Category: Reflection

“Then the seven years of plenty which were in the land of Egypt ended, and the seven years of famine began to come, as Joseph had said. The famine was in all lands, but in all the land of Egypt there was bread.”
Genesis 41: 53-54

Biagio d’Antonio’s The Story of Joseph (c.1485)

The disturbing almanack

In the past, that is not too distant was a decade of abundance, peace, and order. Food, energy, resources, and capital were plenty and affordable if not cheap by today’s standards. Today, we have the exact reverse.

Six months ago, we wrote about the rising food security risk globally (link). Since then, food prices have cooled down in the wake of recessionary fears driven by the global central bank tightening cycle. The FAO food price index has fallen by 14.7% in USD terms from its peak in April 2022.

The question: is the food security risk now no longer a concern?

Anecdotal evidence of the rising popularity of food-protectionism measures would suggest the contrary. In 2H2022, Malaysia banned chicken export, India restricted the export of rice, and recently Mexico halted 24 key food exports.

Furthermore, the recent surge of the US dollar actually has worsened the food security risk for many countries. At the same time whereby the FAO food price index fell by 14.7 percent from its March 2022 peak, the dollar index rose by 21.5 percent. This means that most countries experienced a 3.65 percent higher food prices. It was no relief.

Furthermore, we still identify three major supply-side overhangs for food security: (1) the high possibility of a third consecutive La Nina; (2) escalation of political risk in Europe; (3) gas-crisis-driven fertiliser cost.

While the almanack that we provide might feel disturbing if not stomach-churning, we think that the mounting pressures of food security could signify the value of food technology. A vertical that has perhaps been taken for granted in the decades of plenty. Ironically, it is also the sector that allows humanity to thrive and defy the infamous Malthusian catastrophic prophecy.

Malthusian prophecy and its 180-degree reality

Students of economics would have been familiar with the Malthusian Trap. The 18^th-century British philosopher and economist Thomas Malthus was well-known by the history book for his grim prediction in 1798. Malthus argued that food production will not be able to keep up with the growth of human populations. As a result, disease, famine, war, and calamity are seen as humanity’s inescapable fate.

Proponents of this school of thought might resort to an extreme solution to this problem like extreme population control. This reminds us of Thanos, the villain of the Marvel Universe, and his conquest to wipe out one-half of the universe’s population to maintain prosperity and peace in the galaxy.

Fortunately, the reality has fared better than the doomsday prediction. Humanity has prevailed and continued to expand the frontiers of welfare. For instance, Our World in Data showed that life expectancy has more than doubled from 29 years old in the 1800s to 71 years old in 2015. At the same time, the global population went up sevenfold from about 1 billion to 8 billion in 2022.

Moreover, data from the 1820s to 2015 suggests that the poverty eradication curve is getting steeper rather than flatten. The share of the global population that lives in poverty plunged from over 94 percent in 1820 to 9.6% percent in 2015.

These are signs that indicate the world’s productivity has exceeded the growth of the population. What went different from Malthus’ view?

The uncounted factors that matter: the man-made miracles

Robert Malthus’ theory of growth lacks respect for the fundamental reality of technological progress. This is implied by assuming that food production would only be growing at an arithmetic progression. In reality, innovation and technology have pushed the boundaries and changed the course of history. Especially in the front of productivity.

Three foundational food production technologies allow the humanities to dodge the Malthusian trap:

1. Fertilizers

One of the cornerstones of modern food production lies in ammonia which contains nitrogen and hydrogen. Nitrogen is one of the most important crop nutrients, a secret sauce of yield improvement. Ammonia can effectively bind nitrogen to be applied directly on crops or to be processed further for fertilisers like urea, DAP, and NPK.

The advent of haber-bosch process in 1908 allowed the synthetic production of ammonia. ­It is a game-changer and worthy to hold the title of one of the greatest inventions of the 20^th century. Erisman et al. (2012) estimated that the existence of nitrogen fertilisers have helped to feed 48 percent of the global population in 2008. In today’s number, that is equal to 3.8 billion people.

Back in March 2022 blog (link), we discussed ammonia as the main feedstock of fertiliser was caught in a perfect storm of geopolitical conflict, energy crisis, tight agricultural market, and supply chain constraint.

So far, we see a minimum disentanglement of these factors. As such, that might keep ammonia prices at elevated heights for a long time. Note that fertiliser crisis could cause a decline in the harvest that will worsen the global food stock.

2. Seeds technology

You reap what you saw. Seeds technology plays a vital role in fulfilling global food needs mainly through variants of better vigour and productivity.

In the case of the US, seed technologies have played an enormous role in jacking up the corn yield from merely 2 tons per hectare to 12 tons per hectare, a six-fold increase. This is a perfect showcase of what 160 years’ worth of long and continuous research effort could bring, defying the Malthusian trap.

In that regard of such immense research effort and multi-billion research budget, we perceive seeds technology businesses to be something secular whose profits are beyond justifiable for society. Their business enhances the economics of farming and helps feed the world in the process.

The advent of gene editing technologies (CRISPR) and super-computer could expand the frontier of seed technology in form of genetic modified organism (GMO) and genetic-edited (GE) seeds. Recent article from Financial Times (link) reported that gene-editing using CRISPR technology could cut product development cycle (variety development including regulatory approval) from 16.5 years to 5 years and research budget from $115 mn to $ 10.5 mn per product. Compared to GMO, gene editing using CRISPR is more precision in terms of adding or cutting the gene. Nevertheless, the technology mastery is still limited to a few and still in due process for more regulatory acceptance. Genetic-edited crop is the new unexplored frontier.

3. Crop protection

Besides fertilizers, the development of chemicals in crop protection has also contributed to feeding the world. For instance, pesticides could improve crop quality and increase crop yield by 30 percent on average (Bromilow, 2005). Pesticides are not something new, it has been widely used since the last 1940s.

Unfortunately, most crop protection products also require petrochemical-based feedstock. This suggests that a severe and prolonged energy crisis could adversely impact global food security by affecting the affordability and availability of fertilisers and crop protection chemicals. From that point, a vicious cycle in global food security could emerge from the subsequent decline in crop yields.

A difficult but hopeful journey ahead

It has been an adage of the investment world to invest in the pain points. Crop solution companies are essentially the direct solution to the looming food security risk. These companies range from fertilisers, seeds technology, and crop protection chemicals.

Given the R&D barrier of the business and the deeper pockets of the farmers, crop solution companies would be one of the few businesses that can thrive in this era of inflation. Crop solution companies’ pricing power is bound to rise in times like this. It is pretty obvious since crop solution products are the must-have ingredients for farmers to extract the risk premium and the cure to the crisis itself.

Although the short-term outlook might be difficult, the long story of humanity would suggest that this is a beginning of a hopeful tomorrow. Today’s market risk premium unveils the challenges and opportunities that lie ahead of us. It’s been years since capital was substantially directed toward resources, the bedrock of civilization. We believe persistent commodities’ risk premiums will redirect the capital into sectors that become the seeds of the next decade of plenty.

