Episode 53: Robert Mullin – Upstream Downstream

In this episode, I talk with Robert Mullin from Marathon Resource Advisors.  Robert is a finance professional with 25+ years of experience managing natural resource investment portfolios for individuals, family offices and institutions. 

We talk about:

  • State of commodity producers
  • Tangential investing ideas
  • Problems in Europe
  • Yield farming and more! 


This podcast was recorded at the stunning Edgewood Resort, situated by the serene Lake Tahoe, where a wonderful private event was organized by Collective.

Collective is a curated community investors and entrepreneurs eager for in-person experiences, authentic connections, and idea sharing. 

I hope you enjoyed this conversation with Robert as much as I did!

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Have comments about the show, or ideas for things you’d like Taylor and Jason to discuss in future episodes? We’d love to hear from you at info@mutinyfund.com.

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Transcript Episode 53:

Taylor Pearson:

Hello and welcome. This is the Mutiny Investing Podcast. This podcast features long form conversations on topics relating to investing, markets, risk, volatility, and complex systems.

Disclaimer:

This podcast is provided for informational purposes only and should not be relied upon as legal, business, investment, or tax advice. All opinions expressed by podcast participants are solely their own opinions and do not necessarily reflect the opinions of Mutiny Fund, their affiliates or companies featured.

Due to industry regulations, participants of this podcast are instructed to not make specific trade recommendations, nor reference past or potential profits. Listeners are reminded that managed features, commodity trading, Forex trading, and other alternative investments are complex and carry a risk of substantial losses. As such, they’re not suitable for all investors and you should not rely on any of the information as a substitute for the exercise of your own skill and judgment in making a decision on the appropriateness of such investments. Visit mutinyfund.com/disclaimer for more information.

Jason Buck:

So here we are, beautiful Lake Tahoe at the Edgewood Resort, at a wonderful private event put on by the collective. I think this is maybe my first time recording an outdoor podcast. How about you?

Robert Mullin:

Definitely a first for me.

Jason Buck:

Well, I think the first is quite an eventful first. I don’t think we’re ever going to do anything better than this.

Robert Mullin:

No, it’s a pretty high bar.

Jason Buck:

So we’re both Northern Californians, so we’re able to drive up here. So both of us have been here many times. And when I look behind us, obviously it’s the grand natural resources of California.

Robert Mullin:

Yeah.

Jason Buck:

Right.

Robert Mullin:

Yep.

Jason Buck:

And we’re here also to talk about the other natural resources. But I was also telling PJ yesterday at the event, what I love about California is the cosmic insignificance meditation. This place is so grand.

Robert Mullin:

Yeah.

Jason Buck:

It makes me feel so insignificant.

Robert Mullin:

Yeah.

Jason Buck:

But you’ve lived here your whole life. Do you take it for granted sometimes or you still see all that natural beauty?

Robert Mullin:

You do have to catch yourself every once in a while. I’ve been coming up to Tahoe since I was three or four years old and my family had a place up here for 20 years.

So, there are times when you’re a younger person where you definitely start to take it for granted. But I think there are always moments where you have the quiet and you have the calm and you look out on something like that and you understand why this was considered such a spiritual place by the original Indians that inhabited it, it’s a very grounding place. I’ve always really enjoyed it up here.

Jason Buck:

And then for those who don’t know, my pleasure today is my illustrious guest, is my friend Robert Mullin from Marathon Resource Advisors in San Francisco. So Robert, maybe we could start with you giving a brief bio in your own words of how you got here?

Robert Mullin:

Sure. So I’ve been a natural resource investor since the early 1990s. Went to school in another beautiful place, the University of Colorado at Boulder. Clearly I like the mountains and skiing and everything that goes along with it. But I started out in the natural resource space at the Franklin Templeton Group. Covered a couple of sectors before that, but really gravitated towards resources.

I had a little bit of a family history, in that my mom grew up on a West Texas cattle ranch where unfortunately they never… They looked for oil and natural gas, they never found it. So it was about as far from Dallas as you could imagine, very unglamorous, but a wonderful place to really understand the outdoors and rural Texas. But came out of the University of Colorado, backpacked around the world for a year and then started working for Franklin Templeton.

And the energy sector was always one that seemed an easy fit for me. It’s fit with my natural skill set, which was, I’ve always been less of a fortune teller about what future multiples might be on certain sectors or certain companies. It’s really about trying to buy a dollar’s worth of assets for significantly less than a dollar. And it’s very mechanical in some ways, and very mathematical. And you build models and you understand cash flows and you understand assets. And so that’s how I got started in it, and been doing it ever since. So now it’s pretty much 30 years of banging my way around the natural resource space.

Jason Buck:

And then you said 30 years, so also you probably won’t mind me dating you a little bit, but I had to go back to backpacking around the world for a year. What year?

Robert Mullin:

So that was 1991, 1992.

Jason Buck:

This is so perfect. Because I remember the very first time I got an email address was 99 in Istanbul Turkey. I signed up in an internet cafe for a Hotmail account. So what you and I both know is when you’re traveling around the world in the early ’90s, it’s a totally different world, right?

Robert Mullin:

Absolutely.

Jason Buck:

No cell phones, no email, no anything. It’s a totally different world.

Robert Mullin:

My parents wanted me to check in every Sunday. So I would try and find a place where I could make an international call, which is easy from Europe, but significantly harder from areas like Thailand or mainland China, which we went for a little while.

We actually thought about doing the Trans-Siberian Railway, but unfortunately there was a coup around that time. So it got a little messy. But it was an amazing experience and it was, navigating around the world back then, pardon the pun, but demanded a resourcefulness to be able to figure out where you were staying. There wasn’t an internet to figure out where you would go. You couldn’t email back and forth with these people.

