Hard Asset Insights – June 14, 2019

Hard Asset Insights – June 14, 2019
Morgan Lewis Posted on June 14, 2019

Weekly Hard Asset Insights
By David McAlvany

It has been a dichotomous environment for hard assets securities.  On one hand, because of the toll that the threat of escalating tariff wars has taken on the broader markets recently as well as declining interest rates, defensive stocks, such as specialty real estate and infrastructure in many cases have had very big moves to the upside. Yield seeking investors have driven these valuations ever higher.  There is still some value in this sector even after this run-up as we will highlight later in this piece, but in general, we will be discerning until a better opportunity to get more fully invested in this area.

On the other hand, global natural resources stocks, due to the threat of a global economic slowdown, in general have not performed well. To illustrate an example, energy stocks, in particular, have performed poorly with the XOP down quarter to date due to a combination of rising domestic inventories, a (so far unfounded) fear that OPEC’s commitment to sustaining higher prices may waver.  Timber and forestry have also performed poorly, and despite curtailments, extreme weather across most of the United States has slowed demand and inventories have continued to build.  While we believe there is great value in many of these stocks, will we take a very measured and disciplined approach building out portfolios in this area as well.  Ultimately, we believe that an increasingly accommodative Fed will boost the relative value of hard assets over paper assets.  We believe that several years of under investment or declining capital investment in natural resources are fuel for the fire of the next up cycle.  

A recent exception and standout have been gold and gold equities and it is our belief that the market is pricing in the possibility of aggressive monetary stimulus in response to any possible decline in economic sentiment or actual economic contraction that the uncertainty around an escalation in trade war may bring about.  On conference calls of the companies in the broader hard assets area that we follow, we are hearing the investment decisions are being deferred as a result of this uncertainty.  It is clear that the Fed is prepared to step in and provide stimulus in an attempt to stimulate growth.  This will only be good for gold.  Further, over the last several years, gold equities have had a very challenged market environment due to the weak commodity price, but also due to other challenges such as resource nationalism, cost inflation (particularly labor).  In addition, there has existed a reputation for poor corporate governance in many gold companies and we have seen a rise in activism in the space.  We see pockets of tremendous value in the sector but we are cognizant that we need a trifecta of a great suite of assets, a rock solid balance sheet, and a management team with a track record of success and governance.  Given how challenged the gold stocks have been, we see opportunities to pick up high-quality companies at reasonable valuation.  

Suffice it to say, a key challenge is balancing our portfolio “ballasts” – those that generate stable income; with our growth drivers in the environment we describe.  However, we are still able to find pockets where investment opportunities make sense to us.  For example, earlier this month, it was announced that El Paso Electric will be bought out by Infrastructure Investments Fund for $2.78B in an all-cash deal.  In noting the deal metrics, the price paid was 8.5X this year’s EBITDA estimate.  We note in our due diligence that EBITDA growth for the company had been just about flat over the last 5 years and a balance sheet that had elevated leverage.  One of our focus infrastructure names also trades at 8.5X EBITDA and has almost doubled EBITDA growth over the last 5 years with more to come as projects come on line in the second half of this year, has a superior management team, and an excellent balance sheet.  

This highlights an example of our “strategy in motion” going forward.  

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