 

Bibliography

Bromillow. (2005). Pesticides. Encyclopedia of Soils in the Environment, Vol. 3, Elsevier, 188-195.

Ritchie, Hannah;. (2017, November 07). How many people does synthetic fertilizer feed? Retrieved from Our World in Data: https://ourworldindata.org/how-many-people-does-synthetic-fertilizer-feed

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Everyone has a plan ‘till they get punched in the mouth. This frequently cited quote by Mike Tyson gains more relevance today. Politicians may aspire with plans to increase their odds of being elected. Greening economy projects, waging war against inequality, exerting political dominance over other countries, and other populist policies are some of the examples. However, all these means nothing if their leadership fails to bring food on the table.

In our past blog (link), we pointed out how supply chain issues, tight agriculture market, energy crisis, and geopolitical tension crystallised in the great rally of ammonia and fertiliser prices. If we consider the factors at play, this might be the warning shot of an upcoming food crisis.

Skyrocketing food prices have been associated with social unrest and we are at all-time high

It is pretty straight forward why high and volatile food prices could destabilise a society.  Food is both essential and have a significant share of our daily spending. Based on 2018 Euromonitor data, food on average accounted for 28.7% of  consumer spending in 51 countries throughout the globe. For some countries like Bangladesh, Myanmar, Kenya and Ethiopia, this figure can be as high as 53% to 59% .

There are anecdotal evidence in the past whereby food problems led into social unrest. In 1789, the famine led French peasants to storm the Bastille prison and ended up overturning the French empire. In the modern era, the high food prices in 2008 and 2011 sparked numerous civil unrests in the Middle East.

Before the recent boom, commodities were the sucker’s bet of the last decade. At the start of its gracious fall in the 2010s, the substantial commodity investments in the 2000s left the world with abundant stocks of commodities. This time around, the prolonged relaxed financial conditions and minimum investments in this sector drift the world into the opposite setting. There is a lot of liquidity, yet so few goods.

If we consider commodity as a currency of its own, we are seeing where Gresham’s rule of bad money drives out good money in action. The rapid expansion of liquidity without a respective production expansion of commodities led to the appreciation of the latter.

Today, food prices already exceeded the highs of 2011 and are yet to lose their steam.

Countries are taking food protectionism measures to stabilise domestic food prices

We find the severity of the potential food crisis cannot be underestimated. Case in point would be the magnitude of Russia-Ukraine war in escalating this matter.

Both Russia and Ukraine play significant roles in the agriculture or fertiliser market. Russia is the biggest exporter of wheat (18% of global export) and a major exporter of sunflower oil (18% of global export) and fertilizers (20% of global ammonia export). On the other hand, Ukraine is also a major exporter of wheat (15% of global export) and the biggest sunflower oil exporter (37.5% of global export).

The prolonged Russia-Ukraine conflict adversely impacts both near and long-term supply. Near-term supply has been affected because of the logistical hurdles made by the war. The future supply is at risk because Ukraine might miss this spring planting season. The ramifications of sudden drop in food exports at a time of tight stock will be painful and costly to bear by the rest of the world.

For some countries, such as those in the African continent, food affordability and availability will become major issues. From the following graph, we could see how Russia and Ukraine war could jeopardise the procurement of wheat in Africa.

This concern over food insecurity gained the spotlight in the world’s most populated country, China. During the 13^th National Committee of the Chinese People’s Political Consultative Conference on 7 March 2022, China President Xi Jinping underscored the importance of food security and ordered greater self-reliance in its production. Below was his speech as quoted by South China Morning Post:

“Vigilance in food security must not slacken, we must not think that food ceases being an issue after industrialisation, and we cannot count on international supplies to solve the problem… We must plan ahead by adhering to the principles of domestic production and self-reliance while ensuring an appropriate level of imports and technology-backed development… the rice bowls of the Chinese people are filled with Chinese grain”

There is no smoke without fire. The mounting food security risk is even more visible with the spreading food protectionism measures. China, Russia, Ukraine, Algeria, Hungary, Moldova, Turkey, Egypt, Serbia, and Indonesia are growing list of countries that curbs food or fertiliser exports.

A resource-rich country like Indonesia may fare better in facing a food crisis

Indonesia has adequate resiliency in the mounting food insecurity globally. In terms of food production, the country is well-known to have a 59% share in global palm oil production. This vegetable oil is extremely efficient. Palm oil supplies 40% of the world’s vegetable oil demand with only 6% of land used for vegetable oils. These economics made the commodity simply irreplaceable.

Furthermore, the USDA ranked Indonesia as the fourth biggest producer of rice with a 7% global market share. This country is also ranked the twelfth largest producer of corn with 1% global market share.

Given this natural advantage, Indonesia is inherently a net exporter of foods. The skyrocketing price of global food prices would suggest that the country will see its surplus widen. As such, Indonesia should benefit from either relative resiliency in inflation or a widening trade surplus.

According to The Economist’s research on the food security index 2021, Indonesia ranked 37^th of 113 countries globally in terms of the availability of food supply. Ample land for production, low volatility of production, and strong food security policies and agency are reasons why Indonesia fared well on this subject.

Furthermore, Indonesia’s food security improvement between 2012 and 2021 ranks 24^th among world countries. Based on our past on-the-ground observation, infrastructures development and strengthening of food security policies and enforcement are the reasons for the improvement. We discussed more detail about Indonesia infrastructure development in our Q1 2019 report (link).

We think that Indonesia’s resiliency in food security is pretty much reflected in the marginal food cost increase relative to the global average from 2010-to 2021.

In the world of commodities shortage and abundant liquidity, those who own the former will stand to benefit. Besides food, Indonesia produces lots of commodities and has been regarded as resource-rich land for decades. How will the booming commodity market affect Indonesia? How it be different this time? Stay tuned to our blog!

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Who would’ve thought that someone is willing to pay a hefty price for turds? Although some might find this to be stomach-churning, it is a reality. According to Bloomberg, manure is selling for USD 40 to 70 per ton, an all-time high level since 2012.

Major reasoning behind this phenomenon could be traced from the ongoing fertiliser crisis, especially from one of its key ingredients: ammonia.

Ammonia is a compound of nitrogen and hydrogen (NH3). The high nitrogen component, a key macronutrient for plants, makes ammonia an essential feedstock for all nitrogen-based fertilisers. Alternatively, it can be applied directly to the soil as well.

Based on our study, the dynamic of ammonia market is reflecting today’s problems on multiple fronts, namely: supply chain, agricultural, energy, and geopolitical tension. Its price performance is a perfect example of what could happen when an inelastic demand faces a serious setback in supply.

Perhaps, ammonia could be good long exposure for the ongoing problems in the world. Below is our learning on this matter:

The now deep-pocketed farmers could afford the unprecedented upswings of ammonia price

The soaring price of ammonia has a profound impact on the agriculture market as fertilisers typically contribute up to 20% of in-farm cash costs. The ammonia market, however, is also affected by the agriculture market as the chemical is their essential derivative demand – 80% of ammonia use case comes from fertiliser.

