INVESTING IN SENSE
NICHOLAS HOPS: Don’t invest on headlines
Making emotional decisions based on headlines is a dangerous road; investing where sentiment is most positive carries a big risk of capital loss
It is perilously easy for investors to get caught up in sentiment and buy into "story stocks". Not wanting to miss out on the next big thing, the market often drives up the price of favourably positioned assets far beyond their intrinsic value, and pushes the perceived losers far below theirs.
At this time, the disconnect between price and value can be extreme. When headlines scream "buy" or "sell" regardless of price, only detailed analysis can give you the confidence to take an alternative view. Take these case studies:
For at least a decade, paper investments have been written off, as many expected a relentless and brutal decline in demand.
Despite this bleak outlook, Mondi has grown earnings before interest and taxes from its uncoated fine paper division almost threefold since 2007. This surprising outcome is due to a combination of constrained supply (a consequence of underinvestment) and demand proving to be more resilient than most expected.
The BEV process will be evolutionary rather than revolutionary. It will likely take decades
Mondi’s low-cost assets and excellent management have thrived through more than a decade of falling demand. This shows the danger of obsessing over one variable, and ignoring the interaction between supply and demand, which is fundamental to the price discovery process.
Thermal coal is another commodity where many thought demand would fall as renewable energy took market share.
What this view failed to consider is the intersection between supply and demand. Although thermal coal demand will fall over time, it is likely to remain more resilient than many think. Underinvestment in supply has led to constrained supply and probably still will do so. This has led to supply deficits and price increases (more than 140% from trough to peak). We expect constrained supply to continue.
When Dieselgate, the Volkswagen emissions scandal, broke in 2015, it coincided with the rise of Tesla as a carmaker, and battery electric vehicles (BEVs) as an alternative drivetrain.
Tesla’s share price has risen sevenfold in the past seven years, and its market capitalisation is comparable to traditional carmakers such as General Motors (GM) and Ford, even though Tesla has struggled to turn a profit and produces only 3% of the vehicles that GM produces. Headlines about "the death of the internal combustion engine" were everywhere.
Within six months of Dieselgate, the price of lithium, a key component of BEVs, more than tripled. Cobalt, another key component, followed a similar trajectory in the next 2 ½ years.
Yet when cobalt and lithium hit their peaks in March 2018, the platinum group metals (PGMs) basket price was trading well below marginal cost. Up to half of the SA PGM industry was burning cash.
Fast-forward 12 months and the rand PGM basket is up 43%, close to lifetime highs, while lithium and cobalt prices are down 56% and 68% respectively. We are believers in BEV technology, but the process will be evolutionary rather than revolutionary.
It will likely take decades, and we think demand for PGMs will be more resilient than most expect. Hybrid vehicles with similar, or higher, PGM content than standard cars will bridge the gap.
Though prices may appear elevated, with the rand PGM basket up 45% off 2018 lows, we estimate they are only now close to incentive prices, enabling PGM miners to earn no more than a fair return on capital.
This is in sharp contrast to lithium and cobalt, which last year hit multiples of their incentive prices.
Yet at peak negativity in the PGM sector last year, Impala Platinum’s market cap was R11.7bn — down 94% from its high.
The bottom line is that investing where sentiment is extremely positive and prices are high is dangerous, and often carries the risk of a permanent loss of capital.
• Hops is an equity analyst at Coronation