Encouraged, but Proceeding Deliberately – June 28, 2019

Encouraged, but Proceeding Deliberately – June 28, 2019
Morgan Lewis Posted on June 28, 2019

Here’s the news of the week – and how we see it here at McAlvany Wealth Management:

Encouraged, but Proceeding Deliberately

It has been a busy week in the hard assets realm as it relates to political and macroeconomic events. We are finally seeing the kind of gold market that we have been waiting for, having finally pushed decisively above the $1400 level. GLD, the most commonly traded gold ETF, saw well over a billion dollars in inflows in just the past week alone. That said, there has not been a lot of follow-through in the gold price following the Fed meeting, despite a clear break in the dollar.

We are not surprised to see the yellow metal take a bit of a breather, given the risk that the Trump-Xi trade talks may not go well. However, we believe this will ultimately give us an opportunity to scale into high-quality equity positions. Even in a possibly moderating gold price environment, we believe that opportunities exist within gold equities. Lack of financing for juniors and seniors with empty growth profiles makes the industry ripe for consolidation. In fact, we read this week that $8 billion was raised in precious metals in 2011, and year to date we have seen about 700-800 million in financing. Companies effectively must self-finance and live within their means, or sacrifice their balance sheets (something we do not condone) to maintain and grow their production and reserves bases. We believe this solidifies our M&A thesis, and we will stick with ideas we believe are either consolidation candidates or have a history of doing measured and disciplined consolidation of early stage assets and moving those from discovery through development and into production at high rates of return.

To a degree, the oil market somewhat paralleled the gold market this week. After many weeks of inventory builds (which we believe have been largely due to unseasonably rainy weather rather than to significant demand contraction), we finally saw a meaningful decline in US crude inventories as reported by the Department of Energy. Thursday we saw a rally in that commodity for the week as well, and we believe that this will kick off the beginning of “inventory draw season” as miles driven begin to rise. However, there was very lackluster follow through by the stocks; as of Thursday the commodity was up 3.8 percent for the week, while the E&P stocks were in essence flat. That said, the recent activism we’ve seen in the energy complex is encouraging. We think that the industry continues to need checks on capital discipline and ill-informed M&A. OPEC has a 2-day meeting scheduled for July 1-2, and we believe that the supply cuts will continue to roll forward.

It is hard to keep from wondering if there may be a nascent theme emerging here. We consider commodity companies of all kinds to have option value to resources in the ground. The market appears unready to price in an end to king dollar just yet, despite its technical break, as the longer-term values of paper versus “stuff” are taking a deep breath to observe the economic data, geopolitical environment – particularly the upcoming G-20, possible trade war escalation, and Fed reaction to declining confidence in the global economy in the face of economic storm clouds gathering.

The more defensive, stable cash flow areas in our coverage, such as infrastructure and specialty real estate, saw a pretty meaningful pullback on Wednesday. Still, they are at or near 52-week highs. Investors have piled into defensive stocks en masse, and as a result we see valuations as somewhat stretched in many of these areas. It is particularly noteworthy that, despite the fact that the Fed seems motivated to push markets into risk assets, defensive stocks are near all-time highs. We aren’t sure what, if anything, to read into this, but it is a dynamic that has caught our attention. Defensives are trading more like growth stocks than stable value stocks at present and as a whole. We are not inclined to chase them, despite the fact that we find many of the business models to be compelling, with a high degree of visibility regarding cash flows. We also recognize that there is the possibility that these valuation disconnects can last for long periods of time. That said, there are many ideas on our radar for which we will wait for the market to come to us, and we believe our patience will be rewarded.

Taken together, this all indicates to us that proceeding to build out portfolios in a measured way is the right way to move the MAPS strategies forward. We thank you for your continued interest and trust in our team.

Best Regards,

David McAlvany
Chief Executive Officer

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