Oftentimes the language barrier was pretty significant, because in some places English was very frequently spoken, other places not so much. So it really took effort to travel. And there was a reward that came with that, which was pretty amazing.

Jason Buck:

I was thinking, now that I’m an adult, my poor parents, I would call home once a month for five minutes. I’m doing fine, I’m alive. And that’s all they knew about it, what was going on.

So I think about too, I’m always very romantic about the natural resource space. And I think about the miners that are flying all around the worlds to these far-flung places, going into these countries, figuring things out. Then so part of that romanticism is Jim Rogers, and Jim Rogers wrote those great books about riding his motorcycle around the world that [inaudible 00:06:14].

Robert Mullin:

Yeah.

Jason Buck:

How much has that tied in? How do you think about that? Probably that backpacking trip, not knowing at the time? So it’s those seeds, where when you’re dealing with natural resources you’re dealing with these global commodities, and it has to me a very romanticism, very global traveler sense to it.

Robert Mullin:

There’s something sort of basal and fundamental to them. You understand how everything works off of the raw materials, whether it be energy or copper or agriculture, just nothing works without it. Nothing survives without it. So you get a taste of that.

But it is also, there is, without question, a adventurism romanticism about… It’s like pirates and buried treasure. You are trying to go to the far reaches of the world to find something that before you, no one thought existed. And so there is an element, it’s distinctly less sexy when you’re camping out in the middle of the Northwest Territories. And this was never me to be clear, banging away at rocks for six or seven years and all of a sudden you’re, well, geez, we got nothing.

But I think the air from the investor side and even the casual observer side is very much that, there is some romanticism to it, absolutely.

Jason Buck:

And then everything now about drilling technology and everything, do you still wish you guys had that west Texas ranch? Do you think there’s actually… Does part of you think with the technology there might have actually been something there? That you missed it?

Robert Mullin:

So the ranch still is in the family.

Jason Buck:

Oh, really?

Robert Mullin:

Yeah. So I’m the oldest of 13 cousins who are still involved with the ranch. We’re pretty sure that… I think natural gas would probably have to go to something very, very high to make whatever is on the ranch economic. It’s called the Marfa Basin, so it’s not too far away from a very cool artsy town, where I actually have family, in Marfa, Texas.

And so, look at some point, if natural gas trades for 20 bucks an M, we might have a story there. Between now and then one of the things that we thought about was when the frac sand boom was going on, where people were looking for the materials to push down into the reservoirs to be able to hold open the cracks in the very highly pressurized reservoirs, we thought we might have a deposit of frac sand on the ranch. And unfortunately that boom crested and rolled over a little bit too quickly for us to take advantage of it.

Jason Buck:

Timing gets us every time.

Robert Mullin:

Yeah. No question.

Jason Buck:

So one of the things that’s been obviously highly prevalent these days, but you’ve been writing about for years, and I always love reading everything you write about and watching all the videos you do and all the talks you give, is this transition to EVs and whether that battery transition looks like with traditional raw materials, but also to rare earths, all that sort of thing.

Robert Mullin:

Yeah.

Jason Buck:

So talk to me a little bit about how you think about that transition to EVs and how that affects the way you think about trading the markets?

Robert Mullin:

So there’s a political imperative to move this way, the decarbonization, flip side of that is anti-fossil fuels. But there is an extraordinary global imperative to move towards more EVs that’s seen as the tip of the spear of decarbonization and reducing CO2 emissions.

I think there are nuances to it that are lost in most of the political discussion. But without question, I think the stats, someone like Robert Friedland from Ivanhoe will tell you, that we need more copper in the next 20 years than we’ve mined in the last 200. So it’s a huge call, whether it’s the batteries for the EVs themselves, the other materials that are necessary to be able to make EV’s work, all of the transmission mechanisms and all the infrastructure that goes around it, the grid level battery storage that you need to turn wind and solar power into something closer to base load so it effectively can be integrated into the grid.

All of that is massively, massively materials intensive for the same kilowatt-hours of energy relative to a natural gas or a coal plant. You need about 7 to 15 times more materials, metals and materials to be able to generate that same kilowatt of energy via wind or solar.

And so I think we’ve seen this as this easy, oh, wind is free and the sun is free, and this is all going to be very easy and just subtract that side of the ledger that is the emissions generated by the oil and gas industry and we’re off, and it’s free and easy.

The energy transition comes with gigantic materials and therefore a energy and carbon footprint along with it to make it happen. So it is both a challenge and a really neat opportunity. One of the things we were talking about in one of the sessions yesterday was AI and how do you express it? And so this is a little less energy transition, but more that… You look at almost everything as materials intensive in one way or another.

So Invidia trades it, depending on your estimates, 35 to 40 times sales. You don’t have to believe that Invidia wins. If you believe AI is a big thing. Clearly the proliferation of significant numbers of microchips and microprocessors is going to be a key theme of that. Invidia may be the winner in that, they may not. The one thing you need for all of those is tin, 50% of the global tin market goes into microchips, to be able to effectively solder them together.

There are alternatives for it, but no one’s using lead anymore for anything. That’s even more toxic than most of the hydrocarbons. So one can’t win without the other. One, you can pay 40 times sales for, the other you can pay four times earnings for. And so to me, I think there’s just a much more interesting way to express it. The consensus around the room was, that’s the way to invest in it, as opposed to trade it and will people ever care? We don’t know. But to me that’s just a much more comfortable way of allocating capital.

Jason Buck:

It’s interesting to me in the sense that when you’re dealing with commodities, it’s almost like a throwback to bygone era, which is part of the romanticism. And then when you think about cash flows and being a value investor, it’s a very staid way of looking at the market, a very smart way of looking at the market.

