TIP 504: Opportunities in Energy, Metals and Mines w/ Will Thomson

Probabilistic thinking is essential while investing in sectors like mining, heavy industries, and energy, where commodity price is unpredictable. Will Thomson, the founder of Massif Capital, suggests waiting scenarios to assess the probability of success and failure of the management team, and fluctuations in commodity price. Developing a perfect value NPV equation takes into account the entire plan given by the management team for the next 10-20 years, but executing that plan depends on many external and internal factors. Therefore, investing in such sectors requires a robust understanding of risk assessment, including political risks, and the ability to think probabilistically, which is essential in making sound investment decisions.

When applying the DCF structure, create scenarios to capture a spread of possibilities instead of pinpointing a single point. Use subjective probability to capture the entirety of the potential outcome and force to think in terms of odds and probabilities. Running a DCF at each price point and summing probability weighted values up to a final value is the best approach. Apply scenarios creatively to incorporate political risk, management success rate, and budget. This approach is ideal for commodity producers and project-based companies. Build an outlook that takes all possible futures into account and use subjective probability built from your mosaic of information. Apply probability after calculating free cash flow forecast to capture complete potential outcome.

When evaluating investment opportunities, it's important to use multiple approaches and triangulate the results to get a clearer understanding of the potential returns. One such approach is to use a DCF model, but it's important to apply weightings to different scenarios to account for subjectivity and uncertainty. It's also important to be clear about the questions being asked and what's baked into the answers. While different approaches may yield different answers, they can all be backed up into alternate methods. Additionally, setting a margin of safety, especially when there are doubts about management claims, can further mitigate risks. Overall, a successful investment strategy is a combination of different approaches and careful evaluation of each investment opportunity.

While explicit and intricate modeling may give better precision in investment decisions, it may not add significant value once the strike zone is identified. A hard, messy DCF can be simplified for practicality, but triangulation through multiple approaches is important. It's better to be directionally right than precisely wrong, and portfolio construction should be done with careful consideration of position sizing, volatility, and desired returns. Understanding one's conviction in positions is crucial for sizing positions correctly. The pursuit of a perfect portfolio involves setting boundaries around position sizing based on time, research capacity, and risk tolerance, with the aim of delivering a NETA fees return of 12%.

The perfect portfolio concept helps to establish the ideal position size and benchmark individual positions against it. This approach helps to reduce volatility and make better investment decisions. For junior miners, focus on those about to turn on a mine in the next 2-5 years. Avoid commodity producers to reduce reliance on commodity price forecasts. In industrials, look for contracted cash flows, niche products, and moats. Energy is more volatile, making it necessary to reduce operational risk. Mass Capital invests in materials, energy, and industrials as they exist on their own individual value chains within the real asset ecosystem. Cyclical stocks are held for 3-5 years.

Investors in real assets like oil and mining tend to look for investments to mature in three to five years and get in and get out. The concept of holding something forever and buying and holding forever might not play out that way. At some point, competitive advantages will fade and companies will revert to doing what everybody else in the industry does. Investors have different constraints and incentives that impel them to do different things, so it's important to understand these differences. Most investors are always a minority, not a strategic investor, and everyone is trading prices on different timelines.

The return from owning a stock comes from dividends or capital appreciation, which is driven by fundamental value and macroeconomic issues. Mispricing may occur due to factors such as market structure and passive buying. Understanding the reason for mispricing and how it will close is crucial for realizing a return in the stock. Uranium is a good example of the importance of assessing fundamental value and understanding the industry before investing. Juniors in the uranium industry may have theoretical value, but may not monetize assets until uranium prices have crossed a certain threshold.

Investing in junior firms in the uranium market is a risky bet, as it relies heavily on the uncertain movement of uranium prices. Instead, investing in a company like Kazatomprom, with a strong discounted cash flow and healthy dividends, can be a better option. The market is highly opaque, and experts on secondary markets and contracting cycles for utilities can attest to this. While there is potential for a strong move in uranium prices, it is hard to predict when this will happen, as the market doesn't clear and there is a lot of supply sitting on the sidelines. With a new appreciation for nuclear power, increasing demand for uranium could lead to an increase in supply, but this alone is not enough of a thesis to rely on.

