Peak Energy & Resources Portfolio

The Peak Resources and Energy Portfolio centers on the Investment Committee’s belief that we are amidst an era of global resource, energy shortages and unprecedented inflationary pressures.
In selecting equity securities for the PREP portfolio, LCM starts by reviewing U.S. and foreign companies engaged in the natural resources industry, including those listed on the S&P Global Energy indices or the S&P Alternative Energy indices, the Philadelphia Gold & Silver Index, energy and natural resources sector ETFs and ETNs, ETFs and ETNs linked to commodities such as gold, silver, oil or agricultural products, or a commodity index; and companies engaged in alternative energy or conservation-related activities. This universe of over 1,000 companies is then screened for market capitalization greater than $250 million, a projected Price/Earnings to Growth (“PEG”) ratio less than that of the S&P 500 Index, and a high free cash-flow yield.
Upon the Investment Committee's discretion, LCM will select companies that do not meet the screening requirement. For example, LCM may invest in junior miners that own large precious metals assets that it judges to have above-market growth potential. Due to the nature of small companies, they may not meet some or all of the requirements aforementioned.
The PEG is an indicator of a stock’s potential value. A lower PEG means that the stock is more undervalued. The resulting watch list of approximately 50 to 75 companies is further reduced by the Adviser, using a rigorous fundamental research process described below, to select approximately 30-40 equity securities for the portfolio. However, the Portfolio Managers have discretion to select stocks that we believe offer extraordinary potential upside even if they do not meet one or more of the cited criteria. The Adviser’s analysis focuses on the following factors:
  • Dominant & Competitive Analysis
  • Growth Factors
  • Company & Quality Analysis
Once investments are identified, the portfolio is constructed under general weighting guidelines. These include but are not limited to:
  • A split between energy & materials (including precious metals)
  • Typical diversification among 30-40 positions
  • An 8% maximum weighting for any single company (see below for details)
  • Including investments in other sectors that could be beneficiaries of resource scarcity(defense, cyber-security, etc.)
LCM may invest in ETFs or ETNs linked to commodities such as gold, silver, oil or agricultural products, or a commodity index. A typical commodity-related ETF or ETN may seek to achieve economic exposure to commodity prices through direct investment in a commodity, such as gold bullion; or by investing in the securities of issuers who are primarily engaged in production of specific commodities. The Adviser’s research suggests that commodity-related investments offer the potential for inflation protection, capital appreciation and returns that are not highly correlated to those of the equity markets. In a typical commodity-related ETF or ETN, the net asset value of the ETF is linked to the value of an individual commodity, or the performance of commodity indices. Commodity ETFs and ETNs may use derivatives which expose them to further risks, including counterparty risk (i.e., the risk that the institution on the other side of the trade will default).
LCM may sell a portfolio security to the extent that the Portfolio Managers have determined it has become over-priced, the price depreciates or could be replaced with a security that offers a better risk/reward opportunity. Lastly, if changes occur that affect a company’s fundamentals and future growth prospects appear weak.
From time to time, the Portfolio Managers may take temporary defensive positions that are inconsistent with the portfolio’s principal investment strategies, in attempting to respond to adverse market, economic, political or other conditions. For example, portfolios may hold cash, money market mutual funds, investment grade short-term money market instruments, U.S. Government and agency securities (including zero coupon bonds), commercial paper, certificates of deposit, repurchase agreements and other cash equivalents.
In addition to its three active investment strategies, LCM manages a limited number of advisory client accounts that are invested mainly in mutual funds. LCM designs this mutual fund strategy based on its screening process utilizing Morningstar data when selecting funds; portfolio composition is based on target sector weights according to LCM’s philosophy and client objectives. The mutual fund portfolios may be constructed with no-load funds, front-end load funds, back-end load funds, or contingent-deferred load funds. Such load fees, if any, are paid from the clients’ accounts and are paid in addition to LCM’s advisory fees. In addition, managers of mutual funds charge management fees that are exclusive of those charged by LCM to its clients.
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.
These forces combine to push prices higher combined with historical levels of monetary expansion, we believe that exceptional levels of inflation are imminent.
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.
Some may argue this massive divergence signifies the end of an era, not a portent of things to come. Noting similar trends in the 1970s culminating in an even greater divergence by 1980. That period was the high water mark for real assets relative to financial ones. This rationale ignores the most striking thing about the current divergence: It has occurred with no burst of inflation.
The closest thing to an exception- in mid-2008, when inflation reached about 5% 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. 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 ensures that rising resource prices become ingrained in the economy. Unlike the 1970s, today’s monumental gap between financial and real assets won’t lead to a less inflationary world. 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.