But at the same time, when we’re talking about EVs, we’re talking about the future of batteries. So you have this bifurcation, you’re thinking about old school commodity and digging stuff out of the earth and what does the cash flows of the company look like? And then people are promising all these future things with batteries. And so I wonder how you deal with that? Some of that dichotomy is, right now the batteries and the EVs are, they obviously become more and more impressive.

But you’re saying for solar and wind, we have transmission, we need better batteries. People talk about even using batteries on planes, so how much you want to believe in this future battery, but sometimes the physics just doesn’t pan out. And so it’s hard to deal with some of this.

Robert Mullin:

Yeah. So you’re replacing… When you build an EV, you’re replacing 180 pounds of a gas tank with a thousand or 1200 pounds of a battery, which is massive. It’s lithium, it is copper, it is manganese, it is graphite, it is all those things. Because of the weight of that battery, you need to do other things to the car, which is you need to make lighter panels, so you need more plastics. Guess what? More hydrocarbons.

You need to replace steel with aluminum. Guess what? Huge energy intensivity on that. And you have to actually get the aluminum. You’ve got to get the bauxite. The torque generated, the weight and the torque of the EV actually goes through rubber tires much faster. So you’re all of a sudden going through much more of a carbon footprint on the tires themselves.

And so I think it is viewed in black and white. I can sometimes be absolutely insufferable at San Francisco cocktail parties when people decide to go off on a tangent and I try to inject some of the real math to it. Occasionally I just get the tap on my shoulder from my wife just saying, all right, I think they [inaudible 00:14:17], come on.

But it’s true. And the real unfortunate truth is that most of the political discussion about the integration of renewable energy and EVs is done on effectively cocktail napkin math. It bears no relation to, A, can we find all the stuff that we need to build these as fast as we’re promising? Which I think the answer is no. B, can we get the infrastructure there fast enough to be able to make all of this work together in a way that gives us power on a reliable basis and allows our economy to at least stay where it is, if not grow?

And then finally, there’s just I think this massive misconception about the actual cost of it, both in terms of dollars and in terms of carbon emissions itself. And so I just think that gets lost in the discussion. And all we get is snippets of politicians competing with each other as to who can promise the transition faster.

Because look, it polls great and people love it. They’re just not being told how much it actually costs. People here, well we’re actually in Nevada, but in the Great State of California we’ve seen exactly what it costs. We’ve been the most aggressive in terms of integrating renewable power into our grid, and our power costs are going up four times as fast as anywhere else in the rest of the country.

And Germany is having the same thing. And so I’d like the discussion to be more honest and more thorough, and unfortunately that’s just not the nature of politics.

Jason Buck:

There’s a couple divergences I want to take there. One I think you were bringing up yesterday too, how many hydrocarbons are in asphalt? So for the roads… And then correct me if I’m wrong, I think even in the rubber tires you need carbon black, which is a hydrocarbon as well, right?

Robert Mullin:

Yeah.

Jason Buck:

But this is out totally outside the box question, but sometimes you read about reflective natures of road services and everything and a lot of scientists or people will speculate that we should have white roads and everything. Do you think we could eventually change that? I was thinking, do they need to change tires? Is there a reason we would go with black everything?

Robert Mullin:

Yeah. I think there are a lot of things that work at bench scale that are really hard to implement at real scale. So someone built a solar road in… I think it lasted about six weeks before the pressure of the cars and the dirt that was on it and everything else just totally… Degradation of productivity was really rapid. And the cost of it… I think they abandoned it after less than six months.

And so I think what we have to believe is that most of the things that are getting integrated today have been in the works for a really long time. These transitions take decades, if not more. And the idea that we have that we can look at, the evolution of microchip technology and how fast do those things move and extrapolate that to the physical world. Where, look, the first lithium ion battery was created by a guy at Stanford who was a consultant for ExxonMobil in the late 1960s.

And while the battery chemistry has changed, it’s not significantly different. The electronics around it have evolved, yes. But I think the likelihood that we find a magic, hugely scalable solution that really changes the economics of renewable power, I think that’s a stretch. The closest thing, quite frankly that we have is nuclear.

Jason Buck:

Right.

Robert Mullin:

And we are for reasons that are wholly political, choosing not to use that, which I think is one of the most remarkably short-sighted things that the world… I think we will look back at this in 30 or 40 years and say, if the goal is really to reduce CO2, why in the world are we shutting down existing nuclear facilities?

Jason Buck:

The other diversion I’ll take, hopefully you’ll disavow me of, because we brought up California, and you’ve been around for both Governor Browns, I assume. Maybe you were a kid with the first Governor Brown. But I’ve always heard, and I never really dug too deep into it, so maybe you can tell me, the idea was with the original California Governor Brown and even to his son, is the idea with PG&E was, you didn’t have to upgrade your infrastructure cost as much, as long as they invested in renewables.

So they gave them the incentive, because they really wanted to push renewable energy. And so for decades now in California, instead of upgrading their wires and their infrastructure, they put it all into renewables. And that’s how they got away with not upgrading the infrastructure. Now that oh is easily… I jumped to conclusions there, but do you think that’s categorically true or is this probably more nuanced?

Robert Mullin:

Is more nuanced, in what I understand. It’s not an area that I am extremely well-versed in. But I do think that the push to spend in areas that don’t necessarily generate a near term economic return, has absolutely caused the starvation of capital to just the base level of maintenance.

And we see that throughout the country, not just at PG&E, they are the most poignant example of that. But look, there’s only a certain number of dollars out there and if you are investing in things that don’t currently generate economic returns, and I think one of the things we discussed in one of the sessions yesterday was those who will tell you that the energy transition will pay for itself are relying on I think one of the most inane statistics out there, which is the Lazard’s levelized cost of energy, which is an interesting way to compare to some degree, if normalizing what the costs of different power sources are.

