The synergy of temperament and intellect has fostered much success for the father-son team of Michael Berry, editor of Morning Notes, and Chris Berry, founder of House Mountain Partners LLC. In this Father's Day interview with The Energy Report, the Berrys reveal what they've learned from each other's investment strategies over the years, and mull energy metals and emerging green technologies that could be "compelling investment opportunities." They also reveal that, for all the familial camaraderie, there are energy issues about which they strongly disagree.
The Energy Report: Mike and Chris, it's always a pleasure to talk with you. Thank you for joining us for this Father's Day edition of The Energy Report. I want to start with that theme. Chris, what's the single most useful thing your father has taught you about investing?
Chris Berry: That's a difficult question to answer because so many things come to mind. I've been privileged to have learned about investing by following my father's career as a professor at a top-tier business school and then as a portfolio manager for a mid-market cap value fund. I have been able to see both the "theoretical" and "practical" sides of investment analysis. The opportunity to hone my analytical skills through these two differing viewpoints has been invaluable.
I think the most valuable lesson I have learned thus far is in the approach to evaluating markets and publicly traded companies. There is no substitute for intellectual rigor and intellectual honesty. The ability to recognize and eliminate biases is crucial. Emotion is definitely your enemy in this business. It's also vital to have a solid vetting process and to stick to it regardless of the volatility in the macro environment.
TER: Mike, today Chris is a standout analyst doing terrific diligence on his coverage, and I know that makes you proud. What has Chris taught you about investing?
Michael Berry: Chris is always on top of the issues. He has helped me develop and refine the 10-point grid we use in our Discovery Investing discipline. Chris gets down to the fine points and assesses each problem in very granular detail. In this respect we complement each other quite well. What I have also learned from Chris is that he has a very sharp memory and can keep several companies—say in the graphite or rare earth space—in close analysis. He is really good at differentiating the "wheat from the chaff," and this just seemed to come naturally to him.
Chris also is very good at assessing detail, listening carefully and dissecting companies when he is in the field. I am always surprised by the next step he takes in his analytical career. It's been a lot of fun working together. It is evident that Chris loves what he does and is good with people. I am learning from him!
TER: Chris, you just spoke at the Cambridge House Resource Investment Conference in Vancouver. Your focus seemed to be deflation. You presented a barrage of 10-year bond charts that showed consistent declining yields over the last two decades. What was your point? What will be the effect of this deflationary environment?
CB: A large part of the research I do is focused on the macro economy and where we are cyclically in the market. In the wake of the financial crisis and the central banks' response to it, there has been a great deal of ink spilled surrounding the debate over the aftereffects of policies such as quantitative easing—specifically the implications for inflation or deflation in the economy.
While I think the U.S. economy is headed for inflation at some point in the future, based on expansion of the Federal Reserve's balance sheet, I do not see enough evidence to lead me to believe that an inflationary episode is imminent. In fact, when I look at a broad array of data, I think deflation is the more pressing issue. Government bond yields are at historically low levels, inflation is "in check" (I know this can be manipulated), unemployment is at a structurally and historically high level, and various metrics like gross domestic product, industrial production and capacity utilization are all operating at levels below the historical trend. In my Cambridge House presentation, I said that the global economy is "treading water." There is growth out there, but it is mostly sluggish—and in the case of the Eurozone, contracting.
This paints an ominous picture for many commodities in the near term. Slowing demand in countries like China, which has been the engine of the commodity supercycle, has put the prices of any number of commodities under pressure since mid-2011, when the commodity complex began its downward trend. With substantial slack in aggregate demand, it's deflation that is the worry, and not inflation.
TER: Chris, you seem to lament the lack of investment in green energy. Is it your contention that we will not turn to alternative sources until there is a price crisis (oil at $250-300/barrel) or a climate crisis?
CB: I wouldn't say I "lament the lack of investment," as billions of dollars are being spent in research institutes, university laboratories and in the private sector globally on advancing green or sustainable technologies. I think it is unfortunate that people view a few poor investments in the space as a proxy for the success or failure rate of the entire burgeoning industry. It is undeniable the companies like A123 Systems LLC (manufacturer of lithium-ion batteries), Fisker Automotive Inc. (manufacturer of premium hybrid electric vehicles), and Solyndra LLC (maker of solar products) have proven to be taxpayer-funded disappointments.
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However, are we really going to assume that all greentech research efforts are failures based on the results from these three? That is a very naïve and narrow-minded approach.
With population increasing globally, becoming more interconnected, and set to live a more commodity-intensive lifestyle, sustainability and efficiency in our progress as a society will be of paramount importance. I just do not believe that you can have as much intellectual capital and financial capital all working toward next-generation technologies and not have breakthroughs that provide compelling investment opportunities and also leave our children a lasting legacy.
An example of a recent success is Tesla Motors Inc. (TSLA:NASDAQ). This company was actually initially funded by private money. The company has just paid back a U.S. Department of Energy loan—nine years early, at a $20 million ($20M) profit to tax payers. This is not a failure. This is a success. It remains to be seen how Tesla performs going forward, but I view the company as a proxy for the commercial viability of next-generation technologies. I recently test-drove a Model S and I am more convinced than ever that vehicle electrification has a place in society, however small it may currently be.