Given such a relationship, ammonia price can only elevate that much for a considerable time because there are people who are willing to pay for it. In this case, it is the farmers who account for most of the demand.

As of 23 February 2022, the Bloomberg agriculture commodity price index was indicated 67% higher than on the end of 2019 level. The favorable agricultural prices certainly have buoyed the fertiliser market as it deepens farmers’ pockets. Nutrien, the world’s largest plant nutrition producer, sees crops producers’ margin to expand by more than two hundred percent for 2021 and 2022 compared to the 2019 level.

We see the outlook for agricultural commodities to remain bright as the tight market is yet to see relief. Global grains stocks-to-use ratio that indicate the carryover availability to fulfill the full-year demand has been in a free-fall in the last couple of years. The weak prices of 2012-2020 might had disincentivized investments in this space and resulted in a weak production capacity to timely respond to demand.

The combination of economic reopening and stimulus packages during the pandemic is also providing strong support for the demand for agricultural commodities.

Provided by these circumstances, farmers should be well-incentivised to continue applying fertilizers for maintaining or boosting their production. Especially, when they know that in some parts of the world crop yield might be adversely impacted by La Nina.

It is amazing to see this rock-solid demand could afford multiple setbacks on the supply side.

The supply-side problems have dislocated ammonia market by at least 48%

Normally, ammonia plants are built altogether with the downstream fertiliser plants. The statistics of the International Fertilizers Associations (IFA) indicated only 18.4 mn tons of 185.3 mn tons global capacity production in ammonia was traded globally in 2020. Only 10% of global production was intended for trade, causing the merchant ammonia market prone to disruptions.

Based on our estimate, the current ammonia market’s equilibrium faced a dislocation of at least 48% from the 2020 locus due to the following supply-side issues:

• Energy-crisis sent one-third of European ammonia plants to shutdown

Ammonia production process requires hydrogen and involved an energy-intense process. Most of the ammonia plants today are using natural gas as their feedstock for their hydrogen rather than coal or water due to environmental and economical considerations. Natural gas as a feedstock could govern 70-90% of the cash production cost of ammonia, excluding energy cost.

According to Bloomberg Intelligence, currently, about one-third of Europe’s ammonia production plants are being shut down due to the pricey natural gas cost. Such supply gap translates into additional demand to the merchant ammonia market and pinched 30% of the merchant ammonia balance.

The reasoning behind the energy crisis was a combination between structural changes and geopolitical tension:

In Q4 2021, we saw the tight energy market take the spotlight and send costs sky-high. The sector underinvestment over the last five years driven by lackluster prices, ESG scrutiny, and global-wide consolidation jolted fossil fuel prices up when it faces a robust demand from economic reopening. We had written some of these matters in our previous blog post in June 2021 (link).

In the case of natural gas, we saw its energy cost per unit has exceeded brent oil in both Europe (Dutch TTF) and Asia (JKM). Indicating the two regions’ competition to secure supply. This was primarily due to the region’s structural shift of adopting natural gas in their path of decarbonization. This structural shift is expected to result in a shortage of LNG in the future according to McKinsey.

With over 20% gas share in their energy mix, gas demand was amplified because intermittent renewable energy did not work during winter. About 10% to 20% of energy sources had to be switched to ‘dirtier’ hydrocarbon and gas has been the top preference.

This condition is worsened as Russia’s gas flows which account for 40% of Europe’s gas supply are reduced significantly. Russia’s gas flow in December 2021 was 10.3 bcm, about 26% lower than the same period last year.

The recently escalated tension of Russia-Ukraine has resulted in the postponement of the Nordstream II pipeline operation, carving out a significant potential gas supply for the region.

The Dutch TTF’s futures are now trading above USD 20 per MMBTU until mid-2023. This price has priced in the delay of the potential gas supply and implies LNG in Europe won’t be adequate to fill in the gas stock-up in the region for the whole year which starts at a very low base as inventory level is lower than five-year lows.

Warmer winter from La Nina for Europe could help to ease the replenishment of gas production but at this rate, this effect would be rather blunt. With natural gas availability remaining uncertain, we believe that the shutdown of European ammonia producers would take some time and the country will be a dominant buyer in the market.

• Missing fertiliser exports from Russia and China

In attempts to control food prices and security domestically, Russia and China have imposed restrictions on fertilisers export to ensure the availability and affordability for local farmers until 1H22. We estimated this resulted in 18% of missing supply from the merchant ammonia market.

The uncertainty looms whether as the policy would be carried as the initial plan since the tight market in agriculture, potash, nitrogen (ammonia), and phosphate market persist. Not to mention the escalating tension between Ukraine and Russia lingering the uncertainty in the already tight agricultural and energy market.

• Supply chain constraints kept prices high

The supply chain problems constraint that was initiated from the COVID-19 pandemic still haunt the economy. The steep freight cost has reportedly caused some producers to switch their inventory policy from just-in-time to just-in-case, stretching up the freight capacity even more.

For Europe and Asia, the steep freight market capped the potential cost savings from importing through LNG freight. Based on the normal calculation, we estimated about half the price of the current LNG price in Europe and Asia is going to the freight.

In addition to supply chain issues, health protocols also delayed the recovery and development of plants. Those factors combined slows down the plant turnaround process from 20 days to 60 days, according to one of our sources in the industry. Another case in point is the development of the Ma’Aden Ammonia-3 plant’s commercialization has been stalled from December 2021 and is expected to be delayed until Q3 2022, a nine-month delay.

Ammonia could be a good long-exposures on today’s world problem

In short, tight agricultural market, energy crisis, geopolitical tension, and supply chain issues are factors that keep ammonia prices high. At the current goldilocks situation, we see European fertiliser companies purchase to set the support price for ammonia as they become the dominant buyer in the market. It still unclear on how long this confluence of problems could be untangled.

So far, the pockets of farmers have been deep enough to pay the high price of ammonia from the tailwind of their commodities. Given the tight relationship of ammonia in the multiple problematic verticals of today’s economy, perhaps ammonia exposure could be a prospective long-exposure towards todays’ world problems?

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While having a getaway from a tumultuous year of a volatile market, one of our team members decided to share his bitter and sweet experience while enjoying delicacies in two different restaurants. The story reminds us of maintaining an underdog spirit to avoid being complacent and getting spoiled. The story in his own words is as follows:

The tale

I recently visited a gorgeous restaurant in Jakarta. The place was busy again after the Covid hiatus. I was so delighted to see the restaurant making a strong comeback, and I was also elated to recognize that we are supporting a local business that had fought Covid and won.

Almost everything about the place has gone back to normal. However, that, unfortunately, includes the poor-mannered and unhelpful staff. How did I forget about that?

Despite my colleague’s warmhearted gestures like making jokes and chatting friendly with the restaurant staff, they gave us a stiff face. We certainly felt that the staff acted like they were doing us a big favour by interacting with us. Others sought ways not to have to do much while pretending to be hardworking. When the wrong food was delivered to us, no apologies were offered, not even in the most basic form.

How could this happen? Is the restaurant staff not grateful for our support?

