For weeks (months?) I have been telling my subscribers that the best thing they can do in this stock market is…nothing.

My own trading has borne that out this year.  I am sitting on 80% cash and 20% losers.  And in the junior markets, I think that makes me look good . All the junior indexes are down 20-30% this year.

Markets are up big this morning after a horrible September, and we could see a big 2-3 week rally  after seeing a little bit of real fear in the markets, with the UK bond scare last week.  But there are still 4 Big Problems out there that are having a global impact:

1. rising interest rates
2. rising US dollar (better today though!)
3. The Fed getting more hawkish than every publicly
4. data showing a clear slowdown in global economy

But how much worse can The Dow get with oil down to the high $70s/barrel already and Mega-Tech trading at single digit PE ratios?

I certainly don’t know, but there is one trade idea–one that could happen soon—like, by the end of October. Let me set the stage:

For me, the Market has had two likely scenarios lately: 

1. Hold the June Lows–in the Dow, the big US index, and we bounced around in a choppy market for a few months until the US Fed paused on interest rates; then get a (potentially very strong) rebound
2. Break the June Lows—which we have now done.  So now I think we drop 5-10%–taking the S&P to 3300 or so (despite today’s bullish action). 

So far, this has been quite a steep but a somewhat orderly downturn in US equity markets—then came the UK bond scare, caused by hedging out low interest rates with leverage.  This came out of nowhere; no one gave two toots about UK pension funds until a few days ago.

The upshot is that after this week’s scare, now there’s some real fear among senior levels of int’l banks, regulators and finance politicians—because the Market doesn’t know what it doesn’t know—the Unknown Unknown as the late US politician Donald Rumsfeld said many years ago.

All I want to point out here, this first Monday in October, is that investors are starting to see some breaking points in global finance—first the UK bond market, then Credit Suisse.  Both are arguably small and isolated.

But these cracks could create an opportunity for investors. Keep reading.
 

THIS IS NOT YOUR 2010’s FEDERAL RESERVE

 
Rising interest rates and leverage are a bad combination.  And figuring out exactly where they might combine into a toxic mess is really hard to do.

There are a lot of bears out there.  They are predicting a lot of bad things.  Exactly ZERO of them were saying the big risk was in UK pension funds.

The single biggest risk that we have right now is another “credit event”.  And I haven’t the slightest idea where that risk may come from.

A credit event can come from all sorts of backwaters of the financial markets.  The Lehman blow-up was a credit event.   The Greece crisis was a credit event.   Even Covid came within a hair of a credit event.

The problem today is that every credit event that we have had since 2000 led to the Federal Reserve and other Central Banks coming to the rescue in some form.

This time, I’m not so sure that will happen.  No one is sure that will happen.  At least not right away—which is why the market can’t find a footing. 

You see, the psyche of the Federal Reserve today is different than it’s been in 20+ years.

Inflation is a problem.  The #1 mandate of the Central Bank is to control inflation.  It takes precedence over everything else.

The only historical example of successful inflation control is the Paul Volcker Fed.  He “tamed” inflation.

He did it by not backing down.

I was listening to an interview former Fed President Thomas Hoenig a couple of weeks ago.  He made the point clear.  If they want to slay the inflation dragon the Fed can’t back down.  They must let unemployment rise.  They must let loans go bad.

This is a fine, fine line.  It is what makes a credit event so dangerous right now.  In the wake of a credit event, the Fed will be slower to come to the rescue.  It will let stock markets fall further.

At worst, it won’t act until things REALLY go south.  As we know from 2008, you can reach a point where it is truly too late.

I hope this doesn’t happen.  Nothing says it has to happen.  But with rising interest rates and leverage, we’ve got the pot, the soil, the water and the seed for my trade idea.

Investors ARE starting to see signs that The US Fed is getting worried. 

Last week, journalist Charlie Gasparino tweeted out that the Fed is “worried about financial stability”.

Source: Twitter

Often, more important than the news itself is the fact you are hearing that particular story at all.  You don’t hear about a leak like this by accident.  The Fed wants you to know that they know they should be getting worried.
 

SO WHAT SHOULD INVESTORS DO NOW

 
The Big Trend for investors is to—continue to do nothing.  Publicly, The Fed is saying they’re not done yet—only a systemic malfunction in markets would get them to pivot dovish.  So investors don’t want to get in the way of that.

But they are absolutely putting out subtle messages now that say they understand market stability is an issue. 

I don’t think that will mean a pause …BUT…I think it’s possible (plausible??) this could mean we have now seen the end of 0.75% increases in US interest rates every two months.

I think The Fed has to stem the rise in the US dollar more than interest rates. 

Market mayhem WILL keep erupting in the developing world—where many global credit events have started—if the greenback continues to rocket up.  It moved up 15-20% against most currencies in a two week stretch.

