Your future is built in this ASX sector

Wednesday, 1 November 2023 — South Melbourne

[11 min read]

Dear Reader,

Hi, Greg Canavan here.

I’m the Editorial Director of Fat Tail Investment Research.

Today is the inaugural edition of our free service, Fat Tail Daily. It replaces the other daily emails we used to send. Hopefully, you’ll appreciate less inbox clutter.

Each day, you’ll get a unique take on the markets from each of the editors here at Fat Tail. The topic will revolve around their area of expertise, so keep the biases that come with it in mind!

But their only remit is to tell you something you don’t know. Or at least, something you might not be thinking of right now.

The financial pages are awash with news. While it might be important to know that the S&P500 rallied 0.65% overnight, with the NASDAQ up 0.5%, what does that really mean?

The bigger picture view is that most global markets (including Australia) are all trending down. The rally of the past few days is simply a bounce from oversold conditions.

Bearish trends are in force. So don’t get too excited.

But keep this in mind…

You plant the seeds for bull market returns in a bear market. Hiding in big safe defensives right now might feel good. And, of course, there is a place in portfolios for those stocks. But you should have one eye on the next cycle. Start planting seeds now.

In the essay below, small-cap specialist Callum Newman argues that you should invest in acorns, not oaks.

Enjoy…

Regards,

Greg Canavan,
Editorial Director, Fat Tail Daily

Dear Reader,

If you think 2023 is a tough time for shares, spare a thought for anyone in AMP, News Corp, Lendlease, QBE and Telstra.

This lot all have a smaller market cap today than…in 2007!

Talk about testing your patience.

Why do you care?

The last 18 months has been a torrid ride for Aussie shareholders.

Goodness me…

In 2022, the Ukraine conflict broke out.

Oil soared over US$130 a barrel.

Interest rates went up at the fastest pace in history.

Inflation pushes up costs and hurts margins. Bad for shares.

Now in 2023 we have China’s rolling property crisis, US banks collapsing, the US debt ceiling crisis…and war in Gaza.

Feeling punch drunk yet? I am!

Point being: investors dump the riskiest market sectors when there’s turmoil like this.

Think small caps and unprofitable technology stocks.

Supermarkets, industrial property and insurance firms look like the smart play.

There’s perceived safety in big stocks like this.

However, go to the opening line above.

‘Blue chip’ security and safety can be an illusion.

The defining feature of a capitalist economy is — or should be — creative destruction.

That means big companies are under the pump from smaller competitors.

Here’s the rub!

Let’s put this into some context today…

There’s been a heap of chat in the last few days about the Aussie share market.

You probably know why.

Right now, it’s trading around the same level that it was 16 years ago.

Some say the share market has done ‘nothing’ in this time. That’s not true if you bank the high dividend payouts along the way.

But it IS true that Australia can suffer from a lack of innovation and investment.

Australia is not the US and the Aussie market is not the Nasdaq. Big banks and big miners dominate the top 50.

That’s worked, more or less, for the last 20 years. Odds on it’s not going to work for the next 20.

Disruption is coming for all sectors of the economy.

Just look at how the favoured health firms CSL and RMD have been cut down from the GLP-1 weight loss drugs this year.

Could the iron ore miners and banks be vulnerable?

Banking and steel are industries over 200 years old. They are ancient in today’s economy.

Australia and Australian investors need to move with the times and position for growth in new areas.

That means to me, at least, you MUST have exposure to smaller stocks with potential for higher capital growth.

An old market adage is to invest in acorns and not oaks.

That sounds wise…but it doesn’t tell you what to buy on a Wednesday.

But cling to it…the sentiment is the right one!

Small-cap shares are out of favour. It’s been this way for two years!

But amongst this carnage is the next wave of potential superstars of the Aussie market.

In 2007, investors hadn’t heard of Xero [ASX:XRO], WiseTech Global [ASX:WTC], Mineral Resources [ASX:MIN] or Pilbara Minerals [ASX:PLS].

These companies turned out to be the stars of the future.

Hindsight is a wonderful thing. There’s been plenty of companies that didn’t become the stars of the future.

Be smart about it.

You don’t have to go crazy speculating here.