Maybe they are not aware of it because the restaurant is busy once again. Maybe because the restaurant staff did not have to do the heavy lifting to make their business successful. The location is superb and the design is first class. The hardware is great.

The problem is with the software. We understand that the restaurants under the same group are not nearly as bad. If anything, the service is known to be outstanding. In other places, however, the hardware, the place, and the design were not nearly as good as for this particular restaurant.

Sometimes the gorgeous hardware, or the ecosystem, works against you. Perhaps it’s too easy for complacency to set in when people would come anyway, thanks to the restaurant’s unique setup.

A few days later, during a holiday in Bali, my family went to dinner in the quiet Sanur area. The restaurant we picked looked gorgeous (now a negative word in my mind) from the outside. But this time around, I did not expect much after the previous experience described earlier. Maybe my defense mechanism kicked in, attempting to manage my expectations after a massive disappointment just days earlier.

To my pleasant surprise, the staff working there were adept, fully engaged, and movingly knowledgeable. No one was glued to their phone. Instead, they were super disciplined, yet very friendly. Their smiles were genuine, even when we did not attempt to make jokes.

The food was no disappointment either. The duck was juicy, and the sauce complemented it very well. It was not too fatty but it did not lack fat. The eggplants were also outstanding. It was soft, tender, and packed with amazing flavours. Even the dessert, cheesecake with mango toppings, did not fail to bring out joy to my table.

Later on, I learned that the restaurant was initially part of a big-name hotel. It is now completely separated and they needed to survive on their own with no more ecosystem support from the big-name hotel. The food was great and tasted even better with such a good service.

The name of this splendid place is Naga Eight. Considering that they just re-started, maybe it’s still too early to tell what will happen in the future. If they can maintain the “day-one” spirit, I think it could one day be a dining institution in Bali.

With the “day-one” mindset and full acceptance that one has no support from any big ecosystem, suddenly Team Naga Eight stops rehearsing their limitations: they have been granted the chance of a lifetime.

Companies’ value creation starts from the people

In Indonesia, many investors are eyeing technology companies as they started to populate the public equity market. We find it quite often that investors overweight their tech stocks investment consideration for the ecosystem and may slightly overlook other aspects of the business as a result.

While the tech ecosystem may provide a better chance of winning as it provides a captive market that may translate into faster and cheaper user acquisition, it is not a necessary nor a sufficient condition for success. As in the tale of the two restaurants, the ecosystem may provide a comfort zone that could be counterproductive for the company’s growth like a spoiled child knowing there will be a divine hand to lift them.

The only way to reduce such risk is by paying more attention to the management team’s execution capability and their attitude towards the game. Like a horse race, it takes both a good horse and jockey to win the race.

If we recall the blitzscaling stories of new-economy companies that are worth hundreds of billions or even trillions of dollars today, a major part of their success can be attributed to the management’s attitude and character instead of just where the company come from. After all, a company is run by the people.

In the industry where there are numerous cases of David and Goliath, the threat of the underdogs should not be taken lightly. Their hunger for victory is what we are looking for. Underdog companies are more likely to question the way they conduct business and more willing to reinvent themselves while ecosystem players tend to be more constrained by their patron.

In start-up companies whose profits are often still imaginary, management team spirit is indeed a reality.

Last words…

The story of Naga Eight reminds us of a scene from Dark Knight Rises (2012). The hero of the story Bruce Wayne (the Batman) successfully made an impossible jump to escape the Lazarus Pit Prison after numerous failed attempts only when he did it without the rope that keeps death away.

Only when he knows that failure is not an option, he can exceed his limitations and achieve the impossible.

Doctor                  : “You do not fear death. You think this makes you strong. It makes you weak.”
Bruce Wayne      : “Why?”
Doctor                  : “How can you move faster than possible, fight longer than possible,

                                without the most powerful impulse of the spirit? The fear of death.”

Bruce Wayne      :”I do fear death. I fear dying in here while my city burns.

                                And there’s no one there to save it.”

Doctor                  : “Then make the climb.”

Bruce Wayne      : “How?”

Doctor                  : “As the child did – without the rope. Then fear will find you again.”

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Resolutions are firm decisions to do or not to do something. While such determinations can be reached anytime, it is a common practice to say out loud in the beginning of each year what those things may be, followed by a reflection at the end of the year on how much have been accomplished during the year. Three topics we believe that may stimulate you to decide some resolutions for 2022 are about health, habit and mindset. More specifically:

Healthcare today is really sickcare, how can we change that? Tiny changes may have remarkable results, how do atomic habits work? Unlearning is a big part of learning itself, how a growth mindset can embrace the metaverse? We gather our thoughts and previous research on these subjects to remind ourselves as well as our readers the importance of staying healthy, nurturing good habits and having a growth mindset.

A siren call to the healthcare (or sickcare) system?

Starting an exercise routine, cutting back on alcohol, eating more nutritious food…

Which ones of these appear on your new year resolutions? As we kickstart another year with the pandemic around, staying healthy is one of our top priorities. The soaring covid cases in the Omicron wave got us to pay attention to the healthcare systems around the globe.

And we noticed a few issues with healthcare systems around the world:

1. Healthcare systems focus on treating illnesses than preventing disease and maintaining wellness.

2. Economic incentives for the industry participants have made treatment and medication extremely costly as well as discouraging better health education in communities.

3. Mental health has been one of the most neglected area of public health. According to the National Institute of Mental Health, nearly one in five U.S. adults had a mental illness in 2019 (51.5 million people).

The U.S. healthcare system over the past decades has been shaped to address the needs of patients instead of maintaining the wellness of the healthy population. Technology has been the greatest driver of improvement in many industries, but healthcare remains the exception. Dr Rafael Grossman, who is the first surgeon in the world to use Google Glass during an operation, believes that the advanced technology has become a tool to improve access to health. He thinks that the collection of data and analysis by AI have become more important in the field in healthcare. These tools enable better diagnosis and prediction of diseases, as well as the likely outcome of a specific intervention through treatment and medication.

However, for participants in the healthcare system, it is not lucrative to help healthcare consumers to prevent health problems. Economic incentives for patenting medical devices and drugs have remained strong barriers to effective disease prevention. More advanced technology may provide a cost-effective solution to correcting this systematic issue. This strategy is unfortunately undesirable to the system participants. The lack of potential for patenting advanced technology impedes one’s incentive to address the problem.

There is no simple solution in transforming the U.S. healthcare system. The best advice to each individual would be to take control and be in charge of maintaining his/her own health.

How do atomic habits work?

Often, we find it challenging to build a good habit or break a bad one. One week, two weeks, then we will likely revert to the old routine.

To be persistent is difficult. This time around, we have turned to the book “Atomic Habits” by James Clear for some guidance.

As stated in the book, atomic habits are defined as:

Atomic:
– An extremely small amount of a thing; the single irreducible unit of a larger system.
– The source of immense energy or power.