THE FED WON’T SAVE THE MARKET
BUT THAT COULD BE GOOD FOR GOLD

I’m not convinced a lower dollar would save US markets.  But I do think GOLD could start A Big Move.

Everybody hates gold.  Gold has been doing what it does so well—break the hearts of believers.  It is mostly an inverse-US dollar play to me, and the window of where it is truly useful in economic disaster is, IMHO, very small.

But

1. it’s there,
2. and nobody owns it,
3. and it’s just enough of an insurance market to just enough people
4. and valuations are low,
5. and it’s a VERY small market that would need very little capital coming into it on a global scale to make it A Big Trade

And I think this theory gets tested very soon—quite possibly by the end of this month.  Realistically, we would need to see another sign or two that the higher dollar and interest rates were causing more problems before this happens—but then again, gold is up today with the Market.

Or maybe the Market starts to price in slightly lower peak rates for Q1 23, or consensus builds that the 0.75% rate increases are done.  History says (look what gold did 2009 – 2011, post GFC) gold could be the big winner in Q4 this year.

There’s so much fear out there in the Market now—but fear, like euphoria, only lasts for awhile.  The Market gives and takes—it’s just hard to figure out how much time each swing will be.
 
I’ve made a lot of money over the last 15 years following Nathan Weiss of Unit Economics, out of Rhode Island.  It’s an independent research firm for a limited number of institutions (and me). Weiss’s ability to use hard data to back up his market thinking is somewhat unique. 
 
Last week he laid out what he sees as a probable scenario for North American markets for the next 15 months.
 
Key to his thinking is understanding how and why The Fed reacts to the economy—and reacts is the key word.  Weiss is a big believer that investors have a bit of a mistaken view of how The Fed and the Market work.
 
He says the Fed prepares itself to be reactive—it is not proactive.  Interest rates were low for a long time so they could raise them when inflation got too hot—like now.  And the Fed will keep rates high as long as they can to have lots of ammunition to lower them when the economy cools off—which he doesn’t expect to happen in a big way until the second half of next year, 2023.
 
So while many investors may cheer The Fed lowering rates late next year and think that will be good for the Market, Weiss believes the opposite—it will be a sign that a potentially long recession is looming.  He put together this historical chart that outlines quite clearly that recessions happen (the grey bars in the chart) as the Fed LOWERS rates:
 

 
 
Of course, The Big Question everyone is asking is—well, when will The Fed stop raising and start lowering rates?
 
Weiss has looked at the history of the ups-and-downs of The Fed on interest rates, and says while there is no specific date in mind (though he has one!!), there is a good range to go by. 
 
He says market history suggests The Fed ‘pauses’ are generally short-lived–since 1990, an average of 10 months from the final hike to the first cut with a range of 4 to 17 months. And again, investors should be careful what they ask for because this pause could ultimately be negative for equities.
 
So when does he think interest rate increases end and The Pause starts?
 
“My best guess is the January 31^st  – February 1^st Fed meeting will mark the last rate increase, making March 21-22 the first ‘unchanged’ meeting,” he told me this week. 
 
And here is his back up:
 
Last Thursday (15th), August Retail sales came in at +.3% sequentially (from July) – a seemingly strong number until the report went on to detail July retail sales were revised down from +.0% sequentially (from June) to -.4%. 
 
Taken together, retail sales declined slightly in July+August.  See the far lefthand column—it is showing the beginnings of a come down in inflation.

 

 
Those are hard numbers.  He points that rents are The Big Culprit in inflation, and everything else—energy and food in particular—is coming down.
 
Now, moving into extrapolating this data forward—and Weiss admits that is tough to do more than a couple months ahead at any time, much less a volatile one like this—he says if CPI comes in at +0.1% sequentially every month going forward, the monthly YoY CPI readings would be as follows:
 

 
 
Now, if you bump that up to .3% sequential monthly increases after November, the trajectory of YOY CPI inflation would be as follows:
 
 

 
So he is thinking in the low 5% range for CPI readings, The Fed pauses its interest rate increases.
 
How do stocks respond to this, assuming this is what happens?
 
“My simple mental roadmap suggests equities decline into year-end – largely due to earnings disappointments and continued ‘high’ CPI readings amidst Fed rate increases.
 
“But then a substantial rally comes in the first half of 2023, particularly for bonds. In the second half though, it will become apparent Fed policy is too restrictive, especially for housing, capital investment and exports, all due to the strong US dollar.  And I think labor markets will remain too tight for sustained economic growth above potential.”
 
Now, a strong labor market does not imply that the economy is OK—another big misconception, says Weiss..  First off, the highest unemployment usually happens at the END of a recession (much like the best business conditions happen immediately BEFORE a recession).

“The loss of consumer CONFIDENCE launches recessions, the loss of EMPLOYMENT comes later,” he  says. “And most people struggle to believe recessions START with very low unemployment and unemployment typically peaks 12 to 36 months after the END of the recessions.”