Right now, there’s established and successful entrepreneurs like David Teoh at Tuas [ASX:TUA], Wes Maas at Maas Group Holdings [ASX:MGH] and the Robinson family at Beacon Lighting Group [ASX:BLX].

They’re building and expanding their companies. You need to give them more than six months to create value.

You have a chance right now to back men and women like this if you can let the macro worries go.

In fact, you can take advantage of these same worries!

When else do you get a look at cheap stocks that successful people run?

I’m not saying there’s no risk. There’s always risk.

I believe all the issues impacting the markets in 2022 and 2023 will be forgotten by 2030 and beyond (and probably by this time next year, really).

The future always seems a long way from today.

But your portfolio needs to be built with this in mind.

The future is coming…and usually it’s the smaller stocks building out what it looks like.

Best wishes,

Callum Newman,
Editor, Fat Tail Daily

Dear Reader,

A couple of years ago, Australians were punting on footy, horses…and lithium miners.

Or so it seemed.

In 2021 and early 2022, lithium stocks were galloping. Traders, chancers, and newcomers alike were rushing to buy.

It was a frenzy.

Developers years out from production and without project costings were trading at billion dollar valuations.

Companies sitting on nothing but tin sheds in Argentina would proclaim themselves future major players in the lithium triangle.

Paper fortunes were made. Early retirement plans were arranged.

All this culminated in eight of the 10 best performing stocks on the All Ords being lithium stocks in 2021.

Then the exuberance vanished.

Lithium stocks take a beating

Economist Herbert Stein once quipped that if something cannot go on forever, it will stop.

Lithium stock valuations were no exception.

Except, instead of stopping, the valuations went backwards. Worldwide.

The Solactive Global Lithium Index — tracking the world’s largest and most liquid lithium companies — is down 48% since November 2021.

Some once-popular ASX lithium miners have fared even worse.

Now lithium stocks are generating a different kind of interest.

Less frenzied, more ruthless.

Short interest.

Lithium miners feature heavily in ASIC’s latest release on the most shorted ASX stocks.

The most shorted stock is in fact the lithium producer Pilbara Minerals [ASX:PLS].

Rounding out the top 10 are Core Lithium [ASX:CXO] and Sayona Mining [ASX:SYA].

Despite becoming a profitable producer in recent years, Pilbara is down 30% since November 2022.

Stocks not yet producing — or not producing at scale — are down even more.

Sayona Mining, for instance, is down 80% since April 2022.

Another former fan favourite, Lake Resources [ASX:LKE], is down 93% since April 2022.

That is massive!

And unfortunate…for I fear plenty of investors — intoxicated by the hype — bought near the top.

But have the steep falls of Sayona and Lake deterred new investors?

Not really.

Lithium still entices punters

The lithium sector is still a happy hunting ground for punters.

Undaunted, some still see great reward among the risk.

Just look at the best performing All Ords stocks over the last 52-months to now.

Topping the list is lithium junior Wildcat Resources, up 2,100%.

The third-best performer is another lithium junior, AZURE Minerals, up 1,000%.

As long as these types of spikes are on offer, risk junkies will continue to flock to the sector.

That’s why Matthew Haupt, portfolio manager at Wilson Asset Management, called lithium stocks the ‘gambling end of town’, attracting ‘hot money and retail’.

It’s not just in Australia, either.

As Bloomberg reported:

‘In South Korea, there’s a similar frenzy for shares perceived as being tied to the metal. Hydro Lithium rocketed more than 1500 per cent last year after the little-known civil engineering firm changed its name from Korea SE Corp and created plans for EV battery-related businesses. Chemicals firm Kum Yang Co has jumped more than 400 per cent this year on its link with a Mongolian lithium mine.’

But this year’s lithium stars have something in common.

Both Wildcat and AZURE, like another Western Australian lithium hopeful Liontown Resources, are big takeover targets.

AZURE is being eyed up by SQM and Gina Rinehart.

And Wildcat is being considered by Mineral Resources.

These hot stocks are not being bid up by an indiscriminate frenzy of yesteryear, where the hype tide was raising any which lithium stock higher.

No, this suggests the lithium investor is becoming more discerning.

Stocks operating in good jurisdictions with sound outlooks that may prove attractive to major players are catching the bids.

