Adam Rozencwaig, portfolio manager of the Goehring & Rozencwajg Resources fund, discusses how to spot the end of a bear market, the outlook for oil and the benefits of investing in natural resources.
The Monday Manager series covers fund managers who have worked on their fund for over three years and where fund assets are over £100m.
Can you explain the fund’s approach to investment and what it is trying to achieve for investors?
Goehring and Rozencwajg are value investors focused on the natural resources sector. We believe the best time to find value in our industry, is when investors are universally bearish, prices are depressed, capital has left the sector, and a narrative has emerged suggesting the market will never recover.
That is when we like to undertake a rigorous due diligence process into the sector’s fundamentals. We are looking for things that are changing below the surface, that are being underappreciated by the market at large.
Notably, we like to focus on depletion, productivity trends and changes in long-term demand trends. We pay especially close attention to capital availability within a sector. We have found over our long career of investing in the sector, that capital starvation is by far the best indicator of future supply disruption, and ultimately the best signal that a bear market is about to end and a new bull market is about to begin.
Which areas within natural resources are you most excited about right now, and which are you avoiding?
We are particularly excited about the global oil industry. The closure of the Strait of Hormuz is by far the largest supply shock in the history of the oil industry. Global producers have, to date, produced 1 billion fewer barrels than originally expected so far this year. Investors have simply not priced in this dislocation. Inventories are very low and will continue to plummet to dangerously low levels.
See also: Macro matters: Japan beyond the oil price headwinds
There is a very real potential that the industry reaches ‘tank bottoms’ later this year – essentially having run out of mobilisable inventories. This has never happened in the history of the oil market.
Investors remain unusually bearish in the face of this crisis, and the biggest pushback we get is why we have not yet experienced a crisis after five months of disruptions. Just wait, we say.
Which global macroeconomic themes are most heavily influencing your positioning at the moment and why?
The most impactful theme in the short-term is the continued flow of capital away from real-assets towards high-valuation, high-growth investments. For several years, this has manifested itself in the tech trade, which has now morphed into the AI trade.
However, we believe both of these capital flows have really been an example of the so-called ‘carry trade,’ in which investors seek out levered short-volatility investments. These ‘carry bubbles’ tend to feed on themselves, and often result in growth outperforming value, large-cap outperforming small-cap and tech outperforming real assets.
There have been several examples in the past 120 years, and each one has been associated with a bear market in commodities. When the carry trade reverses, it results in a massive bull market in resources. We believe we’re getting closer to that moment – as the current ‘carry bubble’ appears very over-extended.
What are the biggest potential headwinds for the portfolio and how are you navigating these?
There are two potential headwinds – and incidentally both are opposite sides of the same coin.
First, the carry trade has resulted in a massive levered hyper-financialisation of the economy. Equities are now over 200% of US GDP – essentially the highest level in history. The two potential headwinds to resources – broadly – are related to this imbalance. The first is that if the carry bubble continues longer than expected, resources may stay out of favour.
An interesting feature of carry bubbles is that their momentum is so great, they can continue on for longer than anyone expects possible.
See also: Fund manager diary: Al Cattermole
The second is that an extremely abrupt end to the carry bubble could result in massive financial dislocation, due to the levered nature of the market. In that situation, equities of all stripes risk forced liquidation to meet margin requirements.
Ultimately, however, these headwinds would only temporarily push out the bull market in resources that we see in front of us. The bull market has driven by a decade-only period of capital starvation.
Only a massive inflow of investment capital could possibly end this unfolding bull market – and that remains years away.
What are the benefits of investing in natural resources at the moment, as opposed to more traditional asset classes?
The two main benefits are diversification and tactical asset allocation. From a diversification perspective, resource equities tend to perform when other sectors struggle. They tend to do well during inflationary periods – during which traditional asset classes lag. They tend to carry higher volatility, but over the long-term they play an important role in a diversified portfolio.
The second benefit is tactical asset allocation. Investing in resources when they are ‘cheap’ relative to the broad market has been a winning strategy over the last several cycles dating back to 1900.
Based upon how we measure this ratio today, commodities are at extremely depressed levels relative to the broad market, suggesting a higher probability of excess returns going forward.
What is the best piece of investment advice you have been given?
Buying according to the capital cycle is best long-term strategy to compound wealth. However, it is inherently contrarian and carries a certain degree of career risk. As a result, many investors feel they cannot pursue the strategy. This is precisely what creates the value opportunity. However, an investor must be prepared to be early and accept a degree of volatility.
There is no safety in numbers – but there is the potential for very strong returns. An investing adage says there is no difference between being early and being wrong. I disagree.
The difference might be hard to discern at the beginning but is abundantly clear by the end.