 
Ever humble given his small town Midwestern roots, Weiss admits this is just one possible scenario. But with me, he has had a track record that’s worth following. 
 
EDITOR’S NOTE: I’m getting ready for a big rally in my portfolio. This coming week I’ll tell you about one of my favourites, with soaring revenue (they’re on a $60 million annualized run rate now), positive adjusted EBITDA and a crazy cheap valuation.

A few weeks back I laid out the case for copper.

Yes, we are probably going into recession.  Yes, that means at least a bit more weakness for copper and copper stocks (most copper stocks fell 50% in three months this summer).
 
But on the other side, as electrification and EV adoption take center stage, copper will be in demand.  As Bloomberg pointed out in a recent article, we may be starting to see that already. In the article John Paulsen, Chief Investment Strategist of Leuthold Group, made note that the copper/gold ratio is reaching a point that suggests growing confidence in the metal and usually precedes a move up.

If that’s right, now is the time to make a list of copper stocks.

That’s what I have been doing.  I’ve worked my way through the producing universe of copper companies listed in Canada or the United States.

A couple general points before I dig into a few names.  First, these stocks are not expensive.  They aren’t expensive at $3.50 copper and are certainly not expensive at $5+ copper. 

Second, it is hard to find the perfect play.  At least on the junior end of the spectrum. Every junior has some hair.

Of course, that can also mean opportunity for the diligent stockpicker to find that diamond in the rough.

But if you are looking for a simple play on the price of copper, it is a tougher find.

The risks fall into one 3 buckets:

1. Operational
2. Development Financing
3. Jurisdiction

In this post I’ll go through a few names, highlighting the good and the bad.  Start making that list so I’m ready to buy when the time comes.
 

COPPER MOUNTAIN MINING – SINGLE MINE HICCUPS

 
The poster child for operational risk is Copper Mountain Mining (CMMC – TSXv).

Copper Mountain’s flagship asset, the Copper Mountain Mine in British Columbia, has been a mess this year.

The mine produced 27 million pounds of copper in H1 22.  That is barely half what it did the year before.

The problems have been twofold.  Lower grades and equipment failures.

The lower grades were expected.  It was mine sequencing and lumpy production is what you get with a single mine operation.

The equipment failures were not.  The mine’s secondary crushing unit was damaged in Q4.  Production still has not recovered from that.

Q2 results brought a painful guide down–from 80-90 million lbs in February guidance (this was after they knew about the crusher failure) to only 65-75 million lbs as of July!

Copper Mountain has a late-stage development project – Eva – but before we can even talk about financing it (it’s not cheap – A$850 million in 2020, likely higher now), they need to get their mine turned around.

These are the risk of a single mine operation, and they aren’t limited to just Copper Mountain.
 

TASEKO – NAVIGATING DEVELOPMENT

 
At Taseko Mines (TKO – TSX), the Gibraltar mine has suffered from production problems of its own.

Mine sequencing is again the culprit. Lower grade zones led to a 0.17% Copper head-grade in H1, down from 0.28% a year earlier (this is a low-grade porphyry deposit).

The result – a 35% reduction in copper produced in Q2 – to 22 million lbs.

Higher grade sequencing should lead to more pounds of copper in H2.  I believe it.  Gibraltar has been a reliable producer for years.

Source: Taseko Mines Investor Presentation

The question with Taseko is their development project – the Florence in Arizona.

Taseko is expecting permits at Florence in H2.  It just might happen.  They received a positive draft permit a few weeks ago, which bodes well.

If Florence is permitted the question will shift to building it.

The budget for Florence was originally US$230 million and is likely higher today. That’s a lot for a company with a $400 million market cap.  Taseko has cash – $175 million of it – but also a lot of debt – over $500 million.

The debt and Capex needs mean Taseko will be walking a tightrope, particularly if copper prices stay weak for a while.
 

CAPSTONE – BETTING ON CHILEAN STABILITY

 
While small, single mine producers may struggle to self-fund their growth, bigger producers like Capstone Copper (CS – TSX) should have an easier time of it.

Capstone has four producing assets: Pinto Valley in Arizona, Cozamin in Mexico and Mantos Blancos and Mantoverde, both in Chile.

Together these assets, along with their Santo Domingo project in Chile, set up an impressive growth profile over the next few years.

Source: Capstone Copper August Presentation

Capstone’s risk is location, which surprisingly is Chile.  Chile has historically been a safe place to mine, but that changed with the election of the current government, which has talked taxes and re-permiting.

The Chilean government is proposing a royalty tax for producers that produce >110 million pounds of copper.  It is a price-based formula that could be as high as 32% on operating margin if copper exceeds $5.

With the expansion of their Mantoverde mine, Capstone would be over that threshold.