TER: Mike and Chris, you have both addressed this question outside this forum: What is concealing the investment potential of energy metals? What are the factors obscuring demand for these vital elements—scandium, cobalt, tungsten and lithium? What are the drivers?
CB: I have already mentioned two—deflationary headwinds and the credibility problem with green technology. Obviously the challenging financing environment for junior mining companies is another huge issue. A final issue is the perceived "death" of the commodity supercycle. The good news is that I view each of these issues as temporary, which should give investors the opportunity to look for undervalued companies that can demonstrate financial sustainability and execute their business plans.
The real driver is that the commodity supercycle is not dead. I do think that it is changing, however—becoming somewhat less infrastructure-focused and more consumer-focused. But by no means has the emerging world stopped yearning for a higher quality of life. Furthering that idea, we here in the developed world haven't given up trying to improve our lives either. As the consumer in the West deleverages his or her personal balance sheet, and countries like China shift development models from one that is export-led to one that is driven by internal demand, there will be renewed focus on many of the energy metals we are following.
MB: These metals, in my view, are very research intensive. They are also, in general, quite small markets, which tends to obscure them. Many companies just don't want to get involved in small markets. The graphite market, for example, is totally different from the copper market on many dimensions. Yet when graphite became the discovery play of the day, dozens of companies "became" graphite companies. The market in graphite simply cannot sustain the attention.
Many of these energy metals must belong to a "supply chain." It is not enough anymore to say you have a resource with a certain grade, you must show how the metal impacts the energy system. It is a fact that China controls the supply chains for many of these metals. There is more to energy metals than exploration and development. . .much more.
TER: Chris, what companies fit into this growth story?
CB: I'm focusing on just a few energy metals right now: uranium, scandium and cobalt. I like scandium, as it is one of those metals for which China doesn't dominate production. Global production, such that it exists, is miniscule and there are a number of future uses—specifically solid oxide fuel cells—that could absolutely take off if a reliable and secure supply of scandium could be found. I have been watching EMC Metals Corp. (EMC:TSX) and Metallica Minerals Ltd. (MLM:ASX)in particular, as they are among the most advanced scandium exploration plays. The lack of scandium availability is a great example of industry being held back by a lack of secure supply. Let's also not forget the potential military applications.
TER: Mike, you have been making a bullish case for energy based on the phenomenon of urbanization. Can you talk about that?
MB: Yes. I just finished presenting at a biotech symposium in Hong Kong. Even there, the participants speak of the healthcare tsunami we are now in. Urbanization is proceeding everywhere. According to Bloomberg, China must spend $8.1 trillion on urbanization in the next three decades. About 60% of her massive population will urbanize and live in cities not yet built, and they willconsume.
A vast new middle class is emerging. Just take a trip to Hong Kong and you will see it. These new city dwellers must have better nutrition and cheaper energy. The food chain is tied to energy, so energy metals and the advancement of cheaper energy modalities will be key.
With 440 new cities to be built in "Emergica" (a term we coined to represent the cities identified in a McKinsey Global Institute report), the commodity supercycle has barely even begun. But the new energy metals boom, in particular, will be fostered and catalyzed by research and development (R&D) and supply chain development; quite a different world from what we have seen in previous industrializations in history.
But get ready, because the new consumer in Emergica is evolving and will demand a higher quality of life. They will be meat eaters. Energy metals, water, arable land and fertilizers will all be part of that onslaught. This why we believe so fervently in Discovery Investing as a critical platform.
TER: Mike, you have been talking to investors about the impact of urbanization on commodity prices. I take it you believe natural gas and oil are about to turn upward? Kindly explain your thesis and, if possible, tell me when we could expect the upturn?
MB: I am not sure about prices turning upward. But a transformative technology has revolutionized the supply-demand equation for oil and gas, particularly in favor of U.S. domestic production. Canada is likely to be hurt most by this "fracking" revolution.
Domestic natural gas and oil production is the one really bright spot in the U.S. economy today. The Eagle Ford shale in Texas will produce 3 to 5 million barrels of oil per day within a very few years. Domestic supplies will turn upward, no doubt. I may disagree with Chris here, but I think that transformative technology like fracking is the death knell for domestic nuclear power. Gas for combined-cycle gas turbine power plants is cheaper, cleaner and much less risky for the environment. Much will come from this oil and gas domestic revolution.
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TER: Mike, Chris tweeted out a June 1 column in Project Syndicate written by New York University economist Nouriel Roubini entitled "After the Gold Rush." Roubini listed and commented on several factors favoring a bearish scenario for gold. To be fair, he did say that all investors should have a "very modest" exposure to gold as a hedge against extreme tail risks. But the gold rush is over, he said. What is your impression of Roubini's thesis? Chris, do you and your father agree?
CB: With more evidence pointing toward deflation as opposed to inflation, I can see gold trading sideways until these dynamics change. That said, if you're a believer in inflation getting out of control, perhaps sooner than many think, this is an ideal time to acquire both gold and silver bullion, as well as select junior mining equities involved in precious metal exploration.
