Trends Watch: Natural Resources

EisnerAmper’s Trends Watch is a weekly entry to our Alternative Investments Intelligence blog, featuring the views and insights of executives from alternative investment firms. If you’re interested in being featured, please contact Elana Margulies-Snyderman.  

This week, Elana talks with Matt Geiger, Managing Partner, MJG Capital Fund, LP.

What is your outlook for investing in natural resources?

It’s no secret that the commodity market has been on a tear since the early days of COVID-19 in February and March of last year. But even considering this strong run of performance, natural resource equities and commodity prices generally have only been this inexpensive relative to U.S. equities on a couple of occasions going back to the 1920s. For those with longer-term time horizons, the outlook for this niche of the market remains excellent.

That said, there is reason to be cautious in the near term. Historically high valuations for most other asset classes, the return of retail investors en masse, the SPAC craze and rampant cryptocurrency speculation are all distinct signs of euphoria that point to a broader market correction sooner rather than later. And whenever the next major risk-off episode occurs, the commodity complex will be hit hard—as is always the case in market panics. Those unprepared to withstand significant volatility will end up selling at just the wrong time.

Where do you see the greatest opportunities and why?

There are a couple interesting opportunities developing within the mining space. To start, we are on the cusp of the first mineral exploration bull market in more than two decades. Since the turn of the century, major mining companies have largely given up on finding new mineral deposits—slashing or eliminating entirely their exploration budgets. Instead, these companies have relied on lowering cut-off grades at existing operations and advancing later-stage development assets to replenish their reserves. The task of discovering new mineral deposits has been left to the junior mining industry which, for a variety of reasons, has led to a dearth of discoveries in recent decades. However, the major mining companies can no longer afford to defer exploration spending; increasingly, these groups recognize that they will not be able to offset depletion in the years ahead without significant new discoveries. It’s reasonable to expect a marked increase in strategic partnerships, joint ventures, option agreements and M&A activity between major miners and their smaller counterparts in the years ahead. This shift in mentality should be to the benefit of well-managed prospect generators and junior explorers.

The second opportunity lies with companies deploying the royalty business model outside of precious metals. The royalty business model has disrupted the precious metals industry since the early 2000s, while rewarding investors due to the diversification, high margins, scalability, limited operating risk and exploration optionality inherent in the model. Over this period, the combined market capitalization of precious metal royalty companies has gone from less than $1 billion to north of $60 billion at present. With these figures in mind, it’s noteworthy that the combined valuation of royalty companies focused on metals outside of gold and silver—including the metals necessary for the world’s continued decarbonization like copper, nickel, uranium and lithium—is less than $5 billion. Given the resounding success of this business model when applied to precious metals, it’s likely that investors will increasingly warm to royalty vehicles focused on other key metals and minerals in the coming years.

What are the greatest challenges you face?

Psychologically preparing MJG investors for the extreme volatility associated with natural resource investing. There’s no getting around it—even the most powerful multi-year commodity bull markets are inevitably interrupted by one or two significant drawdowns along the way. For those who haven’t experienced volatility of this nature, it is all too easy to pull one’s money out at just the wrong time. This explains the ten-year lock-up requirement for all MJG Limited Partners, as it self-selects for patient capital and sets a more reasonable expectation on the timeframe needed to succeed in this niche of the market.

What keeps you up at night?

The specter of a broad market correction of similar size and scope such as with COVID-19 last year. Over the past 40 years, investors have become accustomed to years of strong financial asset returns punctuated every decade or so by a significant drawdown. Many active in the market today believe this process is set to repeat itself, with another five or ten years to go before the next major blowup. But the speed and strength of this V-shaped recovery off the 2020 lows—coupled with the plainly evident speculative behavior previously mentioned—suggest that the next major drawdown will occur sooner than most anticipate. Balancing this risk with the positive outlook for natural resources longer-term is a challenge, particularly when it comes to determining the appropriate cash weighting for this market environment.

The views and opinions expressed above are of the interviewee only, and do not/are not intended to reflect the views of EisnerAmper LLP.