Once their Santo Domingo project is in production (still probably 5 years off), about ¾ of Capstone’s production will come from Chile.

However its not all doom and gloom.  Last week the Chilean people had a referendum vote where they rejected a new constitution. 

The constitution would have been unfavorable for mining companies.  The focus was the environment, which would have made permitting a new mine much more difficult.

The defeat puts the government back on their heels. But Chile comes with other risks.  For one–water. 

Water is in short supply through much of Chile.  Yet copper mining needs a lot of it.

The Mantos Blancos mine depends on water that comes from government concessions.  While the current water supply agreement is good until 2025, if it isn’t extended Capstone will be scrambling for another solution.  Mantos Blancos is about 30% of Capstone’s copper production.
 

AMERIGO – STAY HYDRATED

 
Amerigo Resources (ARG -TSX) is in the same boat, one that may ground ashore.

Amerigo isn’t a true copper “miner”.  They produce copper from the tailings of Chile’s enormous state-owned copper producer, Codelco.

Amerigo has more immediate water worries than Capstone.  Taken from their own presentation, Amerigo estimates they have water for 18 months.

Source: Amerigo Resources Investor Presentation

Amerigo has been a steady producer and gives a nice dividend.  But the water is a worry in the long-run.

Source: Amerigo Investor Presentation

While Amerigo says there is nothing to worry about, I worry because 18 months is not a long time.  I wonder about the long-term plan if the drought persists.
 

HUDBAY MINING – A WORLD OF COPPER

 
Hudbay Mining (HBM – TSX) has operating mines in Manitoba and Peru.   They have two large development projects in the United States.

Hudbay plans to grow production both this year and next.  Because of by-product credits, cash costs will decline to close to $0.

Source: Hudbay Investor Presentation


That translates into free cash flow.  Hudbay has one of the best free cash profiles over the next few years.

Source: Hudbay Mining Investor Presentation

The first risk is political, in this case, Peru.  But while Peru is far from perfect, it is so bad it may be good?!? 

Peru’s left-leaning government has had to pull back from their tough talk (nationalization, big taxes) that got them elected.  Right now the government is having enough trouble just keeping power.   

There are corruption issues–the prime minister resigned and there was an impeachment vote.  It is too much disarray to drive sweeping reforms.

Hudbay’s second risk is permitting.  They have had their own issues permitting in Arizona.

Hudbay’s Copper World project is the going to drive future growth.  It is an open pit project, low cash costs ($1.15 per pound), and will produce 190 million pounds of copper per year (compare this to the 255 million pounds Hudbay will produce this year).

Bu part of the Copper World project lies on Federal lands.  While permits were issued, they have since been reversed by a District Court ruling.  That decision was upheld in an Appeals court this year.

Hudbay pivoted by focusing on private lands.  They can operate a 15-year mine life before they need to tap the Federal land.   The entire project has a 44-year mine life.

The focus on the private lands only should mean an easier permitting process.  But as Hudbay said on their Q4 2021 conference call, they “have the interest of the environmental crowd”. 
 

FREEPORT – THE BIG KAHUNA

 
Given the landscape, maybe the best way to play copper is just to KISS – keep it simple stupid.

That means Freeport McMoran (FCX – NYSE).

Freeport is the biggest copper play by some margin.  They will produce 4.2 billion pounds this year, 4.45 billion next year.  That is a little under 10% of global supply.

They are also a low-cost producer.  While cost ballooned at many junior operations, Freeport put in a $1.41 cash cost number in Q2.

Being the biggest and low-cost copper producer, Freeport should trade at a premium valuation – and they do.  But not as much as you might expect.

Source: BMO Capital Markets 2023 Estimates

Smaller names can be as much as half the valuation.  But they all have risks that Freeport does not.
 

YOU GET WHAT YOU PAY FOR

 
With Freeport’s diversity of low-cost production, they are better prepared to survive a prolonged bear market.  In fact, they will still generate cash.

The capex and cash flow estimates below come from the #2 Canadian brokerage firm, BMO.  Their tables assume $3.50 copper for ’23 and ’24.

Source: Company Data, BMO Capital Markets

Freeport is the safest.  Hudbay and Capstone give you multiple mines, some future growth, and free cash flow. 

Taseko and Copper Mountain need to turn it around, but they could turn out to be triples when copper turns. 

There is something there for everyone.  It just depends on how much risk you want to take.

Renewable stocks have been on a tear.

The run started when the Biden Administration introduced the Inflation Reduction Act, which included $369 billion tagged to renewables and clean energy.

I am not sure what this act is going to do for inflation, but it certainly is working to inflate stocks in the renewable sector.

To name some names, Enovix Corp (ENVX – NASDAQ), Plug Power (PLUG – NASDAQ), Enphase (ENPH – NASDAQ) all remain at or near their even as the stock market has gone into a severe tailspin.