MB: Roubini is wrong. Gold has stood the test of millennia. Since we discarded it in 1971, our economy has loaded up with debt and is now sick. I am not suggesting a gold standard or even a currency backed by gold, simply that gold will always hold its value in deflations (which I believe we are in now) and inflations (which is where we are likely going). I want gold in my portfolio under these circumstances.
TER: I'd like to ask about uranium. Its fate rests solidly on the nuclear power industry, which seems to be out of favor. I'll ask you both, what is your case for uranium? What companies are interesting?
CB: I see uranium as the one contrarian opportunity among energy metals. The spot price of uranium has been hammered, excess supply has been dumped on the market and nuclear power is experiencing a crisis of confidence in the mainstream media in the wake of Fukushima.
That said, there are a number of reasons to be optimistic about nuclear power going forward and, by extension, demand for uranium. We are all aware of the fundamental reasons for this thesis, including the looming end of the Megatons to Megawatts Program, reactors in Japan coming back online over the next few years and the build-out of nuclear reactors in the emerging world.
In addition, we can't forget that the nuclear power infrastructure in place today would be extraordinarily expensive to dismantle, and that process could last for years. I have seen estimates of anywhere from $500M to $1 billion to shut down and decommission a nuclear reactor. Who pays for this? Additionally, what will fill in for the base load power that a given nuclear reactor was generating? Wind and solar, with their intermittency challenges? What about the cost to build out a new infrastructure and integrate it into the existing electricity grid? Will governments pay for this? Utilities? Tax payers? The path of least resistance is to relicense existing reactors as a more cost-effective strategy for all involved.
Additionally, though this is debatable, the energy return on investment (EROI) is much more advantageous with nuclear than with most other forms of power generation. EROI essentially tells us what we "get" in energy returned for what we "put in" in investment. If economics come into question, nuclear power is, and will likely remain, a very compelling option despite some of the challenges that the industry faces.
Given this backdrop, we have seen a number of deals completed. Most recently, Energy Fuels Inc. (EFR:TSX) signed a letter of intent to acquire Strathmore Minerals Corp. (STM:TSX; STHJF:OTCQX). I have followed Strathmore Minerals Corp. for some time and always thought that the location of its deposits, plus the relationships it has with Sumitomo Corp. and Korea Electric Power Corp. (KEPCO) would make the company an ideal take-out candidate. Congratulations are in order for the Strathmore management team on its accomplishments.
Another company I am following and own shares in is Uranerz Energy Corp. (URZ:TSX; URZ:NYSE.MKT). This company is a near-term uranium producer in Wyoming, and is particularly attractive due the fact that it is essentially derisked. Uranerz is exceptionally well managed and could be generating cash flow within a year. The company is fully permitted, has offtake agreements in place and should be receiving a $20M loan from the Wyoming Industrial Development Revenue Bond Program. The tolling agreement in place with Cameco Corp. (CCO:TSX; CCJ:NYSE) is another positive attribute for Uranerz. Given that the Russians (JSC Atomredmetzoloto or ARMZ) have taken Uranium One Inc. private, Cameco may look to consolidate the Powder River Basin in Wyoming and integrate Uranerz into its operations there.
Finally, European Uranium Resources Ltd. (EUU:TSX.V; TGP:FSE; EUUNF:OTCQX), another company I own shares in, continues to develop the Kuriskova deposit in Slovakia. This is a high-grade resource and its European location is ideal given the number of reactors in Europe and the fact that there is only one operating uranium mine in Europe. AREVA is a shareholder of the company, which is something we want to see—majors with "skin in the game."
MB: No! I am against uranium-powered reactors. Uranium produces plutonium, which is toxic for thousands of years. It cannot be stored reliably. The Canadians had the correct idea with their CANDU reactor, in which the water is enriched and not the uranium. Uranium-powered reactor technology is old and dangerous. We must move to thorium technology in the next few decades if we plan to stay with nuclear energy as a prime source of power. There are more Fukushimas coming!
TER: Thank you, Mike and Chris.
CB: My pleasure.
MB: Thank you.
From 1982–1990, Michael Berry served as a professor of investments at the Colgate Darden Graduate School of Business Administration at the University of Virginia, during which time he published his book, "Managing Investments: A Case Approach." He has managed small- and mid-cap value portfolios for Heartland Advisors and Kemper Scudder. His publication, Morning Notes, analyzes emerging geopolitical, technological and economic trends. He travels the world with his son, Chris, looking for discovery opportunities for his readers.
Chris Berry, with a lifelong interest in geopolitics and the financial issues that emerge from these relationships, founded House Mountain Partners in 2010. The firm focuses on the evolving geopolitical relationship between emerging and developed economies, the commodity space and junior mining and resource stocks positioned to benefit from this phenomenon. Chris holds a master's degree in business administration (finance) with an international focus from Fordham University, and a bachelor's degree in international studies from the Virginia Military Institute.
By. George S. Mack of the Energy Report