Habit:
– A routine or practice performed regularly; an automatic response to a specific situation

Clear introduces the importance of small changes. Little things add up to big things and time can create a multiplier effect. A small change may seem insignificant at first, but over time, the impact can be greater than you would have imagined. Sometimes we find it difficult to form good habits while bad habits linger. Clear explains that this is not uncommon. He elaborates using two reasons for why changing habits can be challenging, first is that we try to change the wrong thing, and second one being that we try to change our habits in the wrong way.

He further explains by using the three levels of change:

1. Outcome change
This level is concerned with changing your results.

2. Process change
This level is concerned with changing your habits and system.

3. Identity change
This level is concerned with changing your beliefs.

Most people managed to get to level 1 or 2 but failed to change their identity / beliefs. The true behavioural change is identity change, once a behaviour becomes part of your identity, you will become more motivated to maintain the habits associated with it.

“Progress requires unlearning. Becoming the best version of yourself requires you to continuously edit your beliefs, and to upgrade and expand your identity. ” – Atomic Habits by James Clear

The above is one of our favourite quotes from the book, it perfectly resonates with our strong belief of the importance of the ability to unlearn.

This also paths a great lead-in for us to introduce the next topic – a growth mindset to embrace the metaverse.

Entering the future with a growth mindset

Our readers would be familiar with the idea of the growth mindset that we introduced in one of our blog posts last year. For those who are new to our blog, you may read the post here.

As we all know, the future is uncertain. But one thing that we can be certain about is that technology will continue and play an even bigger role in driving our future. And metaverse will be one of the important representations of this technology driven future.

The word metaverse was the tech buzzword of 2021. With metaverse becoming a reality and hybrid culture are here to stay, how should individuals seek to familiarize themselves with it?

Having a growth mindset can create a significant impact. People with a fixed mindset may find it difficult to embrace the new concept of metaverse as it blurs the line between the physical world and virtual world. It is against the beliefs of “reality” fixated in our mind. Is the metaverse real? How do we define what is real? In the metaverse, we are represented by our avatars, we see and communicate with other avatars. Are they real? This all comes down to our beliefs. No difference to being in the physical world, we can experience feelings such as happiness, sadness and anger in the metaverse. Such sensations and emotions created by our brain influence how our brain construct reality.

A growth mindset encourages development. People with a growth mindset are not fixated on existing, stereotypical concepts, they are always seeking to find new ways to learn. In the era of digital disruption, this concept is more important than ever. Sometimes, people may struggle to make progress. The problem is that they have been focusing on the wrong thing. Learning is not the spigot to embrace new ideas, it is the unlearning. Unlearning is the ability to adapt and perceive differently. We cannot learn a new skill or concept without unlearning an older one.

Embracing the metaverse means unlearning what we understand today as the internet, what’s real and what’s virtual. Embracing the metaverse means embracing a future of unknown, unknowable and unique.

 

Reference:

Is Mental Illness on The Rise?, https://www.banyanmentalhealth.com/2021/07/01/rise-in-mental-illness/

Going from ‘Sickcare’ to ‘Healthcare’, https://healthmanagement.org/c/healthmanagement/issuearticle/going-from-sickcare-to-healthcare

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In our quarterly report of Q2 2020, we wrote about our thoughts on the inflation outlook. More than a year has gone by, with the global pandemic situation and subsequent responses from central banks, it seems that our thesis has become more mainstream.

In fact, a survey by the Fed suggests an increasing fear that inflation may not be transitionary. More respondents, who came from respective fields in the market such as broker-dealers, and investment funds, acknowledged the risk of persistent inflation as compared to 6 months ago.

Readers who have been following us are familiar with our discussions about MMT and the increasing prospect of high rates of broad money growth. Conventional economic theory would tell us that the resulting outcome of all the money printing and extreme reactions from central banks would most likely be inflation.

As Milton Friedman famously said, “Inflation is always and everywhere a monetary phenomenon.”

When Milton Friedman meets Blockchain

An emerging new world that is unfolding is the Web 3.0, a decentralised internet based on blockchain technology – the same technology where cryptocurrencies are built upon.

In the past year…

1. Bitcoin grew by 240%, outpacing gold substantially.

2. The total value locked in DeFi platforms grew more than 19 times.

Source: defillama.com

3. And the overall cryptocurrency market was up by 5 times, from slightly over $0.5 trillion to $2.7 trillion.

Source: CoinGecko.com

With all these numbers above, the cryptocurrency’s rise seems to be a phenomenon that is too big to ignore. We may be one of the first few to question how these events may have changed the inflation outlook.

With the abundance of money supply, it is natural that risky assets (such as real estate, equities, and high yield bonds) attract speculations. This time around, virtual assets such as bitcoin, NFT’s and other cryptocurrencies are also highly sought after.

While fiat will be losing its purchasing power due to uncontrolled supply, arguably bitcoin’s is preserved as its supply is capped at 21 million coins with the additional annual supply automatically reduces by half roughly every four years until all coins are in circulation. Its scarcity has been the main driver of its value. Some may even consider bitcoin as the new gold. More investors have dipped their toes into the cryptocurrency space not only out of a vehicle for speculation, but also a necessity as a hedging tool. At the moment, cryptocurrencies are worth around $2.7 trillion, which may seem to only represent a small portion of the global financial system. However, whether its net impact will be inflationary or not is yet to be seen. One can argue that a wealth effect is being created, no smaller than the last tech boom more than 20 years ago. Therefore, its potential inflationary impact cannot be ignored.

Blockchain offers the “trustless” environment for peer-to-peer transactions, this functionality is central to the growth of the DeFi market. The distributed ledger technology eliminates the need for trusted third parties, or intermediaries such as banks. For instance, securities transaction settlement which currently takes “T+2” to complete can be shortened to split seconds once the intermediaries are replaced by a smart contract. Not only does this reduces the costs of transacting, but it also speeds up transactions, driving the velocity of money.

Photo Credit: Beeple
The most expensive NFT art – “Everydays: The First 5,000 Days” by Beeple was sold for $69.3 million in March 2021.

NFTs have become a hot space for speculators, unlocking the rarity value of some assets. In 2021, the sales volume of NFTs surged to $10.7 billion in the third quarter alone, up more than eightfold from the previous quarter. The NFT market gained traction quickly, while most of the NFT hype has been around art and music, physical assets such as wine and spirits have also entered the NFT marketplace.  For example, a 1991 The Macallan cask which was appraised by Bonhams between $1.1 and $1.2 million earlier this year, were sold together with a digital asset from artist Trevor Jones called “The Angel’s Share” for a record-breaking $2.3 million in October. The NFT marketplace is essentially creating a more accessible platform to inject liquidity into the perceived illiquid assets such as collectables, driving up their demand. Physical assets are stored away once they have been sold as NFTs, lowering their supply in circulation. The NFT market may potentially bring an upward pressure to the prices of physical assets.

Photo credit: Trevor Jones
“The Angel’s Share” by Trevor Jones

The emergence of cryptocurrencies, DeFi and NFTs undoubtedly raised the curtain on the world of Web 3.0. The Web 3.0 architecture, however, is still in construction before it can infiltrate the mainstream. Such building of infrastructure will require more resources and technological innovations.