But buying these stocks at current levels takes courage.  These are expensive names.  

They all trade at nose-bleed multiples.

It is hard for a value-oriented investor to pay the 70x PE that Enphase commands or the 16x sales for Plug Power.  Those are sky-high valuations.

I have been looking for a cheaper way.  One that lets you participate in EVs and renewables while not going down the quality ladder to a pre-revenue microcap with a blueprint and a slide deck.

I believe I have found one.  In the most unlikely of places.  I’m talking about Cabot Corp (CBT – NASDAQ).
 

MORE THAN JUST TIRES

 
Cabot Corp is in the business of carbon black.  This company is the largest producer of carbon black in the world.

Source: Cabot Corp Investor Presentation

What is carbon black? 

Carbon black is a powdered material almost like soot.  It is the primary ingredient in paints, ink, and rubber. 

The biggest end use of carbon black is as a reinforcing and coloring additive to tires.

Source: Cabot Corp Investor Presentation

Carbon black is a mature, slow-growing business.  The carbon black market is growing at a blockbuster rate of… drum roll please… 2-3% per year.

I know, so far, I’m not painting an exciting picture of growth.  But hear me out.  I buried the lead.

Yes, Cabot is the #1 producer of carbon black.  In fact, Cabot is #1 or #2 in a number of the markets they serve, including specialty carbon coatings and inkjet inks.

But that isn’t the story here.

The story is electric vehicles.  Cabot is a sneaky leading player in the EV battery market.

Sometimes the chart tells the story.  In this case, you immediately know there is something going on with Cabot if you compare the chart (top) to the S&P Chemical Index (bottom).

Source: Stockwatch.com

While the Chemical Index has broken down (not surprising given the signs of recession) Cabot has bucked the trend.  It is within spitting distance of its highs.

The reason?  Cabot has turned itself into a leading producer of conductive carbon, carbon nanotubes and carbon nanostructures.

They operate through 3 facilities in China that produces carbon structures designed specifically for battery materials.  They are open to building manufacturing in the United States but right now, if you produce batteries, you do it in China. 

Each of these facilities is expanding production to meet the growing demand.

Source: Cabot Corp Investor Presentation
 

CARBON NANOSTRUCTURES IN BATTERIES

 
Carbon nanotubes and nanostructures are relatively new introductions to battery composition. 

The battery anode has undergone several changes the last few years.  It started as a graphite anode, which had drawbacks for capacity and safety. Alloy anodes improved capacity but had drawbacks with recharging losses.  Silicon anodes are promising but they have issues with changes in volume and capacity declines during cycling.

As it turns out, introducing carbon nanostructures into these solutions balance out the weaknesses. You get a better anode, one that is safer and cycles more effectively.   The result is a better battery.

Carbon structures are used in a lithium-ion battery anodes that use silicon or metal alloys to provide big gains to performance and help stability.  

These battery anodes are next gen to the graphite anode batteries that have been used in the past.
 

CABOT’S BATTERY BUSINESS IS SMALL BUT GROWING FAST

 
Right now, battery materials are a relatively small piece of the puzzle for Cabot.  They estimate 2022 EBITDA from the segment of around $35 million.  That compares to average EBITDA estimates at the corporate level of $700 million.

But battery materials are growing much faster than the rest of the business.  Cabot is expecting a 50% topline CAGR over the next 3 years.

Source: Positioned for Profitable Growth Investor Day Presentation

Cabot is a leader in this space.  They are delivering material to 6 of the top 8 battery companies.  They are working with these manufacturers on the next-gen battery designs.  Cabot is right in the middle of the still-evolving battery supply chain.

At the Credit Suisse Specialties and Basics Conference Cabot said that looking further out they believe this could be a $500 million revenue business in 5 years, a $1 billion business in 10 years.
 

CHEAP BUT NOT CHEAP

 
Cabot is not a microcap.  They have a market capitalization of $3.9 billion and an enterprise value of $5.2 billion.

Cabot did $3.4 billion in revenue last year and is expected to do $4.2 billion this year (can you say inflation?).  EPS is expected to grow from $5 per share to $6.20.

While the renewable names I mentioned at the start of the article trade at double- and triple-digit multiples, Cabot trades at 7.5x EV/EBITDA.  They pay a 2% dividend and based on average estimates, are forecast to yield 8% free-cash-flow in fiscal 2023.

While these numbers seem very reasonable compared to the renewable sector, this is still a big premium to the valuation of chemical peers.  For the most part, chemical stocks are trading at single digit PE’s. 

But of course, these companies are going to see their earnings get whacked by a recession and they don’t have the secular growth that Cabot’s battery material business has.

As the chart I posted illustrates, the dip buyers are out in force with Cabot.  I have little doubt that the buying pressure are investors seeing dips as an opportunity to get a foothold investment into their battery technology.

