Why Commodities, Why Now?
- Natural resources are a cornerstone of global commodities markets. Oil, natural gas and precious metals are evergreen investments, but prices have been a rollercoaster ride over the past few years.
- Adam Rozencwajg’s firm Goehring & Rozencwajg specializes in natural resource investing and in this post we cover everything from OPEC to rare earth commodities.
- Find out why Adam talks about the state of nuclear energy and gold as a “very strange” asset class.
At first glance, nuclear energy and gold might not seem to have anything in common. But it’s worth noting that for commodities investors, both operate within unique global supply and demand frameworks — and they’re often sought as “safe” investments during times of economic and geopolitical uncertainty. And because of those things, gold and nuclear energy are about the looooong game. While they each can undergo periods of volatility, the prices of gold and uranium are generally stable over time.
Adam Rozencwajg is buying both right now (and silver, too), but it’s safe to assume those investments come with a lengthy time horizon. The firm he co-founded, Goehring & Rozencwajg, specializes in a “contrarian value approach to commodities and natural resource investing.”
To generate returns for its clients, Goehring & Rozencwajg uses robust research and analysis — and patience. “We don’t move all that quickly,” Adam says. “We tend to be long-term investors in our philosophy.”
However, Adam and his team are keyed into the daily fluctuations and geopolitical implications of natural resources of all kinds.
Adam joined Cem and me for another Global Macro edition of Top Traders Unplugged to talk global commodity markets: why oil prices are down, OPEC’s production cuts, U.S. versus European natural gas prices, base metals and rare earth metals and much more.
Read on for an excerpt of our conversation about the promise of nuclear power, as well as the idiosyncrasies of investing in gold.
Conservation: It’s the law
Adam says that he has been “super critical about renewables” like wind and solar.
“It’s not because I don’t appreciate the externality of carbon,” he says. “I just don’t think that wind and solar are the solutions.”
He believes that human history has been a process of harnessing ever more efficient sources of energy — and that “economic activity is basically harnessing energy and transforming it,” whether that’s building, buying or eating things. It’s like the law of the conservation of energy, he adds: “Energy is neither created nor destroyed. It’s just transformed.”
That’s why we need to find an energy solution that’s both more efficient than what it’s replacing but emits no CO2, Adam says.
“Nuclear power fits that bill, so I think that we have to be pursuing that aggressively on all fronts.”
He invokes the concept of the “efficient frontier,” which posits that optimal portfolios offer the highest expected return for a defined level of risk — or the lowest risk for a given level of expected return. In his experience, efficiency and carbon correlate with each other: more energy efficiency, more carbon.
But under the efficient frontier framework, nuclear power is “off the charts.” It’s three times as efficient as oil and gas compared to renewables (which are one-sixth as efficient as oil and gas), but without CO2 emissions.
Unfortunately, nuclear energy is often met with trepidation in many places worldwide. In the U.S., nuclear reactors provide only about 18% of electric power. In France, nuclear powers more than 70% of its energy needs. But other countries, like Germany and Italy, have completely phased out nuclear power. Many more are undergoing the phase-out process or considering it. Why?
Nuclear: Safe, slow and staggeringly expensive
Third-generation nuclear reactors (the ones in use today) are massive and extremely expensive. That’s mostly due to stringent safety regulations — which is completely appropriate, says Adam. But perceived safety among any given population is always a challenge, even though nuclear reactors are (statistically) extremely safe.
Over the last 60 years, dozens of countries have been operating nuclear reactors (including 32 today). But the three high-profile nuclear disasters — Three Mile Island, Fukushima and Chernobyl — have such haunting legacies that they deter entire countries from pursuing this clean, reliable, cost-effective energy.
Nuclear reactors are also expensive because the process itself — creating power from uranium — requires constantly pumped, high-pressure water as well as extremely thick steel and cement. Cost overruns are so bad that companies funding new reactors experienced bankruptcy.
The newest, fourth-generation reactors are small and modular. They’re a quarter of the size of third-generation facilities and can be built in factories instead of onsite. The technology they use, however, is effectively the same — and the industry is notoriously slow to change.
Will the latest reactors shake up this energy sector? It’s unclear. But in the era of climate change, proven solutions like nuclear may take precedence over less effective renewables like wind and solar.