In general, technology is seen as a key tool to boost productivity and reduce costs. Therefore, some may see it as deflationary. However, in the context of Web 3.0, technology plays a much bigger role. Rather than just being a tool in production, it is also the key enabler of such an evolution. IoT, cloud computing, AI, machine learning, these are just some examples of the value chains of technologies required for the Web 3.0 expansion.  Waves of capital may swarm into these investment opportunities to accompany the development of these exciting innovations. This would no doubt result in a rising unprecedented demand of energy and raw materials for the development of this infrastructure.

Of course, it is difficult to reach an unambiguous conclusion on how inflation will take shape. From an investor point of view, we are of the camp that 1) the accelerating supply of virtual assets, 2) growth of DeFi and 3) technological innovation may serve as a contributing factor to inflation. As such, we believe that real assets and commodities would remain as the top picks for inflation hedging, while Web 3.0 strategy may present profitable opportunities in times of uncertainty.

Reference:

Dapp Industry Report: Q3 2021 Overview, https://dappradar.com/blog/dapp-industry-report-q3-2021-overview

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On the previous blog (link), we mentioned that some discouraged investors from China tech stocks might shift their portfolio allocation into Southeast Asia tech names who have similar high-growth profile yet lesser regulatory risk.

Below is our reflection on the Southeast Asia tech investment opportunity:

The Southeast Asian market has been unloved due to post-commodity supercycle currency depreciation and low-tech exposure

Southeast Asian equities were the investor’s darling because of the region’s high economic growth and exposure to commodities during the 2000-2012s commodity supercycle. However, the last decade has been rough. The ASEAN market simply lost its charm as it has been underperforming relative to the S&P500 for almost a decade.

From our understanding, elevated currency risk and non-existent tech exposure are the major reasons for ASEAN’s relative underperformance to the U.S market.

Currency pressure – ASEAN currencies had suffered from three things between 2010 to 2020: (i) the Fed Taper Tantrum to prevent inflation post-GFC due to the massive quantitative easing, (ii) Donald Trump’s economic policies that caused capital flows to the U.S. denominated assets, and (iii) post-commodity-boom-triggered current account deficits in the commodity-exporting countries. As a result, the currency risk in the ASEAN rises, enter the super dollar era.

Furthermore, the ASEAN market also lacks the 2010-2020 bull’s DNA. The region has low-to-none tech exposure as suggested by the figure above. Hence, it missed the huge tech bull market between 2010 to 2020. This factor, however, is finally set to reverse as many South East Asian technology firms will be entering the stock market within the coming year.

The mounting interest in the Southeast Asian technology companies

Southeast Asia is an inherently lucrative playground for tech companies to grow. The region’s fast-growing economy could enhance the high-growth trait of tech companies. Furthermore, given that most Southeast Asian countries are in the emerging market category, it offers even more problems that could be addressed. It is all the right business at the right place. There you go, a triple leverage for a growth stock in Southeast Asia.

Investors’ interest in the region’s tech firms could be gauged well from Sea Limited’s (SE.US) stock price, which increased by 7.35 times since the COVID-19 low in March 2020 and shows no sign of slowing down. The company owns Garena gaming company and Shopee e-commerce. Each subsidiary is one of the biggest players in their respective fields in the Southeast Asian region. Sea Limited is now worth about US$ 168.8 Bn in enterprise value in August 2021, up from just US$ 15.9 Bn last year.

Moreover, some unicorns / decacorns in Southeast Asia are going to be listed in the stock market either through SPACs or direct listing. We are going to see a wave of structural changes in the Southeast Asian equity market. Technology companies will take over the region’s stock market for the next decade.

Indonesia has kickstarted its technology season

As the biggest and one of the highest growing economies in Southeast Asia, many venture capitalists have invested in Indonesia’s tech companies and eyed the debut of its first technology company on the stock market.

In early August 2021, Indonesia had its first unicorn tech listing, Bukalapak. This e-commerce company was valued at US$ 7.5 Bn and raised US$ 1.5 Bn, setting a new record as the biggest IPO on the Indonesian stock exchange. With that valuation, the company ranked among the top 25 biggest companies by market capitalisation. As a side note, the previous listing record was held by Adaro Energy, one of the world’s biggest coal companies who listed in 2008 with US$ 3.8 Bn valuation.

The listing of Bukalapak, however, had sparked some controversies between investors as they were divided into two camps: tech vs. value investors. The value investors argued that the company has not yet recorded any profits but already offered at an extremely high valuation and some see it as a way for VC’s to exit their investment by selling to public investors as the “greater fool”. On the contrary, those who belong in the tech camp welcomed this IPO as the first pureplay tech company listing. Nevertheless, the stock was oversubscribed by 4 times, reflecting investors’ enthusiasm in the company.

We estimated that the Indonesian stock market exposure to pureplay technology (excluding telco) is only 5.08% of the total market capitalisation in August 2021. Even more extreme, there is no tech stocks included in LQ45 index that represent the most liquid stocks in the country.

This is very low compared to the weightings of MSCI APAC and S&P 500 who had 38.4% and 26.8% contribution to the index, respectively.

Considering the high allocation of venture capital investments in Indonesia startups and the currently low weighting of tech stocks in the JCI Index, the arrival of an Indonesian technology stocks era is inevitable.

The nascent stage of Southeast Asia technology investment can provide numerous opportunities for investors

With many Southeast Asian technology companies planning to be listed soon and its underweighting of the sector in their regional stock markets, investors who understand how the game will be unfold can enjoy a significant advantage.

Those who are interested could learn from the development of the more mature technology companies that got listed in the USA, China, and India.

Could the shift of Chinese tech investors’ portfolios be a life-changing opportunity? Only time will tell.

“We can be knowledgeable with other men’s knowledge,

but we cannot be wise with other men’s wisdom.”- Michel de Montaigne

Reference:

https://www.cento.vc/wp-content/uploads/2021/04/Cento-Ventures-SE-Asia-tech-investment-FY2020.pdf

https://heyokha-brothers.com/web-3-0-investment-series-another-gale-of-creative-destruction/

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The Chinese word for Crisis (危机, read: Wéi Jī) is the combination of the words “Danger” (危险, read: Wéi Xiǎn) and “Opportunity” (机会,read: Jī Huì) philosophically suggesting that there is always opportunity in every crisis.

 

The clampdown by the Chinese government and stricter compliance requirements by the US SEC has created a perfect storm for Chinese tech companies.

Hundreds of billions in market value vanished within months as a result. Kraneshares China CSI Internet ETF (KWEB.US) has fallen by 56% from its peak in February to 19 August 2021. Stock prices of big names like Alibaba (BABA.US), Tencent (700.HK), JD (JD.US), Pinduoduo (PDD.US), and the recently publicly listed Didi Chuxing (DIDI.US) have fallen by 40% to 50%. Even more extreme, names like Joyy Inc. (YY.US) and New Oriental Education (9901.HK) saw their stock prices fall by more than 70% from their highs.