My only hold back on the stock is what happens if the recession is deep?  Cabot still relies on several commoditized products.   

As the tide turns volumes and margins could take a hit.  Can the stock hold up even in the face of this?

I’m not so sure.  It might not be the right time to buy a chemical stock.  But when the turn comes, buying one with a big secular growth driver will be the way to go.

I love cheap stocks.  I love them even more if there is a good runway for growth.

Nothing is more exciting than finding a high-growth gem with a single-digit multiple. 

But the truth is, those are rare.  If you want to own growth, you are going to have to pay up.

This has been the case for years in the 3D printing business (I’m going to call it by its more technical name – additive manufacturing).  The big names in the space have tended to lose money and trade at expensive multiples.

But today, the market has wiped away a lot of that excess.

While I would not go so far as to say these stocks are “cheap”, they are certainly a lot cheaper than they have been in the past.

Stocks like Stratasys (SSYS – NASDAQ) have given up nearly all the gains of the post-COVID bubble.

Source: Stockwatch.com

With so much froth taken out of the stocks, the sector is worth a look.  Additive manufacturing is a business that looks like it has years of growth ahead of it.  The drivers of this growth are trends that  – for the most part – are irreversible.

But if I can see the trends, everyone sees the trends.  You can’t expect it to not be in the stock.   

While you want to get these names cheap, you can’t expect them to be too cheap. 

They might not be there yet.  But its getting close.  It could be that “cheaper than they’ve ever been” is cheap enough.
 

DEMOGRAPHICS IS GOING TO DRIVE TECHNOLOGY

 
Trying to talk about demographics and stocks can be a hard sell. 

Demographics are like tectonic plates to the raging river of the stock market. 

One moves slow, the other fast.  The market cares about the next quarter, at best the next year.
Spelling out a trend that will take decades to play out makes a trader’s eyes glaze over.

Yet there are demographic shifts that are going to create some big changes in the next few years. 

The population is aging.  The 2020s are going to be a tipping point.

According to a UN Report released in July, global population grew by less than 1% in both 2020 and 2021.
This is the first time this has happened since WWII.

Two-thirds of the world has a fertility rate of less than 2.1 births per woman, which is the level needed for stable population.

People are old and getting older.  30% of the population is over 65 in Japan.  In the United States, which has some of the better demographics (thanks to immigration), it is just under 20%.

In the manufacturing hubs of the world, the outlook is grim.  While China has only 15% over-65, their one-child policy makes it a virtual certainty that their labor force is going to go into decline.  They will be Japan by 2050.

In Korea, the birthrate has gotten so bad (only 0.81 per woman 2021) that the government is offering a $740 per month allowance for each newborn child!

If we want to get work done, we are going to have to do it without the worker.  Meaning more technology, more machines.

This is the sweet spot for additive manufacturing.

This is not the same technology as a couple of decades ago.

This is not plastic prototypes and trinkets.  Today’s additive technologies are about manufacturing end-use parts at scale.

Consider Stratasys, one of the biggest additive manufacturing names.  In 2020, 25% of Stratasys’s revenue came from end-use manufacturing.  In 2021, that increased to 29%.  Stratasys expects 20% growth in 2022.

Stratasys has a partnership with General Motors (GM – NYSE) and another high-performance OEM, Radford, to produce parts on the floor that go into the cars. 

Source: Stratasys Investor Presentation

It is not just cars.   Aerospace (Lockheed Martin), military (General Atomoics), and medical devices are all taking advantage of the customization and quick turnaround time of additive manufacturing.

Take medical device maker Stryker (SYK -NYSE) for example. 

Stryker manufactures its Tritanium implants, used for the knee, spine and hip, using additive manufacturing. 

In Q1 Stryker expanded the offering to include patient matched shoulder implants. 

These implants are custom made for the shape of each patient, manufactured with additive manufacturing.

Stryker can turn around a custom-made implant in 14 days.  They expect that number to get below 10 days by next year.

Stryker announced a new 156,000 square-foot facility with 600 high-tech jobs in Anngrove Michigan that will be dedicated to expanding their additive manufacturing capacity.

Nano-Dimensions (NNDM – NASDAQ) goes a step further, using additive manufacturing to create micro-devices.  Their DragonFly and Fabrica systems are micro-additive – meaning they can produce very small footprint devices.

Their systems fabricate the circuit boards, can add capacitors, transformers and coils, creating functional electronic devices on the fly.   These are used in smartphones, drones, cars and medical devices for use in the human body.

None of these examples are one-off prototypes.  We’re talking end-user and scale.
 

BRINGING IT ALL BACK HOME

 
While demographics is going to drive adoption over time, the process is going to be sped up by de-globalization.

COVID put the spotlight on supply chains.  Geopolitical tensions are amplifying that.  Together these forces strengthen the call for bringing manufacturing back home.