But it bears absolutely no relation to the economic reality of installed power anywhere in the world. And so they’ll point to these metrics and say, solar’s the cheapest way to generate power. And it’s, yes, if you don’t have to pay for the land, and yes, if you don’t have to figure out how to transmit it from one wave or the other. And yes, if you don’t have to store it someplace so you can use it at a period of time. And yes, if you don’t need backup power from anywhere else just in case the sun stops shining, which it happens to do half the day, and there are clouds.

There’s a shallowness of the arguments of economic viability. I’m fine with trying to make the environment better. I think this maniacal focus on CO2 is a little short-sighted. There are other things that we should be concerned about as well. But we have to have an honest discussion about what it’s going to cost. I think people will be much less likely to give politicians a blank check to push renewables to a mass thing, if they get the honest scoop, which is, well, guess what? Your power bills are going to go up by 30% or 50% or a 100%.

So let’s just have that discussion, have it honestly. And if we’re willing to pay for that, great. If we’re not, if we’d rather pay for schools or roads or retirement for employees or whatever we need to do, then we have to prioritize.

Jason Buck:

One of my favorite things in life is one of those minor epiphanies or light bulb moments when somebody makes a statement of the obvious that you didn’t think about before, and then you hear it and you’re, oh my God, that’s so obvious.

And one of the things you were really going into yesterday that was so brilliant, that to me was a statement of the obvious. I couldn’t believe I hadn’t really thought about it as much before, was the idea, you were saying, any natural resources extraction to go EV or however you’re looking at it, the input cost of the energy and the cyclicality of this feedback loop of how much energy does it take to get these energy intensive resources out of the ground and the feedback loops of that? And as these prices go up, the input costs go up. And so maybe you could speak on that circular nature, a little bit of the cost structure.

Robert Mullin:

So the energy transition has progressed as fast as it can, and renewables have grown as fast as they have because over the last decade we’ve had very low cost of inputs. The raw materials and energy inputs have been very inexpensive. Production has been consistently moved to low-cost locales, a lot of it into China where they get cheap labor and cheap power, and quite frankly a massive amount of government subsidies.

And so the spend on renewables has been something close to 10 trillion. Globally, a significant portion of that has been government funded. Very little of it has generated actual profits or economic return. I’m a believer that at some point, whether 10 trillion is that point or not, renewables have to put on their big boy pants, kick off the training wheels and show that they can generate economic returns. And we haven’t got there yet. So the subsidies are still really significant.

But then absolutely, you look at this cycle of, okay, in order to create the renewable systems that we need to do, we need to extract 20 times as much lithium, we need to, as I said, get as much copper in the next 20 years as we’ve gotten in the last 2000. The problem with all of this, that is lost in those who just look at the US Geologic Survey and say, yes, there’s tons of copper out there, we can easily meet these needs. They miss the fact that there is copper in the ocean, just like there’s gold in the ocean. It’s just not economic to extract.

Look, we’ve had a big boom in the production of natural resources that was driven by the Chinese and Asian industrialization back in 2000 to 2010. That capital expenditure boom extended out to 2014, and we built a huge number of projects and that led to the overcapacity that made resources such an awful place to be, effectively from 2010 to 2020.

But now all of a sudden we’re stuck with having to massively accelerate how much of these things that we need to produce for renewables, copper, lithium, nickel, zinc, all of the rare earth elements and things. At a time when the cupboard is, it’s not bare, but there’s a reason that the current projects that are in jurisdictions that we can do that have gotten the permits that they need, that have had the delineation drilling that they need to really understand that deposit, the ones that are left are… The way I described them yesterday was an island of misfit toys.

There are reasons that they haven’t been developed yet, because if they weren’t developed in the last, from 2006 to 2015, there was something wrong with them, because we had a really low cost of capital, equity and debt were freely given to the resource companies because there was this belief of this, the extrapolation of this great commodity boom.

So if you didn’t get developed, it’s because your grade is too low, you’ve got to move too much dirt, it’s too deep, it’s too remote. And all of that, what that all boils down to is, it’s more energy intensive. Look, the head grade, which is typically the production grade of copper, 15 years ago was 1.3%. Now it’s 0.7 I think.

So the amount of dirt that you have to move from today’s mines, the existing mines, not the new ones that we have to build, but the existing mines, you have to move twice as much dirt to get the same amount of copper, that is energy to be able to move all that. And the idea that we can go out into the wilds of Chile or Nunavut up in Northern Canada and then power that with renewables, a big electric dump truck is going to have to have a battery about as big as the truck. So it decreases the efficacy of it.

There’s starting to get some of that technology forth, and in some places there may be ways to use it, but then you’re talking about having to make the battery for that truck. And so there’s, the way I described it was a giant ouroboros, the more you create renewable systems, the more energy and extraction and quite frankly CO2 production that will happen because of that. So I just think we’re looking at a very narrow part of the ledger without taking into account the secondary and tertiary effects of it.

Jason Buck:

My simplified analogy of it, that I thought of too, was those first few seasons of The Gold Rush, the TV show, very romantic, loved watching it, but all I could ever look at was the input cost. The more tailings they… Like you said, all the good lands been picked over in the Yukon, so they’re going into tailings, so they’ve got to dig deeper, whatever, and then every time they fire up all of their bulldozers or all of their dredge, everything they do is requiring that oil input cost. So as long as oil remained low, they had that delta and gold prices remained high.