But Herb Stein should be heeded here.

If something cannot go up forever, it will stop.

Albermarle, SQM, and even Gina don’t have unlimited coffers. At a certain price, any project — no matter how good — becomes too expensive.

Not to mention that even without the anchoring effect of potential takeover bids, the mines themselves may prove more problematic than anticipated.

Just look at Core Lithium…and its short interest.

Core Lithium skyrocketed in 2022 as it neared production.

But once it shipped its first ore, the mood soured.

All of a sudden, it became just another producer — and had to deal with being treated like one.

Production delays and output guidance cuts have all weighed the stock down this year.

And consider Pilbara, too.

Despite becoming a very profitable producer, the stock’s heavy short interest implies the market thinks the outlook baked into its current valuation is too rosy.

Falling lithium prices have a lot to do with that.

What’s the go with lithium prices?

Yes, current electric vehicles need lithium to run. Along with graphite, nickel, cobalt, and copper.

The more EVs the world sells, the more lithium we’ll need.

The crux is whether we’ll need more lithium than we can get our hands on.

Just because an input is needed, doesn’t automatically mean it’s in short supply.

Sometimes I like to remind myself of a point made by historian Edward Chancellor, who said that ‘investors spend 90 per cent of their time thinking about demand and only 10 per cent on supply’.

Demand for lithium is clear to see.

You can see the demand on the roads, after all!

But what about the supply side?

In early October, the Department of Industry released its latest quarterly report on key materials like lithium.

Regarding the white metal, the Department was adamant supply was quickly catching up to demand, expecting prices to fall further by 2025:

‘In 2023, prices have fallen significantly as the market swings from deficit to being in balance. The high prices in 2021 and 2022 incentivised more investment in lithium production, resulting in global supply catching up to demand. The high prices of the period also drove companies to destock to reduce the cost of carrying inventory — putting further downward pressure on prices.

‘Prices are forecast to fall further by 2025 as the lithium market enters a period of surplus supply, and is expected to result in rising stockpiles. However, prices are expected to remain well above levels traded in the few years prior to 2021.’

Billionaires like Rinehart are positioning for a different outcome, expecting long-term prices to march higher as EV adoption explodes.

The years ahead will prove who’s right.

In the meantime, it looks like investors will punt on lithium juniors forever.

Regards,

Kiryll Prakapenka,
Editor, Fat Tail Daily

Dear Reader,

From a**hole to anti-semite, the 21st century explained in curses and calumnies.

And those are just the ‘A’s​!​

Over the years, the name calling comes in waves. We try to connect the dots. We describe what we see. Some people don’t like it.

The dot.com fantasy began to evaporate in March, 2000. The internet was a great success, of course. But it did not lead to greater prosperity for most people. Today, the average person is said to spend seven hours a day looking at an electronic screen. Most of it, we believe, is time wasted.

Then came 9/11. It showed that the great empire — the US at the height of its glory — was remarkably vulnerable. A small group of (mostly) Saudis, on a limited budget, launched a spectacular attack on the heart of American capitalism.

The US had no way to retaliate against the terrorists. Its blood was up…with nowhere to go. The attackers were dead. The US had no Gaza. So, it attacked Iraq, which had nothing to do with 9/11.

One of the most visible supporters of the Iraq invasion was ​New York Times​ columnist Tom Friedman. Ten years after the Iraq invasion, Charlie Rose on NPR asked Friedman, in effect, what was the point? Here is his reply:

‘What they [Islamic extremists] needed to see was American boys and girls going house to house—from Basra to Baghdad—and basically saying:

‘Which part of this sentence don't you understand?: You don't think we care about our open society? You think this [terrorism] fantasy [you have]—we're just gonna let it grow?

‘Well, suck. on. this. That, Charlie, was what this war was about. We coulda hit Saudi Arabia...​We coulda hit Pakistan. We hit Iraq because we could.’

In 2003, the empire was losing its mojo. Like a middle-aged man who has an affair, it had to show that it could still rattle windows and bury children in rubble.

But it was expensive. The total cost of the ‘War on Terror’ was $8 trillion. Coincidentally, that was the amount that the Fed ‘printed’ since 1999.

And thus was the next crisis set in motion.