It is putting additive manufacturing at an inflection point.  

What we saw in 2021 was a faster transition from prototyping to production of end-use parts.

Yoav Zeif, CEO of Stratasys said that “the last two years opened up new markets” for Stratasys and have been a “catalyst to rethink how [companies] manage their product lifecycle.”

Zeif estimates that their opportunity set has doubled over that time.

The US Government sees it as well.  In May the White House announced the Additive Manufacturing Forward Program.  The program is aimed at “building more resilient supply chains” and “onshoring manufacturing”.

There are 5 initial participants in the program: GEO Aviation, Honeywell (HON – NYSE), Lockheed Martin (LMT -NYSE), Raytheon (RTX – NYSE) and Siemens Energy. 

These large manufacturers have committed to source a large percentage (between 20% and 50%) of their additively manufactured products from within the US.

The goal here is to establish the United States as a hub for small and medium manufacturers of additive products.

The Biden administration will support the program by providing low-cost access to capital that allows the manufacturers to build up their additive equipment base.
 

SOFTWARE CATCHES UP

 
Software has held back additive manufacturing applications in the past.

Until recently, the steps from designing a part to printing it were cumbersome.

Parts were designed on traditional CAD tools.  Solidworks, Autodesk, Pro-Engineer.  The design was then converted to a 3D-printer compatible tool, where it would be sliced and diced into increments that could be handled by the additive manufacturing process.

Today that process has been simplified.  Large names like Autodesk (ADSK – NASDAQ) and Solidworks (owned by Dassault (DSY – FR)) have integrated additive design tools. 

Tools like ANSYS now have options to evaluate the final part design, including choice of layers, to detect structural issues.

Materialise (MTLS – NASDAQ) has even built software specifically for additive manufacturing. 
 

RECESSION WATCH

 
The long run looks bright.  But in the short run, these stocks are going to be held back by recession.

2021 saw a surge in growth across the sector.

Stratasys grew 24-25% in Q2 and Q3 of last year after a number of years of flat to negative topline growth. 

3D Systems grew 44% YOY in Q2 2021 and 15% in Q2 2021, well above anything they had done before that.

The economy was hot and COVID restraints were driving investment. 
Now those tables have turned.

Nearly every additive manufacturing name printed slowing growth in Q2. 

Bigger names like Stratasys and 3D Systems pulled back on their growth estimates for the second half.

3D Systems saw declining revenue – down 14% in Q2. Stratasys saw revenue growth drop to 13% and their guidance dropped YOY growth to only 6-7% in the second half.

The slowdown has pummeled the stocks.  Every one of these names is down for the year, most by a lot.

Source: Stockcharts.com

Yet I don’t think the bottom is in just yet.

At the end of the day this is manufacturing folks.  What these companies are driven by is manufacturing capex – they need manufacturers to invest in their business and for that you need healthy growth.

That means that regardless of how good the tech is, if growth disappears, if orders are weak, there is no need to invest.

That’s the headwind.  It will last for as long as the economy is slow.  It won’t last forever.

Separating the long-term trend from the short-term is the trick here.   

These stocks may have further to fall. 

But some will turn out to be big winners once the recession passes.

US natgas prices have been trading near or above $9/mcf for a week now, while Canadian natgas prices actually hit ZERO for a short time recently—and on the main AECO benchmark no less!

ZERO, as in $0.00.  How can that happen you say, in a North American market where natgas is integrated remarkably well between the two countries.

Now, that would have only been for a trade or two where a producer was caught offside with too many molecules on the wrong day.  Believe it or not, natgas trading at zero or even negative in Canada—especially at the smaller Station 2 hub—was not unusual in August in Canada some years.

But now, when Europe is buying every molecule from around the world, how can Canadian natgas be at such a discount to the US.  The simple reasons are that

1. Production is now up over 17 bcf/d—an all time high, just when…
2. …Maintenance issues on Canadian pipelines are reducing capacity

And there’s a good chance this won’t be fixed until AFTER the big Freeport LNG facility in the US Gulf Coast restarts and sucks up another 2 bcf/d for export to Europe.

Now the good news is, Canadian prices are generally at $4/mcf now, not zero. But the bad news is, Canadian prices are generally at $4/mcf now, not US$9/mcf like down south.

Let me put this in a bit of context.
 

THE GOOD OLE DAYS AND THE BAD OLE DAYS—ARE BACK

 
Natural gas prices are back up at highs we have not seen in well over a decade.

Europe continues to scramble to get whatever LNG they can get their hands on. 

While EU storage is actually up year-over-year, and Germany just announced they reached their interim storage goal a couple weeks ahead of schedule, that has not helped bring down gas prices.

Contributing is that the summer in Europe has turned scorching hot.  

This and the looming threat that Russia shuts of the tap in the fall has driven natural gas prices above $70 per million BTU.