And it was always this race. Everybody looked at the gold at the end of the week being poured in. They go, oh my god, they made a half a million dollars this week mining. And then I’m waiting for the after, of how much did they spend on gasoline, how much did they spend on labor, running three shifts? The amount of gasoline, the inputs cost to that, and of how they have to mine. It was fascinating to me to think about the input cost.

And the other one I thought of just now, was thinking about, you have to have a rational perspective. It’s good for people to be optimistic to push us forward, but then it made me think of Eike Batista in Brazil, deep ocean drilling off the coast of Brazil.

Robert Mullin:

Yeah.

Jason Buck:

Great idea. Maybe the input costs were higher than he expected and he…

Robert Mullin:

A little ahead of his time.

Jason Buck:

And he lost his wealth faster than any billionaire in history. Sorry, to give another example.

Robert Mullin:

Yeah. A little less romantic version. That’s the first source, right?

Jason Buck:

That’s definitely the less romantic version. It’s such a fascinating story. I was living in Brazil at the time that all that stuff happened. So it was always fascinating to me.

One of the other things, we talked about all these different parts. You have a coordination problem. And you and I didn’t have time to talk about this yesterday, but when you’re talking about, especially movement to electric vehicles, batteries, renewables, there’s a global coordination problem. And I think historically it always is interesting to me, that as first world countries we tend to push our pollution, our refining, our toxic industries often to emerging markets. And then we tell them, you need to upgrade to our standards. And then they’re, we’re just industrializing our nation and you push this pollution unto us.

So there’s a tragedy of the commons problem. But the one that I thought was most interesting recently, a guy with Stock Gen was talking about this, was that when Germany, was always hold the line, hold the line, we’re doing all this stuff, and then when all of a sudden their natural gas pipeline gets shut down and everything, all of a sudden they flipped on a dime.

And so what does that tell to all the emerging markets? They’re, hey, you changed your mind and you switched. Who are you to tell us to do what you couldn’t do?

Robert Mullin:

Yeah. They spent half a trillion dollars to build out their renewable infrastructure and built a very flawed and very vulnerable system. And then the moment that it looked like the lights might go out, they went straight back to lignite coal, which is the bottom of the barrel, dirtiest, nastiest stuff that you can imagine.

So I think it’s a great example of how challenging this is. It really is. It’s just the struggles to be able to do that. The political imperatives have outrun the physical realities. Last year was a bit of a day of reckoning for that. I think we’re slipped back into a little bit of complacency about that. Look, we have gone… If you think about what’s happened in Europe and the European power markets, we have gone from the equivalent of oil prices hitting $145 in 19… Whatever, or sorry, 2007, right at the very front end of the global financial crisis. Two, the equivalent of the negative $45 print in COVID, you’ve actually got negative power prices in Europe right now because they swung so far.

They spent again, in addition to the half a trillion dollars that Germany’s alone spent to go renewable, to go wind and solar, Europe as a whole spent half a trillion dollars this summer, or sorry this winter, just to make sure they had enough resources to be able to… So they got a little bit of a hand from Mother Nature. So they had a two standard deviation warmer than normal winter.

And so now they’ve got this surplus and power prices have gone negative. And so everyone’s, hey, we’re good. There was a problem, we’re done with it. We’re back. That’s not the case. There were some things about last year, not only just the weather variability that you can’t count on having cooler summers and warmer winters in rapid succession like that. History shows it just doesn’t happen.

But really the reason that they were able to secure as much LNG as they did last year was that China was shut down. China was effectively out of the market. They were importing I think 30% less LNG. So that opened it up for Europe to go out and compete for it. China’s no longer closed down. And so if we do, and certainly Nord Stream doesn’t look like it’s going to be working anytime soon.

So there’s a really interesting opportunity set opening up. Because we’ve gone from maximum concern to total complacency, again. And that’s reflected in the equity markets for some of the European natural gas producers. And so I think there’s an interesting, I think very asymmetric bet that can be put on there, that I think is interesting.

Jason Buck:

So I want to come back to the asymmetric bag. I want to also come back to global macro and how you think about that overlay and supply chains and dynamics with China Belt and Road Initiative and those sorts of things. But I’ll come back to some basics a little bit.

When we think about natural resources, commodities, et cetera, I work with a lot of CTAs and that’s how people usually think about investing in those markets is via future strategies. But part of it is a lot of people will say that when they look at stocks, bonds, and then commodities, it’s a neutral return environment. So people like to put a trend falling overlay on it and trade directly in those futures markets. But I think a lot of times, we were talking about yesterday that when we talk about rare earths or some off the run so to speak, metals, et cetera, there’s not liquid commodity futures markets for that. They do only spot markets.

And so then it’s maybe better to go into the resource equity markets like you do, and that’s where you can find companies that are working on this. But now you got another set of problems, we all have nuanced trade-offs, right?

Robert Mullin:

Yeah.

Jason Buck:

And now you have a management problem. You also have that Keynesian beauty contest that we were talking about yesterday, with what’s the market’s voting machine doing to that equity? So maybe talk to me about the nuances of why you prefer the natural resource equities than necessarily playing in the futures markets?

Robert Mullin:

Yeah. And I will say, I do some of the futures directly and we put on some reasonably successful gold and silver direct commodity trades earlier this year. But really this skillset that I think I’ve developed over the last 30 years is really in the resource equities.

And so it’s part about trade construction, it’s part about understanding the different variables and it differs at various points of the cycle and sometimes it’s better to do a commodity investment. But to me, I have always believed that if you really do your work in the 300, 400, 500 resource securities that I think fit our criteria which are high free cash flow generating some capital return and folks doing it.