Is this big sale justified or does it represent a bargain-hunting opportunity instead?

The Chinese government is exerting its role as a great equalizer

It is clear that the Chinese government possesses the ability to put their local tech companies on their knees. Their clampdown targeted companies in various tech-sectors, such as e-commerce, fintech, gaming, delivery platforms, and edutech. Given the massive consequences, we asked ourselves why this action is necessary in the first place.

The rise of today’s tech titans begun in the US in the 1980s. It was kickstarted by the development of personal computers and the internet. At first, the vision of tech companies was simple. They were addressing the pain points of society. Fast forward several decades later, digital businesses such as e-commerce, social media, digital media, ride-hailing, and XaaS businesses have reduced many frictions in our daily life.

Despite the benefits, tech entrepreneurship has reduced equality. As more capital became available to finance innovative ideas, competition got fiercer. Most tech entrepreneurs must play in a winner-takes-it-all game. The winner will obtain most of the market share with competitors lagging far behind. Winning in the game also means better access to resources like user data and capital that arrives in form of exceptional free cash flows or a generous valuation. Data and capital become the seeds and fruits for venturing into tech businesses.

It is important to note, these tech titans remained agile despite their size. Small businesses only have a slim chance to compete with them.

Considering the improvements that technology companies have brought to the economy, we think it is unlikely that the Chinese government aims to shut down its internet sector. Reflecting on the worsening inequality in the US that is partly driven by tech companies, it is sound for any government try to avoid that trajectory. History has shown that extreme inequality will hinder economic growth and develop social unrest.

From the perspective of building an ideal nation, these clampdowns actually serve a greater good by promoting equitable economic growth, preventing abusive monopolistic power, protecting consumers rights, providing data protection, and enhancing national security. We see these objectives to be similar with what the United States and European Union trying to achieve. However, the Chinese government acted faster because of their single-party system while other legislative institutions in the West were still debating on how they could regulate the tech sector for the last decade.

We should note that the lack of regulation had been facilitating the extraordinary growth of most tech companies. Exploiting user data, avoiding taxation (to some extent), and leveraging ecosystem exclusivity are some of the examples. These advantages will be taken away for Chinese tech stocks and their valuation has adjusted accordingly.

The new regulations on user data security and enforcement of fair trade (i.e- the crackdown) eliminates some of China tech companies’ growth hack tricks. As such, investor’s may justifiably reduce their expectations on the China technology companies’ growth prospects because of the new rule of the game. However, we are of the view that this crackdown is not the end of China tech stocks.

The new regulation could translate into a lower top-line growth rate but a healthier bottom-line and more productive economy. Case in point, imagine if the culture of attracting customers by ‘burning money’ ends. Without excessive marketing and subsidy, China tech companies will have to rely heavily on their product quality and efficiency as the source of customer acquisition. Should this circumstance occur, the incumbent players will now have a better chance to compete as they face the tech companies’ true pricing instead of a subsidised one. Thus, tech companies’ profit margin could be healthier and national productivity also could benefit from efficiency-and-innovation-driven competition.

Furthermore, completely shutting down technology companies is inherently counter-productive to what the Chinese government has tried to build. After achieving monumental poverty eradication and industrial revolution since the 1960s, this might be just the right time for the Chinese government to start closing the wealth gap. The Covid-19 pandemic recovery has been K-shaped. A huge chunk of brick-and-mortar and mom-and-pop businesses have been absorbed by e-commerce firms.

On the other hand, the government is promoting ‘new infrastructure’ sectors including semiconductors, renewable energy, and AI as indicated in the 100th anniversary of the Chinese Communist Party. It also has promoted health-tech companies in one of the government policies to improve healthcare quality in the country. This fact shows that the government is not anti-tech but intends to curb the side effects of the inequality it produces.

Investors can benefit from the repositioning of China tech investors’ portfolio instead of a mean reversion

We do not see the current big sale will turn into a classic mean reversion play because the rule of the game for China tech companies has changed. Instead, the Chinese crackdown has caused investors to reconsider their portfolio allocation. Some will remain invested, and some will leave the market entirely.

We believe that those who remain invested might shift their capital into technology names that truly improve the nation’s productivity such as technological infrastructure and deep technology names or the ones with regulatory-compliant business model. Through this rebalancing, they can reduce the regulatory risk in the future while leveraging the growth of China’s economy in the tech space.

Meanwhile, discouraged China tech investors might shift their portfolio allocation towards US tech companies or Southeast Asia tech companies that have a similar high-growth profile and less regulatory risk as they are still in the early days.

 

How lucrative Southeast Asian tech companies could be?

That will be our discussion for next week. Stay tuned!

 

“There is a bit of conspiracy, and of authoritarianism, in every democracy; and a bit of democracy in every dictatorship.” – George F. Kennan

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Some context: 

Lumber price went up 244.5% from USD 435.5/mbf January 1^st 2020 to all-time-high of USD 1500/mbf in April 2021.

 

 

If we merely rely on periodicity measures, a commodity supercycle is supposed to happen only once in several decades. As the latest supercycle only ended about seven years ago in 2014, a new supercycle should not happen anytime soon.

However, dare we say that this time it’s different? The mix of worldwide synchronisation of government infrastructure spending as a response to COVID-19, a weak USD, underinvestment in the commodity sector, industry consolidation, and extreme weather could result in the perfect cocktail for the next commodity supercycle.

Both the swiftness and magnitude of the recent commodity rally is unprecedented. Within just a few months, the price levels of many commodities have risen to all-time-high and multi-year-high levels after suffered to a multi-year low plunge. This price movement occurred within two years.

In our previous blog, we already discussed the reasons behind the weak USD and inflation scares in the U.S that blame commodity as one of the scapegoats.  Let us explore the other ingredients of the perfect cocktail:

Government spending synchronisation and green infrastructure construction across the world will translate into surging demand for base metals

In 2020, the COVID-19 pandemic has synchronised global government spending. According to Cassim et al. (2020), more than US$ 10 trillion, more than 11 per cent of global GDP, was spent last year to relieve the teetering global economy.

After the relief spending, the classic playbook of economic recovery would suggest increasing spending on infrastructure. This time around, we believe that the grand theme would be green and digital infrastructure as there have been escalating commitments  by governments to battle climate change and to accelerate digitalisation during the pandemic.

Investors should note that these initiatives are metal-intensive.

In our 3Q 2020 report, we discussed plans for large infrastructure spending (New-Deal-inspired policies) by governments to take on the “K-shaped” economic recovery. Historically, high infrastructure spending (measured by gross fixed capital formation) will translate into higher base metals prices as shown by the figures above.

In particular, we believe that base metals such as nickel and copper will benefit the most from digital and green infrastructure development because most of the upcoming projects will hover around electronics, electricity, and energy storage.

A decade of underinvestment in the mining industry could result in a potential supply crunch

The subdued commodity prices in the last decade reduced the appetite for investments in the mining and energy industries. Consequently, there will be a longer lead time from discoveries into production which would translate to lower replenishment of the depleting resources.