Those prices are ricocheting around the world, sending natural prices sky high.  In Asia, spot LNG prices have jumped to nearly $60 per million BTU.

Source: Bloomberg

In the United States the biggest impediment to natural gas prices rising – the shutdown of the Freeport LNG terminal – looks to be hitting its timeline on getting back online, which is only in a couple more months. 

The terminal shutdown has led to a decrease of about 2 bcf/d in LNG exports the last few months and kept a lid on US natural prices in the process.

Source: Bloomberg

I suspect that natural gas prices in the US are moving back up in part because the Freeport restart is getting close.  But there is more to it than that.  Even with lower LNG exports, the last few weeks have seen a drop in seasonal storage builds, which is telling you it’s a tight market in the US.

Source: Bloomberg

The economy is a concern but so far there isn’t a lot of evidence of demand destruction.   

Maybe we shouldn’t be surprised.  Even during COVID, natural gas demand – mostly for heating and air conditioning – proved to be remarkably resilient.

For now, average daily electricity generation from natural gas is sitting at all-time seasonal highs.

Source: NBF

So yes….the good old days are back.

Unless you produce in Canada.

Not that things have been that bad for Canadian producers.  Canadian producers have been getting far and beyond the price they got last year, likely well beyond anything they would have imagined getting ever again!

But it is far from what it could be.  And over the last few weeks it has gotten a lot worse.

The differential between the Canadian AECO hub price and US Henry Hub has blown out in recent weeks.

The issue is same the old foe that has plagued Canadian gas producers in the past—egress capacity.

Drilling is up across the Western Canadian Sedimentary Basin (WCSB).  That goes for both natural gas and for oil.  Most Canadian oil plays come with significant associated natural gas.

Source: RBC Capital Markets

More drilling means more gas.  WCSB production is now above 17 bcf per day.  Last year at this time production was a little under 16.5 bcf per day.  In 2020 it was only 15 bcf per day.  Much of this is coming from the Montney, in NE Alberta and NW BC.
 

THE REAL CULPRIT IS SUMMER MAINTENANCE

 
The increase in production comes at a time when investors are seeing a lot of pipeline capacity down for maintenance.

Station 2 natural gas prices – this is gas that has come south from Northern BC (the Montney) – dropped to 50 cents per mcf this week!  The most widely used benchmark for WCSB prices, AECO, was trading at around C$3.25/mcf before Thursday (not great), when it dropped to $0/GJ (really not great!).

The drop to $0 was due to additional maintenance south of Grande Prairie along the TC Energy Nova Gas Transmission Line (NGTL) which brings gas north to south across eastern Alberta.

The maintenance was on top of existing the maintenance work along the pipeline that is already being done and reduced volumes through the pipeline further.

Combining much higher volumes through the NGTL pipeline and maintenance reductions is a recipe for low (and negative!) prices.

Source: NBF

The #2 Canadian broker, BMO Capital Markets, does not see the situation improving until the late fall.

It all adds up to a massive discount in pricing for Canadian producers. NYMEX natural gas futures have been above US$9 all week long.
 

WHAT CANADIAN PRODUCERS ARE EXPOSED?

 
But not all Canadian producers are equal.  There are some with a lot of exposure to AECO, and others that have either hedged their exposure or have transmission to the United States hubs that bypasses the Alberta bottleneck.

Canadian mid-tier broker NBF put out a helpful table that shows the exposure of to AECO of various producers.

Source: NBF

NBF highlighted Birchcliff Energy (BIR -TSX) in particular.  Birchcliff is showing a 20% free-cash flow yield at current prices.  They are only marginally exposed to AECO prices.

Source: NBF

The other big driver for Birchcliff is that they are about to become debt free. 

When that is announced (expected Q4) expect cash flow to come streaming back to shareholders.

NBF estimates that with a 50-75% free cash flow payout Birchliff could be paying out as much as $1.75 in dividends.  Not bad for an $11 stock.

Nuvista (NVA – TSX) also looks interesting with very low AECO exposure and a 20%+ free cash flow yield.

Finally, it may still be a bit early, but at some point, the contrarian path could pay a big dividend to investors.

From what I’m reading, most of the collapse in differentials is because of maintenance.  Maybe poorly timed maintenance.  Come late fall, we should be looking at a more balanced picture.

One of the most exposed producers is Pipestone Energy (PIPE – TSX).  According to BMO 80% of their volume is priced at AECO.

This has likely been a factor in the stock underperformance.  While most natgas stocks are at their highs, Pipestone sits well below its June level.

Source: Stockwatch.com

In the third quarter Pipestone will take a hit on its natural gas pricing.  Their natgas selling price averaged over $8/mcf in Q2.

But once we see that the bottom is in for AECO and differentials narrow, Pipestone could see a quick re-rating back to the level of its peers.