And so we’re naturally self-selecting a less volatile, less downside vulnerable subset of resource equities. And so to the extent that we can find things that work in that realm and you can really get comfortable with management risk and local geopolitical risk and the geologic risk of the specific deposit. And the more you invest in later stage things and not taking exploration risk, the more you have certainty about that.

And so that’s why we’ve typically done. I did a lot of early stage pre-production exploration and early development stage investing earlier in my career. I’m just more comfortable when we know what’s underground and we know what the cash flow statement looks like. And so sometimes it’s hard. I have found at times where there might be a very specific nichey commodity that I want to be involved with, and there just isn’t a good equity way to express that.

So then you have to look for something else. And Chris had a fantastic talk yesterday about options, theory and trade expression. So then there are ways, you can find different ways to express it. But for the most part there’s typically enough equity depth to be able to find what we want to do in at least modest size, to be able to make it work in various markets.

And so right now we’re very constructive in energy, which is usually pretty easy to express. There’s lots of options there because of globally, and it’s probably half of the natural resource traded market is in energy. Agriculture is a little bit of a thinner market, but there’s still a fair amount of volume in those names. And a lot of different options whether you want to be into fertilizers or plantation companies. We’ve been involved with palm oil companies in Indonesia. And so there are lots of different ways to get there. I think that’s a very interesting space.

Last year was a big year for us in the lithium space. And so we’ve had some things that were a little bit earlier stage than we typically go, but it was just a really spectacular asset in a place where we thought we had a due diligence edge on it, because of some of the people that we work with. And so I think there’s just a lot of very interesting things going on in the natural resource space. And there’s no shortage of ideas, if anything, it’s just a shortage of capital to be able to invest in all the things that we want to.

Jason Buck:

So one of the ways I think about resource equities too, I think a lot of people’s first entree and resource equities is via gold. People start with gold and then they want more leverage versions. So they go with the gold mining equities and you see people play that. They’re searching for positive convexity, but a lot of people tend to get burned in that scenario. Because also they don’t maybe do enough research or due diligence or expertise in the space. They’re just looking for leverage gold play.

So maybe talk to me then about how you construct your book and how you think about it. When I think about your book, that the three elements are equities, yield and options, even though blend together. Talk about how you think about… How do you achieve positive convexity in the natural resource space?

Robert Mullin:

Yeah. So let’s start with the Gold Book. So really the core criteria is significant free cash flow generation that is sustainable. So not just someone that’s going to generate great cash flow for three or four years but can do it for 10 or 15 or 20.

Low-cost structure so they can survive the cyclical nature of these commodities. Hopefully coupled with the management team who’s willing to give some significant portion of that income free cash flow generation back to us. We like to see a combination of growth and capital returns. So we’re not just necessarily looking for stagnating or even liquidating entities. We like people who can grow assets over time as well. And so we’re willing to accept lower yields off of things like that, that have a growth element to them as well.

And then it’s really about spreading the book across the resource spectrum in a way that gives us stability. And I think most resource funds are typically mostly energy, maybe a little bit of copper. And so that tends to be a very GDP economic growth sensitive book.

I like incorporating in areas like agriculture, which are a little less cyclical from a traditional, in a growth sense. I like some of the processing industries or transportation industries, shipping and refineries and chemical producers and things like that. Gold has a tendency to be countercyclical. And so you don’t see a lot of people who incorporate a decent gold book into a traditional energy and maybe base vennel book. And so that’s an area that I’ve always really liked.

And then you do delve into those pockets and you say, all right, how big do I want that to be to? And how should it fit into the overall structure? And then how do I construct it via the securities underneath it? And so I think the Gold Book right now is a really interesting example of that. I have a combination of larger cap gold producers, again, very low-cost, generating good dividend yields and good highly economic growth. And those are a basket. I think our biggest position there is 7% or 8%, but I think our total precious metals books is over 40%, on a gross basis of fund equity.

Jason Buck:

Do you run any constraint bans when you think about sector waiting or do you not worry about them?

Robert Mullin:

I don’t. And really, it’s just if it feels too big, then you’ve got to take it down. Or if you can’t find enough ways to express it, then you’ve just got to keep it smaller.

So the way we’ve expressed the Gold Book is, so we’ve got some producers, we’ve got some royalty companies and we also have a very interesting way to play that, that I’ve talked about publicly before, is a gold asset manager. Where I think you’ve got… I’ll go ahead and name it, Sprott Inc. I used to work with John Hathaway at Tocqueville, he and Doug Groh and the rest of the team are great mutual fund managers, but Sprott has this really interesting combination of physical commodity, ETFs, not just precious metals but also uranium and other PGMs and things like that.

And you look at this asset manager and it was the same market cap. Stock base was the same place today when they ran 8 billion in AUM. And then they went to a 16 billion in AUM. And then they went to 20 plus billion in AUM. It’s in the same spot. And so in a world where I think people would prefer, if they’re going to go into these dirty extractive industries and they’re going to have to make a strain on their ESG, give them the easiest thing to find that they can. And a gold asset manager is a very low bar. The royalty companies are very similar because they don’t have relatively good ESG scores.

And so what you’ve got is, if you’re… And my parallel for this is, in the early 2000s, so the great gold market of 2001 to 2007, there was a period in the middle part of that bull market where I think from 2004 to 2006 the GDI or the predecessor to the GDX was up 50% or 60%. So a good move over a couple of years.

The one major gold asset manager, which is a company called US Global was up tenfold. And it was because portfolio managers found a way. They’re, all right, this market is getting underway. Gold asset managers can win in multiple ways, in that they get both the appreciation of the existing asset base as the sector rallies, but they also get inflows.

