being in cash is the wrong place to be when the underlying currency needs to be devalued. Since early 2019 I have been in an exchange traded fund of gold miners which has done quite well. It is relatively easy to buy physical gold but I picked mining companies as I suspect during a gold boom their shares will go up by more than the increase in gold price. Gold is a traditional ‘store of value’ and will continue to appreciate as long as governments print money.

The other idea I like is marrying the trend of currency debasement with the other trend of our era – decarbonisation. In the race to replace coal, oil and natural gas, one powerful development is the ‘electrification’ of society. Whether it’s in transportation (batteries) or home heating (hydrogen fuel cells), the emphasis on renewable electricity will be significant.

Therefore I am focused on the materials required to roll out these new products and additional infrastructure, in particular base metals such as copper, aluminium, nickel and cobalt. For companies mining these metals such as Rio Tinto, BHP, Norilsk Nickel etc., apart from a complete financial meltdown, it’s hard to see why they won’t thrive over the next decade.

At the moment it’s hard not to tip the hat to Bitcoin, a speculation made for our times. It’s global in nature and easily transactable with the glamour of technology. Its main attraction supposedly is limited supply and its decentralised nature.

Bitcoin has quickly evolved into a competing store of value to gold, whether justified or not. In conjunction with this, Bitcoin offers incredible speculative returns, which is in direct contradiction to its supposed store of value.

A further Bitcoin attraction, from a speculative perspective, is that there is no limit to its price appreciation. While the price of Tesla can reach a theoretical limit based on some rationale e.g. having the same market cap as all other car makers combined, there would not seem to be any theoretical cap on Bitcoin. It doesn’t have to justify itself beyond its own store of value rationale.

For example, the total value of Bitcoin currently is $600 billion and the total value of gold is about $10 trillion. So why shouldn’t Bitcoin appreciate to the same level as gold, which would imply a sixteen-fold increase from its current price? And why not ten times beyond that!

Where it will eventually end up,

I have no idea, and there will be wreckage along the way. Gold is already suffering as investors seek BTC as an alternative, and I do wonder whether the FANG stocks have now seen their best days, as new money flows to crypto and they face increasing regulatory headwinds. They’ve had a decade of exceptional returns and that’s probably all they’re due.