Yes, there are patterns to life. Cycles. Stories with beginnings, climaxes, and endings. We all play our roles. Even​ the ‘greatest story ever told’ had its extras.

What would Christianity be without the ​crucifixion​​ and the glorious resurrection? ​And for that you needed a mob. Pontius Pilate stood as judge over Jesus. ‘I find no guilt in this man,’ he reported. But the mob wanted blood. ‘Crucify him, crucify him,’ they demanded.

People always come to think what they need to think when they need to think it. They need to play their parts. They need to follow the script.

By the early 2000s, the fever of war and inflation was upon the land. Under cover of a ‘national emergency’ all resistance gave way…and the dollars rolled off the printing press.

Following 9/11, the Fed cut 500 basis points off its key lending rate. Americans were urged to ‘spend, spend, spend’ to support the economy. The feds even funded a ‘cash for clunkers’ program to boost auto sales.

But what Americans bought most eagerly were houses. Some bought them to live in. Some bought them to ‘flip.’ And by 2007, the Fed’s ultra-low rates had created another bubble, this one in housing. Buyers paid too much; mortgages couldn’t be paid.

That was an easy call: the real estate bubble was going to pop. Many people said confidently that ‘real estate never goes down,’ and dismissed us as cranks or wet-blankets. But some were angry. Here’s Dan:

‘I was working on 'The Housing Report' in 2005…. That turned into an alert we published that was titled (with understatement) The Total Destruction of the US Housing Market.

‘This was BEFORE the huge increase in adjustable rate mortgages, interest-only mortgages, and all the subprime fraud that followed. But even then we could see the writing on the wall.

‘I got a few calls to do radio interviews on it. Most hosts confused or disinterested. But I got ambushed on one interview. The host said I ought to be ashamed for alarming and panicking the public without any proof and that housing was a safe investment and it was disgraceful etc. ’

Soon, families were walking away from their overpriced houses, dropping the keys through the letter slot (and sometimes leaving the water running). Mortgage finance companies were going broke. Four million people lost their homes.

Then, after the failure of Lehman Bros…and a big drop in the stock market, the Fed went to work…proving once again that there is no calamity that it can’t make worse. Another great emergency! Too much credit had caused too much debt. So, what was the Fed’s response?

More credit—​ a zero rate policy that was the law of the land for the next 12 years.

The picture was becoming clearer and clearer. The US was acting like a banana republic in-the-making, a sh*thole country with too much debt and an incompetent, parasitic elite. But it was also a great empire, financing its far-flung operations on credit…which​ was bound to end in inflation.

By 2016 the whole War on Terror had flopped. Heartland citizens had now spent 36 years trying to keep their heads above water. More and more people saw the nation in decline.

It was then that an out-of-left-field presidential candidate admitted that the nation was slipping and pledged to ‘make America great again.’

People wanted to believe that Mr Trump would do it. He was the messiah they had been waiting for. But the picture we were looking at was very different from what many people wanted to see. The difference was jarring and upsetting. It led to the biggest wave of Dear Reader disaffection that we had ever seen.

And they weren’t especially nice about it.

‘You old fossil…you don’t know what the f** you’re talking about,’ they pointed out.

During Mr Trump’s four years in office, federal debt grew faster than any time in history, with the biggest financial deficits ever…while GDP growth slowed to its lowest since the Great Depression. Yet Mr Trump vetoed no spending bills.

He demanded no balanced budget from Congress. He closed no foreign bases nor ended any of America’s woebegone military adventures. He pushed through a major tax cut, but made no budget cuts to offset the lost revenue. He presided over the COVID Panic lockdowns…and the Great Stimmie Giveaways…and urged the Fed to lower rates even further.

And his trade war was a flop, as everyone knew it would be. On Mr Trump’s watch, the swamp grew deeper. The nation grew weaker. And the working millions — the people Mr Trump had ​pledged​​ to help --went deeper in debt than ever before.

But wait…there’s more. The late, degenerate empire was now declining faster than ever…Joe Biden picked up where Donald Trump left off. Inflation was on the rise. More stimmies. More giveaways. More sanctions. And two new wars!

Stay tuned​..​.

Regards,

Bill Bonner,
For Fat Tail Daily