So there’s a reflexive element to it that can make them go from say 20 or 30 million or 20 or 30 billion under management to a 100 billion under management. Then all of a sudden you put a 5% of AUM multiple on that, and you’ve got a stock that can go up five or six times, where you’re not taking geopolitical risk, you’re not taking specific taxation risk, anything else from [inaudible 00:42:08]. You’re not taking specific asset risk where you have a wall cave in or something like that or a tailings dam break.

What you’ve got is just a very clean way to say, is this a sector that I think is going to work, expressed in a way that can potentially be very symmetric? In the interim I’m just clipping a 4% dividend. And so I’ve got that positive carry with a convexity that’s it looks to me like assets could fall by half and the stock would really not go down much from here.

Jason Buck:

One of the other things you said yesterday, that is one of those obvious things, but it takes a while to learn and it’s easier said than done, is the idea of, like you said, you’re finding these securities, you’re doing your due diligence, you like cash flow, free cash flow and that gives you that dividend yield. So there’s your equity and your yield. But part of what you said too is if you structure the trade properly and you’re comfortable with what they’re doing, and you could create that positive convexity through that structuring. That now your position size need to be larger.

And it’s the correlation between position, size, conviction or limiting or truncating the left tail to opening up to the right tail, is now you’ve found over the decades that you need to take larger positions than you previously would based on maybe it wouldn’t be volatility, but you’re figuring out a way to structure maybe lower volatility with positive asymmetry or based on Sortino ratio effect.

Robert Mullin:

It’s really about the asymmetry. What is my potential to look in… When I was a 25 or 30 year old hedge fund manager, the biggest upside had the biggest position in the portfolio. Now it’s more about upside relative to downside. And that’s just part of getting kicked in the teeth a couple of dozen times over the last 30 years.

So then the next element of it is the short book. And so layered on top of that is areas where I try and isolate specific risks for the portfolio, whether it be in specific commodities. So if I’ve got a big energy book running, I’m going to look for ways that I can find a short energy position, whether that be through companies destroying economic value, whether it be through… And this is true across the book, a lot of times I like companies that are destroying clearly negative cash flow and will be perpetually.

But I also finding companies where unsustainable dividend deals are being paid. And after 20 plus years of really understanding what’s sustainable and what is not in the sector, when you find the unsustainable dividends, the asymmetry on the downside, when dividends have to be reduced or cut are fantastic.

And so we had something work this year in the wood pallet space, that I thought was a little bit of a BS green story anyway. But there was a company involved with that, that was paying double-digit dividend yield that was generating negative free cash flow. And so you knew it could not last forever. And when they finally did cut it, the stock was already down 50%, it fell another 70% that day.

So that’s where we try and create. So that’s part of the short book, is directly within the resource verticals we have. Sometimes it’s more efficient to express we’re vulnerable to a negative turn in the economy. And so whether you can express that well by shorting more cheap copper companies or steel companies or whatever.

And we do some of that when we can find situations where we think we’ve got an edge, but sometimes it’s better expressed through other ways. We have a little bit of a consumer discretionary short book on right now. Also short a little bit in subprime auto lenders and things like that where that is the most vulnerable segment. If we do have an economic slowdown that people would say, oh no, we’re going to be consuming less resources.

Energy companies might not be the ones that’re trading at four times cash flow and 10% dividend yields. They may not be the most vulnerable to that. Most vulnerable to that is consumer or some of these highly leveraged stocks that really require consumer spending and consumer health to remain very high.

Look, if you think people are going to drive their cars less, maybe they just can’t afford the car. So that’s where I think there are some other things in our book that are a little bit tangential to what we do. And then the overlay on top of that, and when you mention the options, this is something that we’ve been doing for the last four years is a long volatility overlay in areas where we think we can find cheap expressions of volatility that correlate well with the vulnerabilities of the portfolio.

Sometimes that can be… For a while we were long dollar calls. The weird thing was last year both long resource equities and long dollar calls actually worked. And so that’s uncommon. But under normal circumstances, a spike in dollar is something that resource stocks are vulnerable to. Right now we own some out of the money puts on the emerging market index, which is typically a group that trades pretty similarly to natural resource equities and it’s just cheaper than puts on the oil service index or vol there is three times as high as it is in the EEM.

There are some other places where, this is always an evolution and as we have become a bigger fund, more instruments open up to us. And so two of the spaces that I think are very interesting for us to try to hedge with on a real macro basis are the growth value rotation, which we have a tendency to be a little bit vulnerable to, because when growth is in favor and people are selling all their resource stocks, that’s oftentimes that’s either neutral or modestly positive for our short book. In other words, those stocks are going up instead of down. And our long book is suffering.

But the other area that there are some interesting ways to potentially hedge in, very highly convex ways, is forward inflation expectations. So clearly when inflation expectations are running high and you go into something like the five-year forwards market and be able to hedge whatever might cause inflation expectations to come down rapidly, that’s an interesting way for us to hedge our portfolio as well.

And again, it’s not a significant capital allocation for us. At any given time it’s 1% to 2% of fund equity, but when we get those things right, they can be very powerful counterweights to negative and shock environments for our long book. And another thing that I talked about yesterday was resource stocks are never going to get this slow and steady up until the right bull market like healthcare or technology.

Because the environment that makes resource stocks perform well, which is rising commodity prices, which is typically a component of rising inflation. That is inherently a very destabilizing force on the broader market, particularly a market that is priced for inflation never to be a sustainable entity ever again. And so that’s something that we want to be cognizant of.

Jason Buck:

I also think about, you get that amazing amount of positive asymmetry in options market when those correlations flips. Like you said, if you’re on the other side of that and historically that correlation’s been negative or flips to positive or vice versa, that’s when you can get some really explosiveness, because people are just basing it on a short-term look-back. And if you can time those correlation changes, that’s amazing.

