The Peak Resources & Energy Portfolio centers on the Investment Committee’s belief that we are in the midst of an era of global resource and energy shortages and unprecedented inflationary pressures.
|The world’s emerging economies, notably China, India, Brazil, Russia, and others are overtaking the world’s developed nations in terms of total GDP. This represents a significant structural shift as their continued growth will require tremendous energy and resources. Driven by the needs of the developing parts of the world, we see global energy demand outstripping supply. Further, global energy production is increasingly hindered by diminishing returns, as harder-to-procure resources close in on a point of parity between energy invested and energy returned.|
Meanwhile, little meaningful investment has been put towards alternative energies, moving us closer to a calamitous outcome. A war-like effort is needed to combat this – including tens of billions of dollars in research and hundreds of billions of dollars in infrastructure in the U.S. alone.
Energy, however, is not an isolated commodity as other resources are interconnected, including base and precious metals, as well as other materials that are in great demand from developing and developed nations alike. Rising global populations are similarly putting strain on food supplies, driving costs for fertilizers higher, and sopping up limited clean water supplies.
All these forces combine to push prices higher. Add in historical levels of monetary expansion, and we believe that we will soon be confronted with exceptional levels of inflation.
Consider the lesson we learned in the 1970s. Sharply rising energy costs led to stagflation: high unemployment, high inflation and economic recession. As the chart below shows, both oil and gold drastically outperformed U.S. large cap stocks as represented by the Dow Jones Industrial Average.
History Lesson: Select Hard Assets vs. Stocks in the 1970s
This time around, however, the situation is unfortunately quite worse. Prices for resources are high courtesy of razor-thin margins between supply and rising demand, rather than because of political forces in the 1970s. Further, navigating the worst economic climate seen in the country since the Depression has involved an historic expansion of the Federal Reserve balance sheet and major funding from the U.S. Treasury. As the dollar depreciates and cost inflation soars, demand will increase for stores of value, namely, hard assets.
Surprisingly, this phenomenon will be nothing new. The chart below makes vivid a key aspect of the behavior of the financial markets in the 2000s—while likely foreshadowing what lies ahead. It shows how sharply hard assets (including gold, oil, silver, and copper) and financial assets have diverged during the past decade. Silver outperformed the stock market by almost fivefold, while even oil outperformed by better than twofold.
History Repeated: Another Decade of Turbulence
Some may argue that this massive divergence signifies the end of an era and not a portent of things to come, noting the similar trends in the 1970s culminating in an even greater divergence by 1980. That period turned out to be the high water mark for real assets relative to financial ones. But this rationale ignores the most striking thing about the current divergence: It has occurred with no real burst of inflation.
The closest thing to an exception—in mid-2008, when inflation reached about 5 percent—was quickly followed by the greatest deflationary scare since the Depression. By contrast, in the 1970s the huge gap between real and financial assets reflected historically high inflation rates.
In 1980, the primary—and perhaps only— mission of the Federal Reserve was to stamp out inflation at any cost. Thus as unemployment rose steadily to double digits, Fed Chairman Paul Volcker kept his foot on the monetary brakes.
Today, the story is decidedly different: Instead of holding money supply back, the Fed is doing its utmost to boost the amount of money in the economy. Even as resource inflation rises, the Fed will be required to keep the pedal to the metal so to avoid throwing the economy into another sharp downturn. By providing all the money it can, it will ensure that rising resource prices become ingrained in the economy.
So unlike the 1970s, today’s monumental gap between financial and real assets won’t lead to a less inflationary world. And thus the worst long-term investments in the early 1980s—inflation hedges—are likely to be the best ones today.
The Peak Resources & Energy Portfolio is managed around this investment thesis – aiming to protect clients from the perils of inflation, while also producing real returns. Read on to learn about how we implement this strategy in our clients’ portfolios.