‘Gold Bugs’ and Cold, Hard Cash
Nuclear power is one of the newer ways we’ve created value from chemical elements on planet Earth. Gold is one of the oldest. But 2023 is an interesting time for gold — not just in terms of supply and demand, but in price.
“We’re big believers that gold has a huge rally out in front of it,” says Adam. “But we’re not ‘gold bugs.’ We don’t think that gold is sort of the solution to everyone’s problem at all times. I don’t think we’d go back to the [pre-Bretton Woods] ‘good old days’ if we could just get on a hard money standard.”
He thinks of gold as an asset — but it’s part of a “very strange asset class,” he says. “In a lot of ways, it doesn’t generate any cash flows. Interest rates aren’t really a thing [when it comes to gold]. But it’s an asset class like any other.”
However, he doesn’t think we can value gold, at least on a relative basis, vis-à-vis some of the other [commodity] asset classes out there. Instead, we should look at the value of gold relative to the value of financial assets: a simple but “extremely predictive” strategy over the last 120 years.
Adam notes that his co-founder and business partner Leigh Goehring wrote an article for Forbes in the summer of 2000 in which he claimed that if all of the dollars in circulation (then $560 billion) were backed with gold, the implied price per ounce would be about $2,500. The piece “raised a few eyebrows and probably upset a few PR departments,” Adam recalls. But gold went on to become the best-performing asset class for the next two decades. Today, gold is $2,007 an ounce, quite close to its all-time high in 2020 ($2,069).
Bullish on Bullion
That same math with today’s numbers (calculating the price per ounce if all of the dollars in circulation were backed with gold) would put gold well over $10,000, with the ability to go as high as $15,000, he adds. In that spirit, Goehring & Rozencwajg predicts a big bull market for gold, which shows no signs of depreciating.
“We’ve never had a massive commodity bull cycle led by capital starvation [significant under-investment in drilling and mining, for example] — like we’ve seen this time — that hasn’t had a gold component to it,” says Adam. “The trick is really always been to try to figure out when in that cycle you want to be involved. Because there [have been] periods of time gold pulled back [in price] hugely, like 1973 and 1974, before rallying into the end of the decade.”
Goehring & Rozencwajg “got mostly out of the gold market in 2020, because energy relative to precious metals was too cheap to ignore,” he adds. “We got back in through last year … and we’ve been adding as we move [further] into 2023.”
What are the drivers of gold prices right now? One of the biggest catalysts over the last 18 months or so has been the arrival of the central bank buyer, says Adam.
“I don’t think you can really overstate how important that is,” he argues, noting that central banks in several countries, including Russia and China, followed up large Q4 purchases of gold with strong buying in Q1 of 2023 — something that hasn’t happened in at least 40 years.
China in particular saw how the U.S. was “weaponizing the dollar against Russia,” Adam says. The government bought gold because it wants to insulate itself from whatever might happen in the future (like invading Taiwan, for instance). It makes sense for China to reduce some of its dollar holdings and get into gold, “which is outside of the financial system,” he explains.
Weaponizing the Dollar
“Gold isn’t consumed, like oil, and it’s not really even installed like copper or steel. It just changes hands, and it goes back and forth from one account to another. So you need to look at the price elasticity of the buyer and the price elasticity of the seller.”
There’s another reason why gold prices are rising: Inflation “puts the Fed in a bit of a box, and that Fed put becomes weaker,” says Adam. “So things that are tied to that — like bonds, the dollar and gold — tend to have significantly more volatility.”
That bullish forecast, Adam says, could drive gold past $10,000 an ounce.
“There’s obviously an ease to owning gold in accounts [like through GLD ETF shares] … versus a degree of security owning gold in bullion. I know a lot of gold investors that do a little bit of both. They’re able to split the difference between a certain degree of safety and a certain degree of ease.”
If you’re wondering whether GLD can withstand the total collapse of the financial system, “that’s a very, very specific set of circumstances, but not a nonzero probability,” he adds. “And if you’re going to the trouble of trying to hedge yourself from some of these really strong tail risks, why not go the extra step and own some physical [gold]?”
If gold prices skyrocket that much, an investment of any size will be worth its weight in … well, whatever currency prevails.
This is based on an episode of Top Traders Unplugged, a bi-weekly podcast with the most interesting and experienced investors, economists, traders and thought leaders in the world. Sign up to our Newsletter or Subscribe on your preferred podcast platform so that you don’t miss out on future episodes.
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