Furthermore, the rising ESG scrutiny in these sectors also makes it harder for the industry to obtain financing – which further decelerates the future supply growth.

This structural condition suggests that there would be insufficient supply to respond to the surging demand for mining and energy commodities. Such circumstance would drive prices up even further.

Oil great reset drives worldwide industry consolidation

Many oil companies got burnt in 2020, especially shale oil producers, because of the historical plunge of oil price that was triggered by the sudden global lockdown. WTI oil price went negative for the first time in history. It  forced them to cut production without any hesitation. It reversed the “growth at all cost” mindset to maximizing return on shareholders’ capital.

As oil prices plummeted to a historical negative level in 2020, the great reset of oil industry in 2020 has led to solid worldwide industry consolidation. Industry CAPEX tanked and production was cut significantly altogether. The consolidation enables tighter output control and leads to a more sustainable price increase.

As of February 28th, 2021, the OPEC is producing at 80% of 10Y-average production, 24.87 mn bpd, with a high compliance rate of 110% among OPEC10 members and showing reluctance to raise output amidst the recovering economy and travel ease. Until the recent OPEC meeting in June 2021, the solidarity among the cartel still persists.

Extreme weather conditions and supply chain disruption will also drive soft commodity price up

Despite the (pandemic) lockdown, the global average temperature is back to a record high in 2020. A study   by Zhao et al. (2017) shows that for each degree Celsius increase in global temperature, yields of corn are expected to decrease by 7.4%, wheat by 6%, rice by 3.2%, and soybean by 3.2%.

The robustness of the recent agriculture rally is reflected in the soaring commodity price in the harvest season. Case in point: Indonesia’s corn price in East Java on farmer’s level has increased 42.8% from approximately IDR 3,500 (USD 0.246) at the beginning of the year to IDR 5,000 (USD 0.352) per kilogram in early May 2021, a harvest season for corn. This kind of event is truly rare.

Investors should be aware of weather conditions as it might further boost agricultural commodity prices if it turns to be unfavourable.

Disrupted supply chain is the cherry on top of the perfect cocktail

The uncertainty on travel restrictions has disrupted the global supply chain. To-the-moon freight costs in three months period between December 2020 to February 2021 perfectly reflect the severity of the disruption.

For instance, the cost of shipping a 40-foot container from Asia to Europe rose about 2.5 times from approximately USD 2,200 to over USD 7,900. From the global perspective, the Freightos Baltic Index, represent container-freight rates in 12 primary maritime lanes, has increased about 80 percent from USD 2,200 to USD 4,000 per container.

The uncertainty in the global supply chain has incentivised some producers to hoard feedstocks. Such behaviour is driven by their interest to secure their production continuity that is currently responding to the pent-up demand.

Furthermore, the disruption also meant a higher cost of production for everyone in the value chain. Consequently, every producer, including the commodity producer, is reluctant to sell cheap.

It is a cherry on top of the cocktail.

This perfect cocktail may either taste sweet or bitter

The pent-up demand from economic reopening and robust additional demand from the expansive economic policies will be responded unevenly from the supply side. Both demand and supply forces are driving prices up. As such, we are of the view that the stars are aligned to form a commodity supercycle.

Regardless of the commodity rally being a supercycle or transitory (might be one year, two years, five years- it’s too late to act by then), the cocktail will taste differently for everyone.

Commodity producing companies would certainly re-experience their glory days meanwhile companies who are unable to pass on their increasing production costs will see their profit margins fade. As the majority of costs rise, a period of sustained inflation would also become inevitable.

With rising inflation, a commodity supercycle, and the shift to value stocks becoming the investment backdrop for the upcoming years, could there be a certain region that benefits from all the forces?

Stay tuned to our next blog!

 

“The test of a first-rate intelligence is the ability to hold two opposite ideas in the mind at the same time, and still retain the ability to function”

-F. Scott Fitzgerald –

 

 

Reference:

Cassim, Z., Handjiski, B., Schubert, J., & Zouaoui, Y. (2020). The $10 trillion rescue: How governments can deliver impact. McKinsey & Company.

Chuang Zhao, et al. (2017). Temperature increase reduces global yields of major crops in four independent estimates. Proceedings of the National Academy of Sciences of the United States of America Vol. 114 no. 35, 9326-9331.

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For the last fifteen years, value stocks have been underperforming growth stocks. As such, many investors think that either value investing is dead or reversion to the mean is imminent.

With the brewing inflation as the catalyst, we are of the view that second scenario is more likely. We are of the view that the return of the glory days of value investing are near and its outperformance will begin with the closing of the unprecedented relative valuation gap between growth and value stocks.

Growth stocks have outperformed value stocks over the last fifteen years

Value investing had worked well in the past, such as in the post-dot-com bubble era. However, for more than adecade, value has underperformed growth and the valuation gap has been widening instead of narrowing.

As of February 2021, value stocks valuation multiple gaps relative to growth stocks is nearly as high as during the dot-com bubble. MSCI Growth Index P/B multiple is at 240% premium to value P/B multiple. This is compared to around 60% premium a decade ago.

The rising inflation expectations and yields could be the potential catalyst for a reversal in growth-value performance

During the high CPI inflation era in the U.S in the 1970s, with CPI registered at around 7.25% per annum, value stocks significantly outperformed growth stocks by 9 percentage points per annum. Value stocks had earned 6.6%, meanwhile, growth stocks had lost 2.4% annually in real terms (i.e adjusted for inflation rate). Compounded annually, it translated to a 136% cumulative real return difference for the decade. How could such outperformance be explained?

In the previous blog, we have discussed the brewing inflation and its driving factors as US April 2021 CPI inflation hit 4.2% YoY. Inflation causes real asset value to decline. As a result, investors will demand a higher yield on their investment to compensate for this. Hence, the (expectations of a) rising inflation rate will create an upward pressure on interest rates.

The inflationary force and rising interest rates explain how value stocks could outperform growth stocks:

A bird in the hand worth two in the bush – The rise of nominal interest rates hurts high-multiple growth stocks more than value stocks. It reduces the present value of projected future cash flows. The more distant the cash flow is, the more severe the impacts will be. This means that growth stocks, which have a higher cashflow duration than value stocks, will experience stronger downward pressure on valuations as result of rising interest rates.

 

 

Being asset-heavy comes in handy given the operating leverage impact – Value stocks tend to be more asset-heavy. As such, during a period of high inflation, their cost structure is less volatile. A big component of their cost is fixed, so less sensitive to inflation. This trait is the opposite of growth stocks.

 

 

Investors should consider adding value stocks DNA to their portfolio

Inflation is the kryptonite for growth stocks. Therefore, investors should consider owning value stocks. The brewing inflation favours the out-of-favour value stocks in general.

In the context of today’s inflationary environment, value-commodity stocks would be on the top of the list. Inflation enhances their earning power and they are currently trading at low multiples of book value. Furthermore, some forces drive commodity prices to sustain at higher prices or to push them even higher.

What forces would that be? Stay tuned to our blog.

“Be still like a mountain and flow like a great river“

-Lao Tzu-

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