The uranium market has been experiencing the same supply-demand imbalance for the last 10 years, and although growth in demand may lead to price movement, timing is uncertain. Investing in uranium companies can be challenging as it is difficult to predict how high the uranium prices will go, and how long it will take for them to rise. Moreover, dealing with derivatives of uranium adds to the complexity of the investment decision. In contrast to the challenges faced by the uranium industry, the sustainable energy industry presents environmental and economic complexities in terms of getting all the necessary inputs, such as copper and poly silicone, for wind, solar, and EVs. A significant challenge for sustainable energy is the careful sequencing of the phase-out of hydrocarbon powers, as power supply and demand always need to be precisely balanced.

Investments in mining and energy assets are crucial to address the challenges of renewable energy production, but these investments take time to yield results. The valuations of OEMs and renewable operators may not justify the enthusiasm surrounding them and require a long-term investment horizon. Oil and natural gas assets face supply and demand imbalances, and pricing at current levels assumes a perfect scenario that may not pan out. Copper assets and other battery materials also require long-term planning due to long lead times to start production, making early investment necessary. While renewable energy has its place, it is essential to keep in mind the timeline for these investments and their potential challenges.

The demand for batteries is increasing but the negative environment impact of mining for metals used in the batteries can't be mitigated. Different chemistries require different metals to be mined. Processing the metal and the material is where the negative environmental impact comes from, so mining firms are developing alternative processing methodologies. While there's no shortage of lithium, there's a shortage of operating mines and turning on a lithium asset requires five to ten years. The value chain of mining it is not where it ends, but instead, it's in the processing step. Shifting around the value chain is critical to investing in the right metal spots depending on the cycle.

Valuing mining companies can be relatively straightforward from a technical perspective because they are all project-based, and their plans must be published in a document called a 43,101. However, on the qualitative side, important variables to consider include permitting and funding risk, geographical exposure, operational diversification, liquidity risk, and whether the company is a producer or developer. Geology is important but doesn't need to be the be-all and end-all variable, and assessing the accuracy of project validation is essential. Overall, mining companies can be easier to approach due to the heavy-lifting done by management in their plans, but qualitative analysis is essential to assess their viability and execution. Operational diversification can help reduce political risk, which is an essential consideration.

Investing in mining firms is similar to investing in biotech firms - there's a sweet spot where the de-risking and trading down occurs, and that's where investors want to be. It's more about finding the right companies than predicting the commodity price. Niche metals like tin have few businesses, making it easier to understand the entire universe. Starting to invest when interesting things happen in the commodity price helps finding the right company. Understanding mining companies by going to the mines is valuable, but not always necessary. However, when investors do go to the mines, they learn something that's critical and informs the mosaic of their understanding. Critical aspects that investors should consider include the viability process and security of the mines.

In emerging and developing markets, it is critical to visit the asset and spend a lot of time with management. This provides value-added components as mining is much about betting jockeys. It is an investment worth the additional cost of research to call up these mining firms and join their trips. Junior mining investors should focus on the management team and spend time chatting about their family life and also discussing the business. Additionally, not all prestigious clubs guarantee the best stock picks, as not all incentives are aligned. Investors should think independently about a company before investing and also look into the management, operational strategies, and financial position of the business.

Polaris Infrastructure, with a new name Piff and ticker symbol P-I-F, is a company that operates renewable assets in South America and runs run of river hydro, solar, and wind projects. The assets are already operating, funded, permitted, and have signed off takes, which makes it a low-risk investment. The geography of South America is ideal for small communities with 10-100k people, as building a hub and spoke electrical system is challenging because of the separated terrains. Although there is political risk because it is in Nicaragua and exposes in the Dominican Republic and Ecuador, the management team is building it for the long term and is a great platform to continue adding to it. They also reassess their timeline every year, and some investments they end up holding for a long time.