One of the other I thought brilliant questions that Kris Sidial did ask you yesterday, and this is in relation to the China Belt road and global macro and how you think about that is, he said, do you just hedge out and neutralize your global macro arrests so that way you can really just look at them as idiosyncratic bets or so how do you think about that?

Robert Mullin:

Yeah. And that’s all part of what the short book and the option book do, is addressing those current risks. And it’s never going to be a clean dollar for dollar, a 100 delta hedge. But if we can find ways where we can inexpensively express that.

Or, if I’m trying to neutralize my falling oil book or my long energy book from falling oil prices, I can express that either in puts or put spreads in the energy in oil specifically, I can do that via puts one energy and resource indices. I can do it via short individual equities. And clearly for us the best is if we can find alpha generating shorts at the same time, that we can layer on top of a long book that we’re very excited about, which is where we are today.

That’s the best of all worlds. And so it’s just a matter of looking at the entire spectrum of ways to be able to try and say, take a step back and say, look, I have to have a macro view, but my macro view does not have to be correct. And more importantly, if my macro view is wrong, how much am I going to lose? And so, one of the other. There’s so many wonderful things about this whole event. But you talk to someone like Mike Green, who is talking about some of the underlying net distribution that’s happening and the potential for a little bit of index funds selling and things like that, A reversal of the passive flows.

It perks up your ears about the need to really be thoughtful, about a risk of a equity liquidation cycle is not something that I think there’s much in the equity markets that’s price for right now. And there are probably some relatively inexpensive ways to express that. And so again, that’s another risk, that if you can find a way to throw 30 or 40 or 50 basis points at it, they can potentially give you a 10 or 15 or 20-to-1 kind of payout. Those are bets worth making.

Jason Buck:

So unfortunately we’re running up on time here, we don’t want to miss our sailboat on this beautiful lake behind us. But I thought a perfect place to end is, because you teased it earlier, so I’ll give the audience the morsels that it wants, you tease some of the opportunities in Europe right now. Tell us about what you think is one of the more interesting trade ideas or interesting ideas you have that could potentially be implemented in Europe.

Robert Mullin:

So I’ll speak about this at a high level because I’m actually still constructing it myself and still getting positioned for it. But what I spoke about earlier, which was we have swung from maximum concern to maximum complacency in the European power markets.

And so you look at some of the natural gas producers in the North Sea and some of the related areas that really feed into the European energy system, and they had an unbelievable year last year. Many of these companies generated their entire market caps in free cash. And what they did is, they paid their debt, they started capital return programs, and now the stocks are 50% off their highs. They’re trading at 2, 3, 4 times cashflow. You can construct a basket of these stocks with different characteristics, so you’re spreading around your risk of specific jurisdictions, specific assets and things like that.

And you can create this interesting basket with a mid to high single digit yield, nice growth component to it. You’re paying two or three times cash flow and expectations for your European power prices are in the gutter. And so I look at that market and I love… Complacency intrigues me, because these markets are self-correcting and it beats you over the head time and time again. But when you’re able to step into those and stocks have gotten blown out and they’re basing around and they’re not acting poorly on bad news or concerns about windfall taxes or anything like that, it feels like this is an area to pick up cheap convexity.

And again, with the positive carry. And so you’ve got six to nine month window where look, maybe we get another super warm winter and these stocks, you clip your 6% or 7% or 8% dividend yield, and maybe these guys retire a little bit of stock. And so fine, 6% to 8% my worst case scenario, that’s okay.

But if we do get to a tight market, which I can actually see because of the availability of LNG, because of the turning on of some of the other European industries that were shut down last winter, now you get the opportunity set for, these stocks could double pretty easily. And so we’ve got, a portion of our energy book is allocated to that, and we’re kind of in the process of growing that.

Jason Buck:

So you had some other really interesting ideas around carbon sequestration. You had some amazing statistics around Petrobras.

Robert Mullin:

Yeah.

Jason Buck:

But for people that have those kinds of ideas they are going to have to come to the next collective event, we can’t give away all the secret sauce. But I want to thank you for this conversation. I always love picking your brain about resources.

And also want to give huge shout out to Shannon and the collective for obviously giving us this beautiful place to have these intimate conversations, where we don’t have to worry about the outside world and we can all banter back and forth. And iron sharpens iron. That’s what I love about these. You have all kinds of experts in the room and people will really push back and collectively we hopefully find a better place. So once again, thank you for coming on.

Robert Mullin:

This has been fantastic, Jason. And such a wonderful event. And as I said, look, my previous travels this month where I went to two different conferences, mining conference and a agricultural conference, met with 40 companies over the course of collectively six or seven days. And so that’s part of the blocking and tackling of what I do.

The harder part of what I do is creating the worldview and how to express it. That enables me to be a better portfolio manager, not just the mechanics of the companies underlying it, but really how to construct a portfolio that’s going to weather whatever the world looks like over the next six to nine months. And that’s why this opportunity set is so unique. It’s been a lot of fun.

Taylor Pearson:

Thanks for listening. If you enjoyed today’s show, we’d appreciate if you had shared this show with friends and leave us a review on iTunes as it helps more listeners find the show and join our amazing community.

To those of you who already shared or left a review, thank you very sincerely, it does mean a lot to us. If you’d like more information about Mutiny Fund, you can go to mutinyfund.com. For any thoughts on how we can improve the show or questions about anything we’ve talked about here on the podcast today, drop us a message via email.

I’m taylor@mutinyfund.com. And Jason is Jason@mutinyfund.com, or you can reach us on Twitter. I’m at taylorpearson.me. And Jason is at jasonmutiny. To hear about new episodes or get our monthly newsletter with reading recommendations sign up at mutinyfund.com/newsletter.

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