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Much has been written about the rise of inflation. We have all been told the causes with supply chains and lack of workers to service a Post Covid world. We know all that. We all know too what the solution is, raise interest rates until it hurts. I am old enough to remember when my mortgage on my two-bedroom terrace in South London hit a very uncomfortable 17%. Of course, if you tell that to the kids today, who would believe you.? Inflation was 10% at the time.
Fast forward 45 years and here we are again (took a while) with inflation at least in the US and UK at 7% plus and potentially heading higher, yet interest rates are at record lows still. That cannot last forever, and central banks are embarking on the good ship rising rates as I write. Some central banks have already moved, our Kiwi neighbours for instance, our British friends and others. We are told to embrace the rise. It’s a sign that things are going well. After all wasn’t inflation the solution to the world’s woes? A little maybe but not too much. Inflate our way out of debt.
The trouble is that inflation leads to inflation. Fischer Black (a famed economist) postulated that if we believe there will be inflation then, lo and behold, it will happen. If we believe, then we buy now, banks make it easy to buy now and so inflation rises.
The answer may not just be raising rates. Volker went hard in his day though it’s unlikely that Powell will do the same. For investors, we may just have to accept inflation and turn to stocks that not only hedge against inflation, but also thrive in this environment.
Commodities are bought because they are a hedge against inflation. Inflation rises because commodity prices are rising. Somewhat a circular argument. In theory at some stage, high prices smash demand or at least push consumers to alternatives.
This oil price inflation will push car owners to go green. EVs are going to be the ‘new black’. If they are not already. We saw a massive shift in the oil crisis in the 70s.
Good then to have some lithium exposure. It is all about the batteries.
There is one large cap lithium player that springs to mind.
A 1 year chart of Pilbara Minerals (PLS.ASX).
The company recently reported slowing production, together with its CEO moving on. Not until later this year, but there is always a point when renewal may be appropriate. It did surprise the market, but fresh eyes may be a positive. The weaker than expected result was partly a function of WA lockouts and cost pressures from higher stripping rates and elevated freight rates. The good news was that despite lower production, prices were materially higher than last year. S$2,600-3,000/dmt for the 3QFY22, against average realised prices of US$1,250/t in 1HFY22. Not only that, PLS have good exposure to spot prices around 30% I understand, something that was sadly lacking in the Mineral Resources (MIN) result. The new auction pricing mechanism (known as BMX, not bandits) reminds me of the time when BHP and RIO stopped fixed price iron ore contracts with Japan and embraced the spot market. Being a current producer means that PLS can access these higher prices now. That is a huge positive. Volumes down but realised prices up.
After recent falls, the stock is now starting to look attractive and with brokers now upgrading lithium price forecasts, PLS is a buy at around 280c.
Having a producer is a bedrock but it is also good to have an explorer with upside potential.
A 1 year chart of Liontown Resources (LTR.ASX).
Staying with Australian based lithium companies, Liontown (LTR) has been a big winner for many. It, like PLS, has come off the boil but its Kathleen Valley project is gaining traction with a recent spodumeme offtake agreement with Tesla no less. This is a key contract to legitimise the project. Further offtake agreements are the next stage following the funding of the project. If the company could access the current spot prices, then the valuation according to one broker rises dramatically to 660c. Offtake agreements now account for 60% of production with the project fully funded now to first production after its $450m placement and $40m SPP at 165c. That is no doubt causing indigestion in the short term and the company needs perhaps another high-profile offtake agreement to counter that. Another offtake agreement will be the catalyst to push the share price higher.
Using spot prices for a valuation is fraught with danger and uncertainty. Especially when the experts believe that the elevated prices for lithium hydroxide and spodumeme will not last forever, in fact with production from Kathleen Valley coming on stream in 2024, along with competition from others, there could be a return to more normalised conditions. But then how much will US100 oil turbo charge the take up of EVs.
Biden just announced the US will build 500,000 charging stations in the US. That is going to be able to service a lot of EVs.
Finally, the big daddy of resource stocks is also worth considering.
A 1 year chart of BHP (BHP.ASX).
BHP is going through a metamorphosis from a 20th century ‘old skool’ commodity facing company to a 21st century new age miner. BHP has simplified its structure with the Dual Listed London listing collapsed into one single listing. It has demerged (or it will have soon) its oil and gas business. It is focussed on iron ore from the Pilbara, copper from sources various, met coal, nickel and soon to come potash. Potash is a 100-year asset. BHP is not building a business for the next five years but the next decade and beyond. This is a company that is radically shifting its focus under new CEO Mike Henry. It is also generating massive amounts of cash, massive amounts of shareholder good will through higher dividends and clearer communication and has resisted doing all the dumb things that miners do in a boom, buy other miners for silly money. It’s called capital discipline. BHP has that in spades at the moment.
Whether you buy BHP as an inflation hedge or just as exposure to the commodity super cycle we are in, doesn’t matter. Whatever the reason, there are compelling argument for having BHP in your portfolio. Come for the yield (5.5% in 2023) and stay for the growth.
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Analysis as at 03 March 2022. This information has been provided by Marcus Today (AFSL is 473383), for WealthHub Securities Ltd ABN 83 089 718 249 AFSL No. 230704 (WealthHub Securities, we), a Market Participant under the ASIC Market Integrity Rules and a wholly owned subsidiary of National Australia Bank Limited ABN 12 004 044 937 AFSL 230686 (NAB). Whilst all reasonable care has been taken by WealthHub Securities in reviewing this material, this content does not represent the view or opinions of WealthHub Securities. Any statements as to past performance do not represent future performance. Any advice contained in the Information has been prepared by WealthHub Securities without taking into account your objectives, financial situation or needs. Before acting on any such advice, we recommend that you consider whether it is appropriate for your circumstances.